497 1 segmentref.txt PVC PROSPECTUSES & SAI PRINCIPAL VARIABLE CONTRACTS FUND, INC.
ACCOUNTS OF THE FUND -------------------- ASSET ALLOCATION ACCOUNT INTERNATIONAL SMALLCAP ACCOUNT BALANCED ACCOUNT LARGECAP GROWTH EQUITY ACCOUNT BOND ACCOUNT LARGECAP STOCK INDEX ACCOUNT CAPITAL VALUE ACCOUNT MIDCAP ACCOUNT DIVERSIFIED INTERNATIONAL ACCOUNT MIDCAP GROWTH ACCOUNT EQUITY GROWTH ACCOUNT MIDCAP VALUE ACCOUNT EQUITY INCOME ACCOUNT MONEY MARKET ACCOUNT GOVERNMENT & HIGH QUALITY BOND ACCOUNT REAL ESTATE SECURITIES ACCOUNT (previously Government Securities SMALLCAP ACCOUNT Account) GROWTH ACCOUNT SMALLCAP GROWTH ACCOUNT INTERNATIONAL EMERGING MARKETS ACCOUNT SMALLCAP VALUE ACCOUNT
This Prospectus describes a mutual fund organized by Principal Life Insurance Company/(R)/ ("Principal Life"). The Fund provides a choice of investment objectives through the Accounts listed above. The date of this Prospectus is May 1, 2006. As with all mutual funds, neither the Securities and Exchange Commission ("SEC") nor any State Securities Commission has approved or disapproved of these securities or determined if this prospectus is accurate or complete. It is a criminal offense to represent otherwise. TABLE OF CONTENTS ACCOUNT DESCRIPTIONS....................................................3 Asset Allocation Account..............................................5 Balanced Account......................................................8 Bond Account..........................................................11 Capital Value Account.................................................15 Diversified International Account.....................................18 Equity Growth Account.................................................21 Equity Income Account.................................................24 Government & High Quality Bond Account (f/k/a Government Securities Accunt)....................................27 Growth Account........................................................31 International Emerging Markets Account................................33 International SmallCap Account........................................36 LargeCap Growth Equity Account........................................39 LargeCap Stock Index Account..........................................41 MidCap Account........................................................43 MidCap Growth Account.................................................46 MidCap Value Account..................................................49 Money Market Account..................................................52 Real Estate Securities Account........................................55 SmallCap Account......................................................58 SmallCap Growth Account...............................................61 SmallCap Value Account................................................64 CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.........................67 PRICING OF ACCOUNT SHARES...............................................72 DIVIDENDS AND DISTRIBUTIONS.............................................73 MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE..........................73 The Manager...........................................................73 The Sub-Advisors......................................................73 Duties of the Manager and Sub-Advisors................................84 Fees Paid to the Manager..............................................84 Fees Paid to the Sub-Advisors.........................................84 GENERAL INFORMATION ABOUT AN ACCOUNT....................................85 Frequent Trading and Market Timing (Abusive Trading Practices)........85 Eligible Purchasers...................................................86 Shareholder Rights....................................................86 Non-Cumulative Voting.................................................87 Purchase of Account Shares............................................87 Sale of Account Shares................................................87 Restricted Transfers..................................................88 Financial Statements..................................................88 FINANCIAL HIGHLIGHTS....................................................88 ADDITIONAL INFORMATION..................................................100 2 Principal Variable Contracts Fund 1-800-247-4123 ACCOUNT DESCRIPTIONS The Principal Variable Contracts Fund (the "Fund") is made up of Accounts. Each Account has its own investment objective. Principal Management Corporation*, the "Manager" of the Fund, has selected a Sub-Advisor for the Accounts based on the Sub-Advisor's experience with the investment strategy for which it was selected. The Manager seeks to provide a wide range of investment approaches through the Fund. The Sub-Advisors are: . Columbus Circle Investors ("CCI")* . Emerald Advisors, Inc. ("Emerald") . Grantham, Mayo, Van Otterloo & Co. LLC ("GMO") . J.P. Morgan Investment Management Inc. ("Morgan") . Mellon Equity Associates, LLP ("Mellon Equity") . Morgan Stanley Investment Management Inc. ("MSIM Inc.") doing business as "Van Kampen" . Neuberger Berman Management Inc. ("Neuberger Berman") . Principal Global Investors, LLC ("Principal")* . Principal Real Estate Investors, LLC ("Principal - REI")* . T. Rowe Price Associates, Inc. ("T. Rowe Price") . UBS Global Asset Management (Americas) Inc. ("UBS Global AM") * CCI, Principal, Principal - REI, Principal Management Corporation and Princor Financial Services Corporation ("Princor") are affiliates of Principal Life Insurance Company and with it are subsidiaries of Principal Financial Group, Inc. and members of the Principal Financial Group/(R)/. In the description for each Account, there is important information about the Account's: MAIN STRATEGIES AND RISKS These sections describe each Account's investment objective and summarize how each Account intends to achieve its investment objective. The Board of Directors may change an Account's objective or the investment strategies without a shareholder vote if it determines such a change is in the best interests of the Account. If there is a material change to the Account's investment objective or investment strategies, you should consider whether the Account remains an appropriate investment for you. There is no guarantee that an Account will meet its objective. The sections also describe each Account's primary investment strategies (including the type or types of securities in which the Account invests), any policy of the Account to concentrate in securities of issuers in a particular industry or group of industries and the main risks associated with an investment in the Account. A fuller discussion of risks appears later in the Prospectus under the caption "Certain Investment Strategies and Related Risks." Each Account may invest up to 100% of its assets in cash and cash equivalents for temporary defensive purposes in response to adverse market, economic or political condition as more fully described under the caption "Certain Investment Strategies and Related Risks-Temporary Defensive Measures." Each Account is designed to be a portion of an investor's portfolio. None of the Accounts is intended to be a complete investment program. You should consider the risks of each Account before making an investment and be prepared to maintain the investment during periods of adverse market conditions. INVESTMENT RESULTS A bar chart and a table are included with each Account that has annual returns for a full calendar year. They show the Account's annual returns and its long-term performance. The chart shows how the Account's performance has varied from year-to-year. The table compares the Account's performance over time to that of: . a broad-based securities market index (An index measures the market price of a specific group of securities in a particular market or securities in a market sector. You cannot invest directly in an index. An index does not have an investment advisor and does not pay any commissions or expenses. If an index had expenses, its performance would be lower.); and . an average of mutual funds with a similar investment objective and management style. The averages used are prepared by independent statistical services. Principal Variable Contracts Fund 3 www.principal.com An Account's past performance is not necessarily an indication of how the Account will perform in the future. Call the Principal Variable Contracts Funds at 1-800-247-4123 to get the current 7-day yield for the Money Market Account. FEES AND EXPENSES The annual operating expenses for each Account are deducted from that Account's assets. Each Account's operating expenses are shown with the description of the Account and are stated as a percentage of Account assets. A discussion of fees and expenses appears later in the Prospectus under the caption "The Costs of Investing." The fees and expenses shown do not include the effect of any separate account expenses or other contract level expenses. If such charges were included, overall expenses would be higher and would lower performance. The description of each Account includes examples of the costs associated with investing in the Account. The examples are intended to help you compare the cost of investing in a particular Account with the cost of investing in other mutual funds. The examples assume you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The examples also assume that your investment has a 5% total return each year and that the Account's operating expenses remain the same. Your actual costs of investing in a particular Account may be higher or lower than the costs assumed for purposes of the examples. NOTES: . No salesperson, dealer or other person is authorized to give information or make representations about an Account other than those contained in this Prospectus. Information or representations not contained in this Prospectus may not be relied upon as having been made by the Principal Variable Contracts Funds, an Account, the Manager, any Sub-Advisor or Princor. . Investments in these Accounts are not deposits of a bank and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. 4 Principal Variable Contracts Fund 1-800-247-4123 ASSET ALLOCATION ACCOUNT The Account seeks to generate a total investment return consistent with preservation of capital. MAIN STRATEGIES The Account invests in a portfolio of securities that is broadly diversified by asset class, global region, country, economic sector, and currency. The Portfolio Manager makes the Account's broad asset allocation decisions and delegates responsibility for selection specific individual securities to the internal, active management teams of the Sub-Advisor, Van Kampen. In deciding how to allocate the Account's assets, Van Kampen assesses three sets of factors: . the relative value of the stock, bond and money markets in the various regions, countries and economic sectors; . the long-term dynamic forces that are driving economies, economic sectors, and companies; and . the short-term technical forces that are affecting market pricing. Factors evaluated include growth rates in gross domestic product, inflation and corporation earnings, labor market conditions, interest rate levels, sales growth, return on equity, dividend yields, price to book ratios and currency valuations. From time-to-time, Van Kampen changes the Account's allocation of assets in various ways, including by asset class, by global region, by country, by economic sector and by currency, in order to keep the portfolio in alignment with global investment outlook. Allocation among asset classes is designed to lessen overall investment risk by diversifying the Account's assets among different types of investments in different markets. Van Kampen reallocates among asset classes and eliminates asset classes for a period of time, when in its judgement the shift offers better prospects of achieving the investment objective of the Account. Under normal market conditions, abrupt reallocations among asset classes will not occur. Van Kampen does not allocate a specific percentage of the Account's assets to a class. Over time, it expects the asset mix to be within the following ranges: . 25% to 75% in equity securities; . 20% to 60% in fixed-income securities; and . 0% to 40% in money market instruments. The Account may invest up to 100% of its assets in foreign securities. Allowable instruments include individual securities (stocks (without regard to the market capitalization of the issuing company) and bonds), equity and interest rate futures, currency forward contracts, futures contracts, Exchange Traded Funds, fixed-income TRAINS and listed options. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. Van Kampen may utilize currency contracts, currency or index futures or other derivatives for hedging or other purposes, including modifying the Account's exposure to various currency, equity or fixed-income market. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. Principal Variable Contracts Fund 5 www.principal.com CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.) FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. HEDGING STRATEGIES . Use of forward foreign currency exchange contracts, currency or index futures or other derivatives involves risks. The contracts may increase the Account's volatility and, thus, could involve a significant risk. If the Sub-Advisor's predictions are inaccurate, the adverse consequences to the Account (e.g., a reduction in the Account's net asset value) may leave the Account in a worse position than if these strategies were not used. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking a moderate risk approach towards long-term growth. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. 6 Principal Variable Contracts Fund 1-800-247-4123 Van Kampen has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"12.92 "1997"18.19 "1998"9.18 "1999"19.49 "2000"1.61 "2001"-3.92 "2002"-12.94 "2003"21.61 "2004"8.49 The Account's highest/lowest quarterly returns "2005"5.79 during this time period were: HIGHEST Q2 '03 12.11% LOWEST Q3 '02 -12.41% LOGO The year-to-date return as of March 31, 2006 is 3.34%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* ASSET ALLOCATION ACCOUNT .............. 5.79 3.14 7.52 8.25 S&P 500 Index ........ 4.91 0.54 9.07 11.02 Lehman Brothers Aggregate Bond Index . 2.43 5.87 6.17 6.92 MSCI EAFE (Europe, Australia, Far East) Index - ND ........... 13.54 4.56 5.84 6.03 Morningstar Moderate Allocation Category Average .............. 5.29 2.93 7.35 8.55 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (June 1, 1994).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM THE ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.80% Other Expenses................... 0.06 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.86%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 ASSET ALLOCATION ACCOUNT $88 $274 $477 $1,061
Principal Variable Contracts Fund 7 www.principal.com BALANCED ACCOUNT The Account seeks to generate a total return consisting of current income and capital appreciation. MAIN STRATEGIES The Account seeks growth of capital and current income by investing primarily in common stocks and corporate bonds. It may also invest in other equity securities, government bonds and notes (obligations of the U.S. government or its agencies or instrumentalities) and cash. Though the percentages in each category are not fixed, common stocks generally represent 40% to 70% of the Account's assets. The remainder of the Account's assets is invested in bonds and cash. The Sub-Advisor, Principal, utilizes an asset allocation approach to the management and development of a diversified balanced account. The strategy incorporates a wide range of asset classes and investment styles with primary emphasis placed on equity versus fixed income allocation decisions. Secondary focus is then placed on growth versus value, large cap versus small cap, and domestic versus international equity exposure. Strategic or long-term asset class targets are determined with gradual adjustments to the mix to enhance risk-adjusted results over time. Any asset allocation adjustments fall within a predetermined range and do not deviate by more than 10% of the long-term asset class targets. All marginal shifts in the asset mix are based on a consistent three-dimensional analytical framework. First, securities are reviewed based on price, earnings, and yield measures relative to long-term historical norms. Next, fundamental economic and market conditions are analyzed to identify opportunities, and finally, market trends are used to compare relative price strength and investor sentiment. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. Because the Account invests in both stocks and bonds, the Account may underperform stock funds when stocks are in favor and underperform bond funds when bonds are in favor. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. Risks for this Account include: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade are commonly referred to as "junk bonds" or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.) FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some 8 Principal Variable Contracts Fund 1-800-247-4123 investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates. This may increase the volatility of the Account. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 115.3%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking current income as well as long-term growth of capital. Principal Variable Contracts Fund 9 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"13.13 "1997"17.93 "1998"11.91 "1999"2.4 "2000"0.13 "2001"-6.96 "2002"-13.18 "2003"18.82 "2004"10.05 The Account's highest/lowest quarterly returns "2005"6.79 during this time period were: HIGHEST Q2 '03 9.82% LOWEST Q3 '02 -9.61% LOGO The year-to-date return as of March 31, 2006 is 3.69%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* BALANCED ACCOUNT ..... 6.79 2.44 5.61 8.43 60% S&P 500 Index/40% Lehman Brothers Aggregate Bond Index . 4.01 2.96 8.24 10.52 Morningstar Moderate Allocation Category Average .............. 5.29 2.93 7.35 9.52 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (December 18, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.59% Other Expenses................... 0.05 ---- TOTAL ACCOUNT OPERATING EXPENSES 0.64%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 BALANCED ACCOUNT $65 $205 $357 $798
10 Principal Variable Contracts Fund 1-800-247-4123 BOND ACCOUNT The Account seeks to provide as high a level of income as is consistent with preservation of capital and prudent investment risk. MAIN STRATEGIES Under normal circumstances, the Account invests at least 80% of its assets in intermediate maturity fixed-income or debt securities rated BBB or higher by Standard & Poor's Rating Service ("S&P") or Baa or higher by Moody's Investors Service, Inc. ("Moody's"). The Account considers the term "bond" to mean any debt security. Under normal circumstances, the Account invests in: . securities issued or guaranteed by the U.S. government or its agencies or instrumentalities; . mortgage-backed securities representing an interest in a pool of mortgage loans; . debt securities and taxable municipal bonds rated, at the time of purchase, in one of the top four categories by S&P or Moody's or, if not rated, in the opinion of the Sub-Advisor, Principal, of comparable quality; and . securities issued or guaranteed by the governments of Canada (provincial or federal government) or the United Kingdom payable in U.S. dollars. The rest of the Account's assets may be invested in: . preferred and common stock that may be convertible (may be exchanged for a fixed number of shares of common stock of the same issuer) or may be non-convertible; or . securities rated less than the four highest grades of S&P or Moody's (i.e. less than investment grade (commonly known as "junk bonds")) but not lower than CCC- (S&P) or Caa (Moody's). The Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income. Under a reverse repurchase agreement, the Account sells securities and agrees to repurchase them at a specified date and price. The Account pays interest on this "secured financing" and attempts to make money on the difference between the financing rate and the interest it earns by investing the proceeds of the financing. While a reverse repurchase agreement is outstanding, the Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account may lend its portfolio securities to brokers, dealers and other financial institutions. In connection with such loans, the Account remains the owner of the loaned securities and continues to be entitled to payments in amounts equal to the interest, dividends or other distributions payable on the loaned securities. Loans of portfolio securities may not exceed 33 1/3% of the value of the Account's total assets (including the value of all assets received as collateral for loan). In connection with such loans the Account will receive collateral from the borrower equal to at least 100% of the value of the loaned securities. The Account may actively trade securities in an attempt to achieve its investment objective. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: MUNICIPAL SECURITIES . Principal and interest payments of municipal securities may not be guaranteed by the issuing body and may be payable only from monies derived from a particular source. If the source does not perform as expected, principal and income payments may not be made on time or at all. In addition, the market for municipal securities is often thin and may be temporarily affected by large purchases and sales, including those of the Account. General conditions in the financial markets and the size of a particular offering may also negatively affect the returns of a municipal security. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining Principal Variable Contracts Fund 11 www.principal.com interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates. This may increase the volatility of the Account. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation maybe chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. REVERSE REPURCHASE AGREEMENTS. . This strategy involves the risk that interest costs on money borrowed may exceed the return on securities purchased with the borrowed money. In addition, reverse repurchase agreements may increase the volatility of the Fund. LENDING OF SECURITIES . If the Account lends its portfolio securities and the borrower of the securities fail financially, the Account may experience delays in recovering the loaned securities or exercising its rights in the collateral. Loans are made only to borrowers that are deemed by the Sub-Advisor to be of good financial standing. PORTFOLIO DURATION . The average portfolio duration of the Account normally varies within a three- to six-year time frame based on Sub-Advisor's forecast for interest rates. Duration is a measure of the expected life of a fixed-income security that is used to determine the sensitivity of a security's price to changes in interest rates. For example, if the portfolio duration of the Account is three years, a change of 1% in the market's yield results in a change of approximately 3% in the value of the Account's securities. The longer a security's duration, the more sensitive it is to changes in interest rates. An Account with a longer average portfolio duration will be more sensitive to changes in interest rates than an Account with a shorter average portfolio duration. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates. When interest rates rise, the value of fixed-income securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of fixed-income securities. Some fixed-income investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.) DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. COMMODITY-LINKED DERIVATIVE INSTRUMENTS . The use of commodity-linked derivative instruments may subject the Account to greater volatility than investments in traditional securities. The value of commodity-linked derivative 12 Principal Variable Contracts Fund 1-800-247-4123 instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 176.2%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking diversification by investing in a fixed-income mutual fund. Principal Variable Contracts Fund 13 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"2.36 "1997"10.6 "1998"7.69 "1999"-2.59 "2000"8.17 "2001"8.12 "2002"9.26 "2003"4.59 "2004"4.98 The Account's highest/lowest quarterly returns "2005"2.5 during this time period were: HIGHEST Q3 '97 4.37% LOWEST Q1 '96-3.24% LOGO The year-to-date return as of March 31, 2006 is -0.55%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* BOND ACCOUNT ......... 2.50 5.86 5.50 7.69 Lehman Brothers Aggregate Bond Index . 2.43 5.87 6.17 7.78 Morningstar Intermediate-Term Bond Category Average...... 1.79 5.32 5.38 7.11 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (December 18, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.45% Other Expenses................... 0.02% ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.47%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 BOND ACCOUNT $48 $151 $263 $591
14 Principal Variable Contracts Fund 1-800-247-4123 CAPITAL VALUE ACCOUNT The Account seeks to provide long-term capital appreciation and secondarily growth of investment income. MAIN STRATEGIES The Account invests primarily in common stock and other equity securities of large capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with large market capitalizations (those with market capitalizations similar to companies in the Russell 1000/(R)// /Value Index (as of March 31, 2006 this range was between approximately $688 million and $387.4 billion) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Up to 25% of Account assets may be invested in foreign securities. The Account invests in stocks that, in the opinion of the Sub-Advisor, Principal, are undervalued in the marketplace at the time of purchase. Value stocks are often characterized by below average price/earnings ratios (P/E) and above average dividend yields relative to the overall market. Securities for the Account are selected by consideration of the quality and price of individual issuers rather than forecasting stock market trends. The selection process focuses on four key elements: . determination that a stock is selling below its fair market value; . early recognition of changes in a company's underlying fundamentals; . evaluation of the sustainability of fundamental changes; and . by monitoring a stock's behavior in the market, evaluation of the timeliness of the investment. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization value stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Principal Variable Contracts Fund 15 www.principal.com ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 120.9%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks, but who prefer investing in companies that appear to be considered undervalued relative to similar companies. 16 Principal Variable Contracts Fund 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"23.5 "1997"28.53 "1998"13.58 "1999"-4.29 "2000"2.16 "2001"-8.05 "2002"-13.66 "2003"25.49 "2004"12.36 The Account's highest/lowest quarterly returns "2005"6.8 during this time period were: HIGHEST Q2 '03 15.52% LOWEST Q3 '02 -15.10% LOGO The year-to-date return as of March 31, 2006 is 6.07%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT CAPITAL VALUE ACCOUNT 6.80 3.64 7.74 11.92* Russell 1000 Value Index................. 7.05 5.28 10.94 14.32** Morningstar Large Value Category Average 5.88 3.96 8.85 13.21** Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 13, 1970). ** Lifetime results are measured from December 31, 1978 (earliest date for which information is available).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.60% Other Expenses................... 0.01% ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.61%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 CAPITAL VALUE ACCOUNT $62 $195 $340 $762
Principal Variable Contracts Fund 17 www.principal.com DIVERSIFIED INTERNATIONAL ACCOUNT The Account seeks long-term growth of capital by investing in a portfolio of equity securities of companies established outside of the U.S. MAIN STRATEGIES The Account invests in a portfolio of equity securities of companies domiciled in any of the nations of the world. The Account invests in securities of: . companies with their principal place of business or principal office outside the U.S.; . companies for which the principal securities trading market is outside the U.S.; and . companies, regardless of where their securities are traded, that derive 50% or more of their total revenue from goods or services produced or sales made outside the U.S. The Account has no limitation on the percentage of assets that are invested in any one country or denominated in any one currency. However, under normal market conditions, the Account intends to have at least 80% of its assets invested in companies in at least three different countries. One of those countries may be the U.S. though currently the Account does not intend to invest in equity securities of U.S. companies. Investments may be made anywhere in the world. Primary consideration is given to securities of corporations of Western Europe, North America and Australasia (Australia, Japan and Far East Asia). Changes in investments are made as prospects change for particular countries, industries or companies. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. The Account may actively trade securities in an attempt to achieve its investment objective. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as companies in more developed countries. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more 18 Principal Variable Contracts Fund 1-800-247-4123 volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 121.2%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital in markets outside of the U.S. who are able to assume the increased risks of higher price volatility and currency fluctuations associated with investments in international stocks which trade in non-U.S. currencies. Principal Variable Contracts Fund 19 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"25.09 "1997"12.24 "1998"9.98 "1999"25.93 "2000"-8.34 "2001"-24.27 "2002"-16.07 "2003"32.33 "2004"21.03 The Account's highest/lowest quarterly returns "2005"23.79 during this time period were: HIGHEST Q2 '03 17.25% LOWEST Q3 '02 -18.68% LOGO The year-to-date return as of March 31, 2006 is 11.97%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS DIVERSIFIED INTERNATIONAL ACCOUNT. 23.79 4.73 8.43 Citigroup BMI Global ex-US Index/(1)/...... 19.59 8.09 7.79 MSCI EAFE (Europe, Australia, Far East) Index - ND ........... 13.54 4.56 5.84 Morningstar Foreign Large Blend Category Average .............. 14.55 2.93 6.47 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 2, 1994). ** Lifetime results are measured from the Index inception date (December 31, 1994). ///(1)/ This index is now the benchmark against which the Account measures its performance. The Manager and the portfolio manager believe it better represents the universe of investment choices open to the Account under its investment philosophy. The index formerly used is also shown. LIFE OF ACCOUNT* DIVERSIFIED 8.09 INTERNATIONAL ACCOUNT. Citigroup BMI Global 8.02** ex-US Index/(1)/...... MSCI EAFE (Europe, 5.94 Australia, Far East) Index - ND ........... Morningstar Foreign 6.27 Large Blend Category Average .............. Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured f the date the Account was first sold (May 2, 1994). ** Lifetime results are measured the Index inception date (December 31, 1994). ///(1)/ This index is now the benchmark against which the Account measures its performance. The Manager and the portfolio manager believe it better represents the universe of investment choices open to the Account under its investment philosophy. The index formerly used is also shown.
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES
Management Fees.................... 0.85% Other Expenses..................... 0.12 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.97%
(EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005 EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate 20 Principal Variable Contracts Fund 1-800-247-4123 account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES -------------------------------------------------------------------------------------------- 1 3 5 10 DIVERSIFIED INTERNATIONAL ACCOUNT $99 $309 $536 $1,190
Principal Variable Contracts Fund 21 www.principal.com EQUITY GROWTH ACCOUNT The Account seeks to provide long-term capital appreciation by investing primarily in equity securities. MAIN STRATEGIES The Account seeks to maximize long-term capital appreciation by investing primarily in growth-oriented equity securities of U.S. and, to a limited extent, foreign companies that exhibit strong growth and free cash flow potential. These companies are generally characterized as "growth" companies. Under normal market conditions, the Account invests at least 80% of its net assets in equity securities of companies with market capitalizations within the range of companies in the Russell 1000/(R)// /Growth Index (as of March 31, 2006, this range was between approximately $952 million and $368.9 billion) at the time of purchase. The Account's investments in foreign companies will be limited to 25% of its total assets. The Account may also purchase futures and options, in keeping with Account objectives. The Sub-Advisor, T. Rowe Price, generally looks for companies with an above-average rate of earnings and cash flow growth and a lucrative niche in the economy that gives them the ability to sustain earnings momentum even during times of slow economic growth. As a growth investor, T. Rowe Price believes that when a company increases its earnings faster than both inflation and the overall economy, the market will eventually reward it with a higher stock price. In pursuing its investment objective, the Sub-Advisor has the discretion to purchase some securities that do not meet its normal investment criteria, as described above, when it perceives an unusual opportunity for gain. These special situations might arise when the Sub-Advisor believes a security could increase in value for a variety of reasons, including a change in management, an extraordinary corporate event, or a temporary imbalance in the supply of or demand for the securities. The Account may sell securities for a variety of reasons, such as to secure gains, limit losses, or redeploy assets into more promising opportunities. The Account may actively trade securities in an attempt to achieve its investment objective. Futures and options contracts may be bought or sold for any number of reasons, including: to manage exposure to changes in interest rates and foreign currencies; as an efficient means of increasing or decreasing fund overall exposure to a specific part or broad segment of the U.S. or a foreign market; in an effort to enhance income; to protect the value of portfolio securities; and to serve as a cash management tool. Call or put options may be purchased or sold on securities, financial indices, and foreign currencies. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization growth-oriented stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation, making returns more dependent on market increases and decreases. Growth stocks may therefore be more vulnerable than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's 22 Principal Variable Contracts Fund 1-800-247-4123 portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed an Account's initial investment in such contracts. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 51.6%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks that may have greater risks than stocks of companies with lower potential for earnings growth. Principal Variable Contracts Fund 23 www.principal.com T. Rowe Price became the Sub-Advisor to the Account on August 24, 2004. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"28.05 "1997"30.86 "1998"18.95 "1999"39.5 "2000"-11.71 "2001"-14.86 "2002"-27.72 "2003"25.95 "2004"9.33 The Account's highest/lowest quarterly returns "2005"7.55 during this time period were: HIGHESTQ4 '9822.68% LOWEST Q1 '01-18.25% LOGO The year-to-date return as of March 31, 2006 is 1.57%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* EQUITY GROWTH ACCOUNT 7.55 -1.84 8.39 10.89 Russell 1000 Growth Index................. 5.26 -3.58 6.73 9.20 Morningstar Large Growth Category Average .............. 6.46 -3.36 6.95 9.09 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (June 1, 1994).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.76% Other Expenses................... 0.01 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.77%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 EQUITY GROWTH ACCOUNT $79 $246 $428 $954
24 Principal Variable Contracts Fund 1-800-247-4123 EQUITY INCOME ACCOUNT The Account seeks to achieve high current income and long-term growth of income and capital. MAIN STRATEGIES The Account seeks to achieve its objective by investing primarily in equity securities (such as common stocks), preferred securities, shares of real estate investment trusts (REITs) and convertible securities. In selecting securities, the Sub-Advisor, Principal, places an emphasis on securities with potentially high dividend yields. Under normal market conditions, the Account invests at least 80% of its assets in equity securities. The Account may invest up to 25% of its assets in securities of foreign companies. When determining how to invest the Account's assets in equity securities, Principal seeks stocks that it believes are undervalued in the marketplace at the time of purchase. Securities for the Account are selected by consideration of the quality and price of individual issuers rather than forecasting stock market trends. The selection process focuses on: . the determination that a stock is selling below its fair market value; . an early recognition of changes in a company's underlying fundamentals; . an evaluation of the sustainability of fundamental changes; and . monitoring a stock's behavior in the market. In selecting preferred securities for the Account, Principal focuses on the financial services industry (i.e., banking, insurance and commercial finance). For a security to be considered for the Account, Principal will assess the credit risk within the context of the yield available on the preferred security. The Sub-Advisor also may consider whether the companies' securities have a favorable income-paying history and whether income payments are expected to continue to increase. REITs are corporations or business trusts that are permitted to eliminate corporate level federal income taxes by meeting certain requirements of the Internal Revenue Code. In selecting REITs for the Account, Principal focuses on equity REITs which primarily own property and generate revenue from rental income. Principal seeks to diversify the Account's REIT holdings by property types (e.g. apartment REITs, mall REITs, office and industrial REITs). MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. VALUE STOCKS . The Account's potential investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. INTEREST RATE CHANGES . Changes in interest rates may adversely affect the value of an investor's securities. When interest rates rise, the value of preferred securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of preferred securities. Some investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. PREPAYMENT OR CALL RISK . Some investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Principal Variable Contracts Fund 25 www.principal.com Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. EQUITY REITS . Equity REITs are affected by the changes in the value of the properties owned by the trust. In addition, they: . may not be diversified with regard to the types of tenants (thus subject to business developments of the tenant(s)); . may not be diversified with regard to the geographic locations of the properties (thus subject to regional economic developments); and . are subject to cash flow dependency of its tenants. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. INVESTOR PROFILE The Account may be an appropriate investment for investors who seek dividends to generate income or to be reinvested for growth and accept fluctuations in the value of investments. 26 Principal Variable Contracts Fund 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999"2.29 "2000"19.18 "2001"-27.7 "2002"-12.61 "2003"13.83 "2004"17.6 The Account's highest/lowest quarterly returns "2005"8.67 during this time period were: HIGHESTQ3 '0018.18% LOWEST Q3 '01-16.65% LOGO The year-to-date return as of March 31, 2006 is 7.04%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* EQUITY INCOME ACCOUNT ........ 8.67 -1.67 3.40 Russell 1000 Value Index ..... 7.05 5.28 5.69 Morningstar Moderate Allocation Category Average .. 5.29 2.93 4.29 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.60% Other Expenses............................. 0.06 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.66%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 EQUITY INCOME ACCOUNT $67 $211 $368 $822
Principal Variable Contracts Fund 27 www.principal.com GOVERNMENT & HIGH QUALITY BOND ACCOUNT F/K/A GOVERNMENT SECURITIES ACCOUNT The Account seeks a high level of current income, liquidity and safety of principal. MAIN STRATEGIES The Account seeks to achieve its investment objective by investing primarily (at least 80% of its assets) in securities that are issued by the U.S. Government, its agencies or instrumentalities. The Account may invest in mortgage-backed securities representing an interest in a pool of mortgage loans. These securities are rated AAA by Standard & Poor's Corporation or Aaa by Moody's Investor Services, Inc. or, if unrated, determined by the Sub-Advisor, Principal, to be of equivalent quality. The Account relies on the professional judgment of Principal to make decisions about the Account's portfolio securities. The basic investment philosophy of Principal is to seek undervalued securities that represent good long-term investment opportunities. Securities may be sold when Principal believes they no longer represent good long-term value. The Account may also hold cash and cash equivalents. The size of the Account's cash position depends on various factors, including market conditions and purchases and redemptions of Account shares. A large cash position could impact the ability of the Account to achieve its objective but it also would reduce the Account's exposure in the event of a market downturn and provide liquidity to make additional investments or to meet redemptions. The Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income. Under a reverse repurchase agreement, the Account sells securities and agrees to repurchase them at a specified date and price. The Account pays interest on this "secured financing" and attempts to make money on the difference between the financing rate and the interest it earns by investing the proceeds of the financing. While a reverse repurchase agreement is outstanding, the Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account may lend its portfolio securities to brokers, dealers and other financial institutions. In connection with such loans, the Account remains the owner of the loaned securities and continues to be entitled to payments in amounts equal to the interest, dividends or other distributions payable on the loaned securities. Loans of portfolio securities may not exceed 33 1/3% of the value of the Account's total assets (including the value of all assets received as collateral for loan). In connection with such loans the Account will receive collateral from the borrower equal to at least 100% of the value of the loaned securities. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: U.S. GOVERNMENT SECURITIES . U.S. Government securities do not involve the degree of credit risk associated with investments in lower quality fixed-income securities. As a result, the yields available from U.S. Government securities are generally lower than the yields available from many other fixed-income securities. Like other fixed-income securities, the values of U.S. Government securities change as interest rates fluctuate. Fluctuations in the value of the Account's securities do not affect interest income on securities already held by the Account, but are reflected in the Account's price per share. Since the magnitude of these fluctuations generally is greater at times when the Account's average maturity is longer, under certain market conditions the Account may invest in short-term investments yielding lower current income rather than investing in higher yielding longer term securities. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates. When interest rates rise, the value of fixed-income securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of fixed-income securities. Some fixed-income investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. 28 Principal Variable Contracts Fund 1-800-247-4123 CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. U.S. GOVERNMENT SPONSORED SECURITIES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. Prepayments, unscheduled principal payments, may result from voluntary prepayment, refinancing or foreclosure of the underlying mortgage. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates and potentially increasing the volatility of the Account. In addition, prepayments may cause losses on securities purchased at a premium (dollar amount by which the price of the bond exceeds its face value). At times, mortgage-backed securities may have higher than market interest rates and are purchased at a premium. Unscheduled prepayments are made at par and cause the Account to experience a loss of some or all of the premium. DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. REVERSE REPURCHASE AGREEMENTS. . This strategy involves the risk that interest costs on money borrowed may exceed the return on securities purchased with the borrowed money. In addition, reverse repurchase agreements may increase the volatility of the Fund. LENDING OF SECURITIES . If the Account lends its portfolio securities and the borrower of the securities fail financially, the Account may experience delays in recovering the loaned securities or exercising its rights in the collateral. The Account lends its securities only to borrowers that the Sub-Advisor determines are creditworthy. PORTFOLIO DURATION . The average portfolio duration of the Account normally varies within a three- to six-year time frame based on Sub-Advisor's forecast for interest rates. Duration is a measure of the expected life of a fixed-income security that is used to determine the sensitivity of a security's price to changes in interest rates. For example, if the portfolio duration of the Account is three years, a change of 1% in the market's yield results in a change of approximately 3% in the value of the Account's securities. The longer a security's duration, the more sensitive it is to changes in interest rates. An Account with a longer average portfolio duration will be more sensitive to changes in interest rates than an Account with a shorter average portfolio duration. Principal Variable Contracts Fund 29 www.principal.com ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading cost which may have an adverse impact on the Account's performance. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 262.1%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking diversification by investing in a fixed-income mutual fund. 30 Principal Variable Contracts Fund 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"3.35 "1997"10.39 "1998"8.27 "1999"-0.29 "2000"11.4 "2001"7.61 "2002"8.8 "2003"1.84 "2004"3.56 The Account's highest/lowest quarterly returns "2005"2.01 during this time period were: HIGHEST Q2 '97 4.52% LOWEST Q1 '96 -1.90% LOGO The year-to-date return as of March 31, 2006 is -0.45%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* GOVERNMENT & HIGH QUALITY BOND ACCOUNT . 2.01 4.72 5.62 7.30 Lehman Brothers Government/Mortgage Index................. 2.63 5.40 6.01 7.56 Morningstar Intermediate Government Category Average .............. 1.90 4.62 5.12 6.67 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (April 9, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.44% Other Expenses................... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.46%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 GOVERNMENT & HIGH QUALITY BOND ACCOUNT $47 $148 $258 $579
Principal Variable Contracts Fund 31 www.principal.com GROWTH ACCOUNT The Account seeks long-term growth of capital through the purchase primarily of common stocks, but the Account may invest in other securities. MAIN STRATEGIES The Account invests primarily in common stocks and other equity securities of large capitalization companies with strong earnings growth potential. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with large market capitalizations (those with market capitalizations similar to companies in the Russell 1000/(R)/ Growth Index (as of March 31, 2006 this range was between approximately $952 million and $368.9 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. The Sub-Advisor, CCI, uses a bottom-up approach (focusing on individual stock selection rather than forecasting stock market trends) in its selection of individual securities that it believes have an above average potential for earnings growth. Selection is based on the premise that companies doing better than expected will have rising securities prices, while companies producing less than expected results will not. CCI refers to its discipline as positive momentum and positive surprise. Through in-depth analysis of company fundamentals in the context of the prevailing economic environment, CCI seeks to select companies that meet the criteria of positive momentum and positive surprise in reported results. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization growth-oriented stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks that may have greater risks than stocks of companies with lower potential for earnings growth. 32 Principal Variable Contracts Fund 1-800-247-4123 CCI became the Sub-Advisor to the Account on January 5, 2005. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"12.51 "1997"26.96 "1998"21.36 "1999"16.44 "2000"-10.15 "2001"-25.5 "2002"-29.07 "2003"26.46 "2004"9.38 The Account's highest/lowest quarterly returns "2005"12.09 during this time period were: HIGHESTQ4 '9821.35% LOWEST Q1 '01-23.55% LOGO The year-to-date return as of March 31, 2006 is 4.86%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* GROWTH ACCOUNT ....... 12.09 -3.91 4.04 5.97 Russell 1000 Growth Index................. 5.26 -3.58 6.73 9.27 Morningstar Large Growth Category Average .............. 6.46 -3.36 6.95 9.05 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (May 2, 1994).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.60% Other Expenses................... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.62%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 GROWTH ACCOUNT $63 $199 $346 $774
Principal Variable Contracts Fund 33 www.principal.com INTERNATIONAL EMERGING MARKETS ACCOUNT The Account seeks long-term growth of capital by investing primarily in equity securities of issuers in emerging market countries. MAIN STRATEGIES The Account seeks to achieve its objective by investing in common stocks of companies in emerging market countries. For this Account, the term "emerging market country" means any country which is considered to be an emerging country by the international financial community (including the International Bank for Reconstruction and Development (also known as the World Bank) and the International Financial Corporation). These countries generally include every nation in the world except the United States, Canada, Japan, Australia, New Zealand and most nations located in Western Europe. Investing in many emerging market countries is not feasible or may involve unacceptable political risk. Principal, the Sub-Advisor, focuses on those emerging market countries that it believes have strongly developing economies and markets which are becoming more sophisticated. Under normal conditions, at least 80% of the Account's assets are invested in emerging market country equity securities. The Account invests in securities of: . companies with their principal place of business or principal office in emerging market countries; . companies for which the principal securities trading market is an emerging market country; or . companies, regardless of where their securities are traded, that derive 50% or more of their total revenue from either goods or services produced in emerging market countries or sales made in emerging market countries. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. EMERGING MARKET COUNTRIES . Investments in emerging market countries involve special risks. Certain emerging market countries have historically experienced, and may continue to experience, certain economic problems. These may include: high rates of inflation, high interest rates, exchange rate fluctuations, large amounts of debt, balance of payments and trade difficulties, and extreme poverty and unemployment. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect 34 Principal Variable Contracts Fund 1-800-247-4123 against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading cost which may have an adverse impact on the Account's performance. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 169.6%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital in securities of emerging market countries who are able to assume the increased risks of higher price volatility and currency fluctuations associated with investments in international stocks which trade in non-U.S. currencies. Principal Variable Contracts Fund 35 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2001"-4.24 "2002"-7.63 "2003"57.2 "2004"24.89 The Account's highest/lowest quarterly returns "2005"34.29 during this time period were: HIGHESTQ4 '0126.63% LOWEST Q3 '01-23.90% LOGO The year-to-date return as of March 31, 2006 is 15.59%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* INTERNATIONAL EMERGING MARKETS ACCOUNT....... 34.29 18.45 16.31 MSCI Emerging Markets Free Index - NDTR/(1)/ 34.00 19.08 18.64 MSCI Emerging Markets Free Index - ID ...... 30.31 16.23 14.18 Morningstar Diversified Emerging Markets Category Average .............. 31.64 18.59 16.26 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (October 24, 2000). ///(1)/ This index is now the benchmark against which the Account measures its performance. The Manager and portfolio manager believe it better represents the universe of investment choices open to the Account under its investment philosophy. The index formerly used is also shown.
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.25% Other Expenses............................. 0.35 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.60%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate 36 Principal Variable Contracts Fund 1-800-247-4123 account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------- 1 3 5 10 INTERNATIONAL EMERGING MARKETS ACCOUNT $163 $505 $871 $1,900
Principal Variable Contracts Fund 37 www.principal.com INTERNATIONAL SMALLCAP ACCOUNT The Account seeks long-term growth of capital by investing in a portfolio of equity securities of companies established outside of the U.S. MAIN STRATEGIES The Account invests primarily in equity securities of non-U.S. companies with comparatively smaller market capitalizations. Under normal market conditions, the Account invests at least 80% of its assets in securities of companies similar in size to companies included in the Citigroup Extended Market Index (EMI) World ex US (as of March 31, 2006 this range was between approximately $3.3 million and $26.1 billion). Market capitalization is defined as total current market value of a company's outstanding common stock. The Account invests in securities of: . companies with their principal place of business or principal office outside the U.S.; . companies for which the principal securities trading market is outside the U.S.; and . companies, regardless of where their securities are traded, that derive 50% or more of their total revenue from goods or services produced or sales made outside the U.S. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller 38 Principal Variable Contracts Fund 1-800-247-4123 capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 132.3%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital in smaller companies outside of the U.S. who are able to assume the increased risks of higher price volatility and currency fluctuations associated with investments in international stocks which trade in non-U.S. currencies. Principal Variable Contracts Fund 39 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999"93.81 "2000"-11.5 "2001"-21.85 "2002"-16.2 "2003"54.15 "2004"30.2 The Account's highest/lowest quarterly returns "2005"29.12 during this time period were: HIGHESTQ4 '9936.59% LOWEST Q3 '01-21.49% LOGO The year-to-date return as of March 31, 2006 is 15.21%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* INTERNATIONAL SMALLCAP ACCOUNT 29.12 11.16 13.32 Citigroup Extended Market Index (EMI) World ex US ...... 11.70 4.32 9.36 Morningstar Foreign Small/Mid Growth Category Average ...... 24.79 8.46 12.37 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.19% Other Expenses............................. 0.14 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.33%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 INTERNATIONAL SMALLCAP ACCOUNT $135 $421 $729 $1,601
40 Principal Variable Contracts Fund 1-800-247-4123 LARGECAP GROWTH EQUITY ACCOUNT The Account seeks to achieve long-term growth of capital. MAIN STRATEGIES The Account invests primarily in common stock of U.S. companies, with a focus on growth stocks. Growth stocks are issues (or securities) that the Sub-Advisor, GMO, believes are fast-growing and whose earnings are believed to likely increase over time. Growth in earnings may lead to an increase in the price of the stock. The Sub-Advisor invests mainly in large companies, although investments can be made in companies of any size. Under normal market conditions, the Account invests at least 80% of its assets in equity securities of companies with large market capitalizations. The Account typically makes equity investments in companies chosen from among the 1,000 U.S. exchange-listed companies with the largest market capitalization. Market capitalization is defined as total current market value of a company's outstanding common stock. In addition, the Account may invest up to 25% of its assets in foreign securities, including American Depository Receipts (ADRs), at the time of purchase. When deciding whether to buy or sell stocks for the Account, GMO considers, among other factors, a company's valuation, financial strength, competitive position in its industry, projected future earnings, cash flows and dividends. In addition to the main investment strategies described above, GMO may make other investments, such as investments in preferred stocks, convertible securities and debt instruments. These investments may be subject to other risks as described later in this prospectus and/or the Statement of Additional Information. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization growth-oriented stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. INTEREST RATE CHANGES . Changes in interest rates may adversely affect the value of an investor's securities. When interest rates rise, the value of preferred securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of preferred securities. Some investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. Principal Variable Contracts Fund 41 www.principal.com INVESTOR PROFILE The Account may be an appropriate investment for investors who are seeking long-term growth and are willing to accept the potential for short-term, volatile fluctuations in the value of their investment. This Account is designed as a long-term investment with growth potential. 42 Principal Variable Contracts Fund 1-800-247-4123 GMO became the Sub-Advisor to the Account on March 31, 2004. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2001"-30.08 "2002"-33.27 "2003"23.14 "2004"3.16 The Account's highest/lowest quarterly returns "2005"3.63 during this time period were: HIGHESTQ4 '0112.16% LOWEST Q3 '01-21.14% LOGO The year-to-date return as of March 31, 2006 is 1.26%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* LARGECAP GROWTH EQUITY ACCOUNT 3.63 -9.29 -13.27 Russell 1000 Growth Index .... 5.26 -3.58 -6.99 Morningstar Large Growth Category Average.............. 6.46 -3.36 -5.29 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (October 24, 2000).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.00% Other Expenses............................. 0.09% ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.09%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------- 1 3 5 10 LARGECAP GROWTH EQUITY ACCOUNT $111 $347 $601 $1,329
Principal Variable Contracts Fund 43 www.principal.com LARGECAP STOCK INDEX ACCOUNT The Account seeks long-term growth of capital. MAIN STRATEGIES Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies that compose the Standard & Poor's ("S&P") 500 Index. The Sub-Advisor, Principal, attempts to mirror the investment performance of the Index by allocating the Account's assets in approximately the same weightings as the S&P 500. The S&P 500 is an unmanaged index of 500 common stocks chosen to reflect the industries of the U.S. economy and is often considered a proxy for the stock market in general. Each stock is weighted by its market capitalization which means larger companies have greater representation in the Index than smaller ones. As of March 31, 2006, the market capitalization range of the Index was between approximately $579 million and $371.6 billion. Over the long-term, Principal seeks a very close correlation between performance of the Account, before expenses, and that of the S&P 500. It is unlikely that a perfect correlation of 1.00 will be achieved. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. Because of the difficulty and expense of executing relatively small stock trades, the Account may not always be invested in the less heavily weighted S&P 500 stocks. At times, the Account's portfolio may be weighted differently from the S&P 500, particularly if the Account has a small level of assets to invest. In addition, the Account's ability to match the performance of the S&P 500 is affected to some degree by the size and timing of cash flows into and out of the Account. The Account is managed to attempt to minimize such effects. Principal reserves the right to omit or remove any of the S&P 500 stocks from the Account if it determines that the stock is not sufficiently liquid. In addition, a stock might be excluded or removed from the Account if extraordinary events or financial conditions lead Principal to believe that it should not be a part of the Account's assets. Principal may also elect to omit any S&P 500 stocks from the Account if such stocks are issued by an affiliated company. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's equity securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth stocks typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. 44 Principal Variable Contracts Fund 1-800-247-4123 INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital, willing to accept the potential for volatile fluctuations in the value of investments and preferring a passive, rather than active, management style. NOTE: "Standard & Poor's 500" and "S&P 500/(R)/" are trademarks of The McGraw-Hill Companies, Inc. and have been licensed by the Manager. The Account is not sponsored, endorsed, sold or promoted by Standard and Poor's and Standard & Poor's makes no representation regarding the advisability of investing in the Account. Principal Variable Contracts Fund 45 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2000"-9.67 "2001"-12.1 "2002"-22.44 "2003"28.32 "2004"10.39 The Account's highest/lowest quarterly returns "2005"4.47 during this time period were: HIGHEST Q2 '03 15.28% LOWEST Q3 '02 -17.27% LOGO The year-to-date return as of March 31, 2006 is 4.17%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* LARGECAP STOCK INDEX ACCOUNT . 4.47 0.18 -0.11 S&P 500 Index ................ 4.91 0.54 0.54 Morningstar Large Blend Category Average.............. 5.77 0.50 1.55 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 3, 1999).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees ................. ......... 0.25%* Other Expenses .................. ......... 0.03 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.28% *Effective January 1, 2006.
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 LARGECAP STOCK INDEX ACCOUNT $29 $90 $157 $356
46 Principal Variable Contracts Fund 1-800-247-4123 MIDCAP ACCOUNT The Account seeks to achieve capital appreciation by investing primarily in securities of emerging and other growth-oriented companies. MAIN STRATEGIES The Account invests primarily in common stocks and other equity securities of medium capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with medium market capitalizations (those with market capitalizations similar to companies in the Russell MidCap/(R)/ Index (as of March 31, 2006, this range was between approximately $688 million and $22.1 billion) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Up to 25% of Account assets may be invested in foreign securities. In selecting securities for investment, the Sub-Advisor, Principal, looks at stocks with value and/or growth characteristics and constructs an investment portfolio that has a "blend" of stocks with these characteristics. In managing the assets of the Account, Principal does not have a policy of preferring one of these categories to the other. The value orientation emphasizes buying stocks at less than their inherent value and avoiding stocks whose price has been artificially built up. The growth orientation emphasizes buying stocks of companies whose potential for growth of capital and earnings is expected to be above average. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. MAIN RISKS The Account is subject to the risk that its principal market segment, medium capitalization stocks, may underperform compared to other market segments or to the equity markets as a whole. Because different types of stocks tend to shift in and out of favor depending on market and economic conditions, the Account's performance may sometimes be lower or higher than that of other types of funds. The value of the Account's equity securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. Principal Variable Contracts Fund 47 www.principal.com MEDIUM CAPITALIZATIONS . Companies with medium capitalizations may have a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the potential for short-term fluctuations in the value of investments. 48 Principal Variable Contracts Fund 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"21.11 "1997"22.75 "1998"3.69 "1999"13.04 "2000"14.59 "2001"-3.71 "2002"-8.75 "2003"32.81 "2004"17.76 The Account's highest/lowest quarterly returns "2005"9.21 during this time period were: HIGHESTQ4 '9923.31% LOWEST Q3 '98-20.01% LOGO The year-to-date return as of March 31, 2006 is 4.55%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* MIDCAP ACCOUNT ....... 9.21 8.46 11.60 14.11 Russell Midcap Index . 12.65 8.45 12.49 14.57 Morningstar Mid-Cap Blend Category Average 9.21 8.14 11.74 14.12 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (December 18, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.57% Other Expenses................... 0.01 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.58%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MIDCAP ACCOUNT $59 $186 $324 $726
Principal Variable Contracts Fund 49 www.principal.com MIDCAP GROWTH ACCOUNT The Account seeks long-term growth of capital. MAIN STRATEGIES Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with medium market capitalization (those with market capitalizations similar to companies in the Russell Midcap/(R)/ Growth Index (as of March 31, 2006, this range was between approximately $952 million and $21.9 billion)) at the time of purchase. In the view of the Sub-Advisor, Mellon Equity, many medium-sized companies: . are in fast growing industries; . offer superior earnings growth potential; and . are characterized by strong balance sheets and high returns on equity. The Account may also hold investments in large and small capitalization companies, including emerging and cyclical growth companies. The Account may invest up to 25% of its net assets in securities of foreign companies, including securities of issuers in emerging countries and securities quoted in foreign currencies. Mellon Equity uses valuation models designed to identify common stocks of companies that have demonstrated consistent earnings momentum and delivered superior results relative to market analyst expectations. Other considerations include profit margins, growth in cash flow and other standard balance sheet measures. The securities held are generally characterized by strong earnings momentum measures and higher expected earnings per share growth. The valuation model incorporates information about the relevant criteria as of the most recent period for which data are available. Once ranked, the securities are categorized under the headings "buy," "sell" or "hold." The decision to buy, sell or hold is made by Mellon Equity based primarily on output of the valuation model. However, that decision may be modified due to subsequently available or other specific relevant information about the security. In addition, Mellon Equity manages risk by diversifying across companies and industries, limiting the potential adverse impact from any one stock or industry. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. MEDIUM CAPITALIZATIONS . Companies with medium capitalizations may have a limited operating history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency 50 Principal Variable Contracts Fund 1-800-247-4123 exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. EMERGING MARKET COUNTRIES . Investments in emerging market countries involve special risks. Certain emerging market countries have historically experienced, and may continue to experience, certain economic problems. These may include: high rates of inflation, high interest rates, exchange rate fluctuations, large amounts of debt, balance of payments and trade difficulties, and extreme poverty and unemployment. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth and willing to accept the potential for short-term fluctuations in the value of their investments. Principal Variable Contracts Fund 51 www.principal.com Mellon Equity has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999"10.67 "2000"8.1 "2001"-16.92 "2002"-26.27 "2003"40.58 "2004"11.82 The Account's highest/lowest quarterly returns "2005"13.72 during this time period were: HIGHESTQ4 '0124.12% LOWEST Q3 '01-25.25% LOGO The year-to-date return as of March 31, 2006 is 7.08%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* MIDCAP GROWTH ACCOUNT ........ 13.72 1.83 3.12 Russell Midcap Growth Index .. 12.10 1.38 5.30 Morningstar Mid-Cap Growth Category Average.............. 9.70 0.01 6.65 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.90% Other Expenses............................. 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.92%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MIDCAP GROWTH ACCOUNT $94 $293 $509 $1,131
52 Principal Variable Contracts Fund 1-800-247-4123 MIDCAP VALUE ACCOUNT The Account seeks long-term growth of capital by investing primarily in equity securities of companies with value characteristics and market capitalizations. MAIN STRATEGIES The Account invests primarily in common stocks of medium capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with a medium market capitalization (those with market capitalizations similar to companies in the Russell Midcap/(R)/ Value Index (as of March 31, 2006, this range was between approximately $688 million and $22.1 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Companies may range from the well-established and well known to the new and unseasoned. The Account may invest up to 25% of its assets in securities of foreign companies. The stocks are selected using a value oriented investment approach by Neuberger Berman, the Sub-Advisor. Neuberger Berman identifies value stocks in several ways. Factors it considers in identifying value stocks may include: . strong fundamentals, such as a company's financial, operational and competitive positions; . consistent cash flow; and . a sound earnings record through all phases of the market cycle. Neuberger Berman may also look for other characteristics in a company, such as a strong position relative to competitors, a high level of stock ownership among management, and a recent sharp decline in stock price that appears to be the result of a short-term market overreaction to negative news. Neuberger Berman believes that, over time, securities that are undervalued are more likely to appreciate in price and are subject to less risk of price decline than securities whose market prices have already reached their perceived economic value. This approach also involves selling portfolio securities when Neuberger Berman believes they have reached their potential, when the securities fail to perform as expected or when other opportunities appear more attractive. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. MEDIUM CAPITALIZATIONS . Companies with medium capitalizations may have a limited operating history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency Principal Variable Contracts Fund 53 www.principal.com exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth and willing to accept short-term fluctuations in the value of investments. 54 Principal Variable Contracts Fund 1-800-247-4123 Neuberger Berman has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2000"31.03 "2001"-2.58 "2002"-9.96 "2003"36.49 "2004"22.67 The Account's highest/lowest quarterly returns "2005"10.55 during this time period were: HIGHEST Q2 '03 14.93% LOWEST Q3 '02 -14.54% LOGO The year-to-date return as of March 31, 2006 is 4.70%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* MIDCAP VALUE ACCOUNT ......... 10.55 10.18 13.65 Russell Midcap Value Index ... 12.65 12.21 10.93 Morningstar Mid-Cap Value Category Average.............. 8.41 9.36 10.54 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 3, 1999).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees ................. ......... 1.05% Other Expenses .................. ......... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.07%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MIDCAP VALUE ACCOUNT $109 $340 $590 $1,306
Principal Variable Contracts Fund 55 www.principal.com MONEY MARKET ACCOUNT The Account has an investment objective of as high a level of current income available from investments in short-term securities as is consistent with preservation of principal and maintenance of liquidity. MAIN STRATEGIES The Account invests its assets in a portfolio of high quality, short-term money market instruments. The investments are U.S. dollar denominated securities which the Sub-Advisor, Principal, believes present minimal credit risks. At the time the Account purchases each security, it is an "eligible security" as defined in the regulations issued under the Investment Company Act of 1940, as amended. The Account maintains a dollar weighted average portfolio maturity of 90 days or less. It intends to hold its investments until maturity. However, the Account may sell a security before it matures: . to take advantage of market variations; . to generate cash to cover sales of Account shares by its shareholders; or . upon revised credit opinions of the security's issuer. The sale of a security by the Account before maturity may not be in the best interest of the Account. The sale of portfolio securities is usually a taxable event. The Account does have an ability to borrow money to cover the redemption of Account shares. It is the policy of the Account to be as fully invested as possible to maximize current income. Securities in which the Account invests include: . securities issued or guaranteed by the U.S. government, including treasury bills, notes and bonds; . securities issued or guaranteed by agencies or instrumentalities of the U.S. government. These are backed either by the full faith and credit of the U.S. government or by the credit of the particular agency or instrumentality; . bank obligations including: . certificates of deposit which generally are negotiable certificates against funds deposited in a commercial bank; or . bankers acceptances which are time drafts drawn on a commercial bank, usually in connection with international commercial transactions. . commercial paper which is short-term promissory notes issued by U.S. or foreign corporations primarily to finance short-term credit needs; . corporate debt consisting of notes, bonds or debentures which at the time of purchase by the Account has 397 days or less remaining to maturity; . repurchase agreements under which securities are purchased with an agreement by the seller to repurchase the security at the same price plus interest at a specified rate. Generally these have a short maturity (less than a week) but may also have a longer maturity; and . taxable municipal obligations which are short-term obligations issued or guaranteed by state and municipal issuers which generate taxable income. Among the certificates of deposit typically held by the Account are Eurodollar and Yankee obligations which are issued in U.S. dollars by foreign banks and foreign branches of U.S. banks. Before the Sub-Advisor selects a Eurodollar or Yankee obligation, however, the foreign issuer undergoes the same credit-quality analysis and tests of financial strength as an issuer of domestic securities. MAIN RISKS As with all mutual funds, the value of the Account's assets may rise or fall. Although the Account seeks to preserve the value of an investment at $1.00 per share, it is possible to lose money by investing in the Account. An investment in the Account is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. As with any security, the securities in which the Account invests have associated risks. These include risks of: CREDIT RISK . Credit risk pertains to the issuer's ability to make scheduled principal or interest payments. This may reduce the Account's stream of income and decrease the Account's yield. 56 Principal Variable Contracts Fund 1-800-247-4123 INTEREST RATE RISK . The value of the Account's shares is directly impacted by trends in interest rates. If interest rates rise, the value of debt securities generally will fall. REPURCHASE AGREEMENTS . The Account may invest in repurchase agreements with commercial banks, brokers and dealers considered by the Sub-Advisor to be creditworthy. Default or insolvency of the other party is a potential risk to the Account. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in securities issued by government-sponsored enterprises. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. EURODOLLAR AND YANKEE OBLIGATIONS . Eurodollar and Yankee obligations have risks similar to U.S. money market instruments, such as income risk and credit risk. Other risks of Eurodollar and Yankee obligations include the possibilities that: a foreign government will not let U.S. dollar-denominated assets leave the country; the banks that issue Eurodollar obligations may not be subject to the same regulations as U.S. banks; and adverse political or economic developments will affect investments in a foreign country. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking monthly dividends without incurring much principal risk. Principal Variable Contracts Fund 57 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"5.07 "1997"5.04 "1998"5.2 "1999"4.84 "2000"6.07 "2001"3.92 "2002"1.42 "2003"0.74 "2004"0.92 "2005"2.69 TO OBTAIN THE ACCOUNT'S CURRENT YIELD INFORMATION, PLEASE CALL 1-800-247-4123 LOGO The year-to-date return as of March 31, 2006 is 1.00%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* Money Market Account . 2.69 1.93 3.60 3.15 *Lifetime results are measured from the date the Account was first sold (March 18, 1983).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.49% Other Expenses................... 0.12 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.61%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MONEY MARKET ACCOUNT $62 $195 $340 $762
58 Principal Variable Contracts Fund 1-800-247-4123 REAL ESTATE SECURITIES ACCOUNT The Account seeks to generate a total return by investing primarily in equity securities of companies principally engaged in the real estate industry. MAIN STRATEGIES Under normal market conditions, the Account invests at least 80% of its net assets in equity securities of companies principally engaged in the real estate industry. For purposes of the Account's investment policies, a real estate company has at least 50% of its assets, income or profits derived from products or services related to the real estate industry. Real estate companies include real estate investment trusts and companies with substantial real estate holdings such as paper, lumber, hotel and entertainment companies. Companies whose products and services relate to the real estate industry include building supply manufacturers, mortgage lenders and mortgage servicing companies. Real estate investment trusts ("REITs") are corporations or business trusts that are permitted to eliminate corporate level federal income taxes by meeting certain requirements of the Internal Revenue Code. REITs are characterized as: . equity REITs, which primarily own property and generate revenue from rental income; . mortgage REITs, which invest in real estate mortgages; and . hybrid REITs, which combine the characteristics of both equity and mortgage REITs. In selecting securities for the Account, the Sub-Advisor focuses on equity REITs. The Account may invest up to 25% of its assets in securities of foreign real estate companies. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SECTOR RISK . Because the Account invests at least 80% of its net assets in securities of companies principally engaged in the real estate industry, the Account is also subject to sector risk; that is, the possibility that the real estate sector may underperform other sectors or the market as a whole. As more of the Account's portfolio holdings to the real estate sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. The share price of the Account may fluctuate more widely than the value of shares of a fund that invests in a broader range of industries. Securities of real estate companies are subject to securities market risks as well as risks similar to those of direct ownership of real estate. These include: . declines in the value of real estate . risks related to general and local economic conditions . dependency on management skills . heavy cash flow dependency . possible lack of available mortgage funds . overbuilding . extended vacancies in properties . increases in property taxes and operating expenses . changes in zoning laws . expenses incurred in the cleanup of environmental problems . casualty or condemnation losses . changes in interest rates Principal Variable Contracts Fund 59 www.principal.com In addition to the risks listed above, equity REITs are affected by the changes in the value of the properties owned by the trust. Mortgage REITs are affected by the quality of the credit extended. Both equity and mortgage REITs: . may not be diversified with regard to the types of tenants (thus subject to business developments of the tenant(s)); . may not be diversified with regard to the geographic locations of the properties (thus subject to regional economic developments); and . are subject to cash flow dependency of its tenants. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. INVESTOR PROFILE The Account may be an appropriate investment for investors who seek a total return, want to invest in companies engaged in the real estate industry and accept the potential for volatile fluctuations in the value of investments. 60 Principal Variable Contracts Fund 1-800-247-4123 Principal REI has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999"-4.48 "2000"30.97 "2001"8.75 "2002"7.72 "2003"38.91 "2004"34.53 The Account's highest/lowest quarterly returns "2005"15.85 during this time period were: HIGHEST Q4 '04 17.84% LOWEST Q3 '99-8.40% LOGO The year-to-date return as of March 31, 2006 is 16.34%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* REAL ESTATE SECURITIES ACCOUNT 15.85 20.46 15.23 MSCI US REIT Index ........... 12.52 18.80 12.60 Morningstar Specialty - Real Estate Category Average ...... 11.59 18.58 12.68 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.88% Other Expenses............................. 0.01 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.89%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ------------------------------------------------------------------------------------------ 1 3 5 10 REAL ESTATE SECURITIES ACCOUNT $91 $284 $493 $1,096
Principal Variable Contracts Fund 61 www.principal.com SMALLCAP ACCOUNT The Account seeks long-term growth of capital by investing primarily in equity securities of companies with comparatively small market capitalizations. MAIN STRATEGIES The Account invests primarily in common stocks of small capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with small market capitalizations (those with market capitalizations similar to companies in the Russell 2000/(R)/ Index (as of March 31, 2006, this range was between approximately $23 million and $5.4 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. The Account may invest up to 25% of its assets in securities of foreign companies. In selecting securities for investment, the Sub-Advisor, Principal, looks at stocks with value and/or growth characteristics and constructs an investment portfolio that has a "blend" of stocks with these characteristics. In managing the assets of the Account, Principal does not have a policy of preferring one of these categories to the other. The value orientation emphasizes buying stocks at less than their investment value and avoiding stocks whose price has been artificially built up. The growth orientation emphasizes buying stocks of companies whose potential for growth of capital and earnings is expected to be above average. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. Principal may purchase securities issued as part of, or a short period after, companies' initial public offerings ("IPOs"), and may at times dispose of those shares shortly after their acquisition. MAIN RISKS The Account's share price may fluctuate more than that of funds primarily invested in stocks of mid-sized and large companies and may underperform as compared to the securities of larger companies. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. 62 Principal Variable Contracts Fund 1-800-247-4123 VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 125.8%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the potential for volatile fluctuations in the value of investments. Principal Variable Contracts Fund 63 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999 "43.58 "2000"-11.73 "2001 "2.55 "2002"-27.33 "2003 "36.82 "2004 "19.82 The Account's highest/lowest quarterly returns "2005 "7.04 during this time period were: HIGHESTQ2 '9926.75% LOWEST Q3 '01-25.61% LOGO The year-to-date return as of March 31, 2006 is 11.13%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* SMALLCAP ACCOUNT ............. 7.04 5.51 3.66 Russell 2000 Index ........... 4.55 8.22 5.77 Morningstar Small Blend Category Average.............. 6.62 9.89 8.23 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.85% Other Expenses............................. 0.03 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.88%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SMALLCAP ACCOUNT $90 $281 $488 $1,084
64 Principal Variable Contracts Fund 1-800-247-4123 SMALLCAP GROWTH ACCOUNT The Account seeks long-term growth of capital. The Manager has selected UBS Global AM and Emerald as Sub-Advisors to the Account. MAIN STRATEGIES The Account pursues its investment objective by investing primarily in equity securities. Under normal market conditions, the Account invests at least 80% of its assets in equity securities of companies with small market capitalizations (those with market capitalizations equal to or smaller than the greater of 1) $2.5 billion or 2) the highest market capitalization of the companies in the Russell 2000/(R)/ Growth Index at the time of purchase (as of March 31, 2005, this range was between approximately $23 million and $5.4 billion)). Market capitalization is defined as total current market value of a company's outstanding common stock. The Account may invest up to 25% of its assets in securities of foreign companies. UBS Global AM seeks to invest in companies that possess dominant market positions or franchises, a major technical edge, or a unique competitive advantage. To this end, UBS Global AM considers earnings revision trends, positive stock price momentum and strong fundamentals when selecting securities. The Account may also invest in securities of emerging growth companies which are companies that UBS Global AM expects to experience above average earnings or cash flow growth or meaningful changes in underlying asset values. Investments in equity securities may include common stock and preferred stock. Utilizing fundamental analysis, Emerald seeks to invest in the common stock of companies with distinct competitive advantages, strong management teams, leadership positions, high revenue and earnings growth rates versus peers, differentiated growth drivers and limited sell-side research. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. The Manager may, from time-to-time, reallocate Account assets among the Sub-Advisors. The decision to do so may be based on a variety of factors, including but not limited to: the investment capacity of each Sub-Advisor, portfolio diversification, volume of net cash flows, fund liquidity, investment performance, investment strategies, changes in each Sub-Advisor's firm or investment professionals, or changes in the number of Sub-Advisors. Ordinarily, reallocations of Account assets among Sub-Advisors will occur as a Sub-Advisor liquidates assets in the normal course of portfolio management and with net new cash flows; however, at times reallocations may occur by transferring assets in cash or in kind among Sub-Advisors. MAIN RISKS The Account's share price may fluctuate more than that of funds primarily invested in stocks of mid-sized and large companies and may underperform as compared to the securities of larger companies. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. Principal Variable Contracts Fund 65 www.principal.com SECTOR RISK . UBS Global AM may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As UBS Global AM allocates more of the Account's portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries . INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks that may have greater risks than stocks of companies with lower potential for earnings growth. 66 Principal Variable Contracts Fund 1-800-247-4123 UBS Global AM became the Sub-Advisor to the Account on October 1, 2002. On August 24, 2004, Emerald also became Sub-Advisor to the Account. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999 "95.69 "2000"-13.91 "2001"-32.01 "2002"-45.85 "2003 "45.64 The Account's highest/lowest quarterly returns "2004"11.24 during this time period were: HIGHESTQ4 '9959.52% LOWEST Q3 '01-37.66% LOGO The year-to-date return as of March 31, 2006 is 13.41%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* SMALLCAP GROWTH ACCOUNT ...... 6.67 -8.64 1.29 Russell 2000 Growth Index .... 4.15 2.28 1.46 Morningstar Small Growth Category Average.............. 5.74 2.17 6.26 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.00% Other Expenses............................. 0.05 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.05%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SMALLCAP GROWTH ACCOUNT $107 $334 $579 $1,283
Principal Variable Contracts Fund 67 www.principal.com SMALLCAP VALUE ACCOUNT The Account seeks long-term growth of capital. The Manager has selected Mellon Equity and Morgan as Sub-Advisors to the Account. MAIN STRATEGIES The Account invests primarily in a diversified group of equity securities of U.S. companies with small market capitalizations (those with market capitalizations similar to companies in the Russell 2000/(R)/ Value Index (as of March 31, 2006, this range was between approximately $29 million and $4.2 billion)) at the time of purchase. Under normal market conditions, the Account invests at least 80% of its assets in equity securities of such companies. Emphasis is given to those companies that exhibit value characteristics. Value securities generally have above average dividend yield and below average price to earnings (P/E) ratios. Up to 25% of the Account's assets may be invested in foreign securities. The Sub-Advisor, Morgan, uses quantitative and fundamental research, systematic stock valuation and a disciplined portfolio construction process. It seeks to enhance returns and reduce the volatility in the value of the Account relative to that of the U.S. small company value universe, represented by the Russell 2000/(R)/ Value Index. Morgan continuously screens the small company universe to identify for further analysis those companies that exhibit favorable factor rankings. Such factors include various valuation and momentum measures. Morgan ranks these companies within economic sectors according to their relative attractiveness. Morgan then selects for purchase the companies it feels to be most attractive within each economic sector. Under normal market conditions, the portion of the Account sub-advised by Morgan will have sector weightings comparable to that of the U.S. small company value universe though it may under or over-weight selected economic sectors. In addition, as a company moves out of the market capitalization range of the small company universe, it generally becomes a candidate for sale. Morgan may also purchase securities issued as part of, or a short period after, companies' initial public offerings ("IPOs"), and may at times dispose of those shares shortly after their acquisition. In selecting investments for the Account, the Sub-Advisor, Mellon Equity, uses a disciplined investment process that combines fundamental analysis and risk management with a multi-factor model that searches for undervalued stocks. Undervalued stocks are those selling at a low price relative to their profits and prospective earnings growth. The stock evaluation process uses several different characteristics, including changes in earnings estimates and change in price-to-earnings ratios, in an attempt to identify value among individual stocks. Rather than using broad economic or market trends, Mellon Equity selects stocks on a company-by-company basis. To ensure ample diversification, the portion of the Account's assets managed by Mellon Equity are allocated among industries and economic sectors in similar proportions to those of the Index. The portfolio is generally kept broadly diversified in an attempt to capture opportunities that may be realized quickly during periods of above-average market volatility. By maintaining such a diversified stance, stock selection drives performance. Since the Account has a long-term investment perspective, Mellon Equity does not intend to respond to short-term market fluctuations or to acquire securities for the purpose of short-term trading. The Manager may, from time-to-time, reallocate Account assets among the Sub-Advisors. The decision to do so may be based on a variety of factors, including but not limited to: the investment capacity of each Sub-Advisor, portfolio diversification, volume of net cash flows, fund liquidity, investment performance, investment strategies, changes in each Sub-Advisor's firm or investment professionals, or changes in the number of Sub-Advisors. Ordinarily, reallocations of Account assets among Sub-Advisors will occur as a Sub-Advisor liquidates assets in the normal course of portfolio management and with net new cash flows; however, at times reallocations may occur by transferring assets in cash or in kind among Sub-Advisors. 68 Principal Variable Contracts Fund 1-800-247-4123 MAIN RISKS The Account's share price may fluctuate more than that of funds primarily invested in stocks of mid-sized and large companies and may underperform as compared to the securities of larger companies. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operational history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities that may be more volatile in price than larger company securities, especially over the short-term. VALUE STOCKS . The Account's investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Companies doing business in emerging markets may not have the same range of opportunities as companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, neither Sub-Advisor can guarantee continued access to IPO offerings and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth and willing to accept volatile fluctuations in the value of their investment. The Account is not designed for investors seeking income or conservation of capital. Principal Variable Contracts Fund 69 www.principal.com Morgan has been the Account's Sub-Advisor since its inception. On August 8, 2005, Mellon Equity also became Sub-Advisor to the Account. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999 "21.45 "2000 "23.87 "2001"6.25 "2002"-8.86 "2003 "50.61 "2004 "23.08 The Account's highest/lowest quarterly returns "2005"6.22 during this time period were: HIGHEST Q2 '03 23.76% LOWEST Q3 '02 -17.74% LOGO The year-to-date return as of March 31, 2006 is 13.36%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* SMALLCAP VALUE ACCOUNT ....... 6.22 13.78 12.31 Russell 2000 Value Index ..... 4.71 13.55 9.19 Morningstar Small Value Category Average.............. 6.13 13.50 9.60 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.09% Other Expenses............................. 0.04 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.13%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SMALLCAP VALUE ACCOUNT $115 $359 $622 $1,375
70 Principal Variable Contracts Fund 1-800-247-4123 CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS The Statement of Additional Information (SAI) contains additional information about investment strategies and their related risks. SECURITIES AND INVESTMENT PRACTICES MARKET VOLATILITY . Equity securities include common stocks, preferred stocks, convertible securities, depositary receipts, rights and warrants. Common stocks, the most familiar type, represent an equity (ownership) interest in a corporation. The value of a company's stock may fall as a result of factors directly relating to that company, such as decisions made by its management or lower demand for the company's products or services. A stock's value may also fall because of factors affecting not just the company, but also companies in the same industry or in a number of different industries, such as increases in production costs. The value of a company's stock may also be affected by changes in financial markets that are relatively unrelated to the company or its industry, such as changes in interest rates or currency exchange rates. In addition, a company's stock generally pays dividends only after the company invests in its own business and makes required payments to holders of its bonds and other debt. For this reason, the value of a company's stock will usually react more strongly than its bonds and other debt to actual or perceived changes in the company's financial condition or prospects. Stocks of smaller companies may be more vulnerable to adverse developments than those of larger companies. Fixed-income securities include bonds and other debt instruments that are used by issuers to borrow money from investors. The issuer generally pays the investor a fixed, variable or floating rate of interest. The amount borrowed must be repaid at maturity. Some debt securities, such as zero coupon bonds, do not pay current interest, but are sold at a discount from their face values. INTEREST RATE CHANGES . Fixed-income securities are sensitive to changes in interest rates. In general, fixed-income security prices rise when interest rates fall and fall when interest rates rise. Longer term bonds and zero coupon bonds are generally more sensitive to interest rate changes. CREDIT RISK . Fixed-income security prices are also affected by the credit quality of the issuer. Investment grade debt securities are medium and high quality securities. Some bonds, such as lower grade or "junk" bonds, may have speculative characteristics and may be particularly sensitive to economic conditions and the financial condition of the issuers. REPURCHASE AGREEMENTS AND LOANED SECURITIES Although not a principal investment strategy, each of the Accounts may invest a portion of its assets in repurchase agreements. Repurchase agreements typically involve the purchase of debt securities from a financial institution such as a bank, savings and loan association or broker-dealer. A repurchase agreement provides that the Account sells back to the seller and that the seller repurchases the underlying securities at a specified price on a specific date. Repurchase agreements may be viewed as loans by an Account collateralized by the underlying securities. This arrangement results in a fixed rate of return that is not subject to market fluctuation while the Account holds the security. In the event of a default or bankruptcy by a selling financial institution, the affected Account bears a risk of loss. To minimize such risks, the Account enters into repurchase agreements only with large, well-capitalized and well-established financial institutions. In addition, the value of the securities collateralizing the repurchase agreement is, and during the entire term of the repurchase agreement remains, at least equal to the repurchase price, including accrued interest. Each of the Accounts may lend its portfolio securities to unaffiliated broker-dealers and other unaffiliated qualified financial institutions. REVERSE REPURCHASE AGREEMENTS An Account may use reverse repurchase agreements to obtain cash to satisfy unusually heavy redemption requests or for other temporary or emergency purposes without the necessity of selling portfolio securities, or to earn additional income on portfolio securities, such as Treasury bills or notes. In a reverse repurchase agreement, an Account sells a portfolio security to another party, such as a bank or broker-dealer, in return for cash and agrees to repurchase the instrument at a particular price and time. While a reverse repurchase agreement is outstanding, an Account will Principal Variable Contracts Fund 71 www.principal.com maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account will enter into reverse repurchase agreements only with parties that the Sub-Advisor deems creditworthy. Using reverse repurchase agreements to earn additional income involves the risk that the interest earned on the invested proceeds is less than the expense of the reverse repurchase agreement transaction. This technique may also have a leveraging effect on the Account, although the Account's intent to segregate assets in the amount of the repurchase agreement minimizes this effect. CURRENCY CONTRACTS The Accounts may enter into currency contracts, currency futures contracts and options, and options on currencies for hedging and other purposes. A forward currency contract involves a privately negotiated obligation to purchase or sell a specific currency at a future date at a price set in the contract. An Account will not hedge currency exposure to an extent greater than the aggregate market value of the securities held or to be purchased by the Account (denominated or generally quoted or currently convertible into the currency). Hedging is a technique used in an attempt to reduce risk. If an Account's Sub-Advisor hedges market conditions incorrectly or employs a strategy that does not correlate well with the Account's investment, these techniques could result in a loss. These techniques may increase the volatility of an Account and may involve a small investment of cash relative to the magnitude of the risk assumed. In addition, these techniques could result in a loss if the other party to the transaction does not perform as promised. There is also a risk of government action through exchange controls that would restrict the ability of the Account to deliver or receive currency. FORWARD COMMITMENTS Although not a principal investment strategy, each of the Accounts may enter into forward commitment agreements. These agreements call for the Account to purchase or sell a security on a future date at a fixed price. Each of the Accounts may also enter into contracts to sell its investments either on demand or at a specific interval. WARRANTS Each of the Accounts may invest in warrants though none of the Accounts use such investments as a principal investment strategy. A warrant is a certificate granting its owner the right to purchase securities from the issuer at a specified price, normally higher than the current market price. HIGH YIELD SECURITIES The Asset Allocation, Balanced, Bond and MidCap Value may invest in debt securities rated lower than BBB by S&P or Baa by Moody's or, if not rated, determined to be of equivalent quality by the Manager or the Sub-Advisor. Such securities are sometimes referred to as high yield or "junk bonds" and are considered speculative. Investment in high yield bonds involves special risks in addition to the risks associated with investment in highly rated debt securities. High yield bonds may be regarded as predominantly speculative with respect to the issuer's continuing ability to meet principal and interest payments. Moreover, such securities may, under certain circumstances, be less liquid than higher rated debt securities. Analysis of the creditworthiness of issuers of high yield securities may be more complex than for issuers of higher quality debt securities. The ability of an Account to achieve its investment objective may, to the extent of its investment in high yield bonds, be more dependent on such credit analysis than would be the case if the Account were investing in higher quality bonds. High yield bonds may be more susceptible to real or perceived adverse economic and competitive industry conditions than higher-grade bonds. The prices of high yield bonds have been found to be less sensitive to interest rate changes than more highly rated investments, but more sensitive to adverse economic downturns or individual corporate developments. If the issuer of high yield bonds defaults, an Account may incur additional expenses to seek recovery. The secondary market on which high yield bonds are traded may be less liquid than the market for higher-grade bonds. Less liquidity in the secondary trading market could adversely affect the price at which an Account could sell a high yield bond and could adversely affect and cause large fluctuations in the daily price of the Account's shares. Adverse 72 Principal Variable Contracts Fund 1-800-247-4123 publicity and investor perceptions, whether or not based on fundamental analysis, may decrease the value and liquidity of high yield bonds, especially in a thinly traded market. The use of credit ratings for evaluating high yield bonds also involves certain risks. For example, credit ratings evaluate the safety of principal and interest payments, not the market value risk of high yield bonds. Also, credit rating agencies may fail to change credit ratings in a timely manner to reflect subsequent events. If a credit rating agency changes the rating of a portfolio security held by an Account, the Account may retain the security if the Manager or Sub-Advisor thinks it is in the best interest of shareholders. INITIAL PUBLIC OFFERINGS ("IPOS") Certain of the Accounts may invest in IPOs. An IPO is a company's first offering of stock to the public. IPO risk is that the market value of IPO shares will fluctuate considerably due to factors such as the absence of a prior public market, unseasoned trading, the small number of shares available for trading and limited information about the issuer. The purchase of IPO shares may involve high transaction costs. IPO shares are subject to market risk and liquidity risk. In addition, the market for IPO shares can be speculative and/or inactive for extended periods of time. The limited number of shares available for trading in some IPOs may make it more difficult for an Account to buy or sell significant amounts of shares without an unfavorable impact on prevailing prices. Investors in IPO shares can be affected by substantial dilution in the value of their shares by sales of additional shares and by concentration of control in existing management and principal shareholders. When an Account's asset base is small, a significant portion of the Account's performance could be attributable to investments in IPOs because such investments would have a magnified impact on the Account. As the Account's assets grow, the effect of the Account's investments in IPOs on the Account's performance probably will decline, which could reduce the Account's performance. Because of the price volatility of IPO shares, an Account may choose to hold IPO shares for a very short period of time. This may increase the turnover of the Account's portfolio and lead to increased expenses to the Account, such as commissions and transaction costs. By selling IPO shares, the Account may realize taxable gains it will subsequently distribute to shareholders. DERIVATIVES To the extent permitted by its investment objectives and policies, each of the Accounts (except Money Market) may invest in securities that are commonly referred to as derivative securities. Generally, a derivative is a financial arrangement, the value of which is derived from, or based on, a traditional security, asset, or market index. Certain derivative securities are described more accurately as index/structured securities. Index/structured securities are derivative securities whose value or performance is linked to other equity securities (such as depositary receipts), currencies, interest rates, indices or other financial indicators (reference indices). Some derivatives, such as mortgage-related and other asset-backed securities, are in many respects like any other investment, although they may be more volatile or less liquid than more traditional debt securities. There are many different types of derivatives and many different ways to use them. Futures and options are commonly used for traditional hedging purposes to attempt to protect an Account from exposure to changing interest rates, securities prices, or currency exchange rates and for cash management purposes as a low-cost method of gaining exposure to a particular securities market without investing directly in those securities. The Accounts may enter into put or call options, future contracts, options on futures contracts and over-the-counter swap contracts (e.g., interest rate swaps, total return swaps and credit default swaps) for both hedging and non-hedging purposes. Generally, no Account may invest in a derivative security unless the reference index or the instrument to which it relates is an eligible investment for the Account. The return on a derivative security may increase or decrease, depending upon changes in the reference index or instrument to which it relates. The risks associated with derivative investments include: . the risk that the underlying security, interest rate, market index or other financial asset will not move in the direction the Manager or Sub-Advisor anticipated; . the possibility that there may be no liquid secondary market which may make it difficult or impossible to close out a position when desired; Principal Variable Contracts Fund 73 www.principal.com . the risk that adverse price movements in an instrument can result in a loss substantially greater than an Account's initial investment; and . the counterparty may fail to perform its obligations. EXCHANGE TRADED FUNDS (ETFS) These are a type of index fund bought and sold on a securities exchange. An ETF trades like common stock and represents a fixed portfolio of securities designed to track a particular market index. The Accounts could purchase shares issued by an ETF to temporarily gain exposure to a portion of the U.S. or a foreign market while awaiting purchase of underlying securities. The risks of owning an ETF generally reflect the risks of owning the underlying securities they are designed to track, although ETFs have management fees that increase their costs. CONVERTIBLE SECURITIES Convertible securities are fixed-income securities that an Account has the right to exchange for equity securities at a specified conversion price. The option allows the Account to realize additional returns if the market price of the equity securities exceeds the conversion price. For example, the Account may hold fixed-income securities that are convertible into shares of common stock at a conversion price of $10 per share. If the market value of the shares of common stock reached $12, the Account could realize an additional $2 per share by converting its fixed-income securities. Convertible securities have lower yields than comparable fixed-income securities. In addition, at the time a convertible security is issued the conversion price exceeds the market value of the underlying equity securities. Thus, convertible securities may provide lower returns than non-convertible fixed-income securities or equity securities depending upon changes in the price of the underlying equity securities. However, convertible securities permit the Account to realize some of the potential appreciation of the underlying equity securities with less risk of losing its initial investment. The Accounts treat convertible securities as both fixed-income and equity securities for purposes of investment policies and limitations because of their unique characteristics. The Accounts may invest in convertible securities without regard to their ratings. FOREIGN INVESTING As a principal investment strategy, the Asset Allocation, Diversified International, International Emerging Markets and International SmallCap Accounts may invest Account assets in securities of foreign companies. The other Accounts (except Government & High Quality Bond) may invest in securities of foreign companies but not as a principal investment strategy. For the purpose of this restriction, foreign companies are: . companies with their principal place of business or principal office outside the U.S.; and . companies for which the principal securities trading market is outside the U.S. Foreign companies may not be subject to the same uniform accounting, auditing and financial reporting practices as are required of U.S. companies. In addition, there may be less publicly available information about a foreign company than about a U.S. company. Securities of many foreign companies are less liquid and more volatile than securities of comparable U.S. companies. Commissions on foreign securities exchanges may be generally higher than those on U.S. exchanges, although each Account seeks the most favorable net results on its portfolio transactions. Foreign markets also have different clearance and settlement procedures than those in U.S. markets. In certain markets there have been times when settlements have been unable to keep pace with the volume of securities transactions, making it difficult to conduct these transactions. Delays in settlement could result in temporary periods when a portion of Account assets is not invested and earning no return. If an Account is unable to make intended security purchases due to settlement problems, the Account may miss attractive investment opportunities. In addition, an Account may incur a loss as a result of a decline in the value of its portfolio if it is unable to sell a security. With respect to certain foreign countries, there is the possibility of expropriation or confiscatory taxation, political or social instability, or diplomatic developments that could affect an Account's investments in those countries. In addition, an Account may also suffer losses due to nationalization, expropriation or differing accounting practices and treatments. Investments in foreign securities are subject to laws of the foreign country that may limit the amount and types of foreign investments. Changes of governments or of economic or monetary policies, in the U.S. or abroad, 74 Principal Variable Contracts Fund 1-800-247-4123 changes in dealings between nations, currency convertibility or exchange rates could result in investment losses for an Account. Finally, even though certain currencies may be convertible into U.S. dollars, the conversion rates may be artificial relative to the actual market values and may be unfavorable to Account investors. Foreign securities are often traded with less frequency and volume, and therefore may have greater price volatility, than is the case with many U.S. securities. Brokerage commissions, custodial services, and other costs relating to investment in foreign countries are generally more expensive than in the U.S. Though the Accounts intend to acquire the securities of foreign issuers where there are public trading markets, economic or political turmoil in a country in which an Account has a significant portion of its assets or deterioration of the relationship between the U.S. and a foreign country may negatively impact the liquidity of an Account's portfolio. An Account may have difficulty meeting a large number of redemption requests. Furthermore, there may be difficulties in obtaining or enforcing judgments against foreign issuers. An Account may choose to invest in a foreign company by purchasing depositary receipts. Depositary receipts are certificates of ownership of shares in a foreign-based issuer held by a bank or other financial institution. They are alternatives to purchasing the underlying security but are subject to the foreign securities to which they relate. Investments in companies of developing countries may be subject to higher risks than investments in companies in more developed countries. These risks include: . increased social, political and economic instability; . a smaller market for these securities and low or nonexistent volume of trading that results in a lack of liquidity and in greater price volatility; . lack of publicly available information, including reports of payments of dividends or interest on outstanding securities; . foreign government policies that may restrict opportunities, including restrictions on investment in issuers or industries deemed sensitive to national interests; . relatively new capital market structure or market-oriented economy; . the possibility that recent favorable economic developments may be slowed or reversed by unanticipated political or social events in these countries; . restrictions that may make it difficult or impossible for the Account to vote proxies, exercise shareholder rights, pursue legal remedies, and obtain judgments in foreign courts; and . possible losses through the holding of securities in domestic and foreign custodial banks and depositories. In addition, many developing countries have experienced substantial, and in some periods, extremely high rates of inflation for many years. Inflation and rapid fluctuations in inflation rates have had and may continue to have negative effects on the economies and securities markets of those countries. Repatriation of investment income, capital and proceeds of sales by foreign investors may require governmental registration and/or approval in some developing countries. An Account could be adversely affected by delays in or a refusal to grant any required governmental registration or approval for repatriation. Further, the economies of developing countries generally are heavily dependent upon international trade and, accordingly, have been and may continue to be adversely affected by trade barriers, exchange controls, managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries with which they trade. SMALL AND MEDIUM CAPITALIZATION COMPANIES The Accounts (except Bond, Government & High Quality Bond and Money Market) may invest in securities of companies with small- or mid-sized market capitalizations. The Capital Value, LargeCap Growth Equity, and LargeCap Stock Index Accounts may hold securities of small and medium capitalization companies but not as a principal investment strategy. Market capitalization is defined as total current market value of a company's outstanding common stock. Investments in companies with smaller market capitalizations may involve greater risks and price volatility (wide, rapid fluctuations) than investments in larger, more mature companies. Small companies may be less significant within their industries and may be at a competitive disadvantage relative to their larger competitors. While smaller companies Principal Variable Contracts Fund 75 www.principal.com may be subject to these additional risks, they may also realize more substantial growth than larger or more established companies. Smaller companies may be less mature than larger companies. At this earlier stage of development, the companies may have limited product lines, reduced market liquidity for their shares, limited financial resources or less depth in management than larger or more established companies. Unseasoned issuers are companies with a record of less than three years continuous operation, including the operation of predecessors and parents. Unseasoned issuers by their nature have only a limited operating history that can be used for evaluating the company's growth prospects. As a result, investment decisions for these securities may place a greater emphasis on current or planned product lines and the reputation and experience of the company's management and less emphasis on fundamental valuation factors than would be the case for more mature growth companies. TEMPORARY DEFENSIVE MEASURES From time to time, as part of its investment strategy, each Account (other than the Money Market Account which may invest in high quality money market securities at any time) may invest without limit in cash and cash equivalents for temporary defensive purposes in response to adverse market, economic or political conditions. To the extent that the Account is in a defensive position, it may lose the benefit of upswings and limit its ability to meet its investment objective. For this purpose, cash equivalents include: bank notes, bank certificates of deposit, bankers' acceptances, repurchase agreements, commercial paper, and commercial paper master notes which are floating rate debt instruments without a fixed maturity. In addition, an Account may purchase U.S. government securities, preferred stocks and debt securities, whether or not convertible into or carrying rights for common stock. PORTFOLIO TURNOVER "Portfolio Turnover" is the term used in the industry for measuring the amount of trading that occurs in an Account's portfolio during the year. For example, a 100% turnover rate means that on average every security in the portfolio has been replaced once during the year. Accounts with high turnover rates (more than 100%) often have higher transaction costs (which are paid by the Account) and may have an adverse impact on the Account's performance. No turnover rate can be calculated for the Money Market Account because of the short maturities of the securities in which it invests. Turnover rates for each of the other Accounts may be found in the Account's Financial Highlights table. Please consider all the factors when you compare the turnover rates of different funds. A fund with consistently higher total returns and higher turnover rates than another fund may actually be achieving better performance precisely because the managers are active traders. You should also be aware that the "total return" line in the Financial Highlights section already includes portfolio turnover costs. PRICING OF ACCOUNT SHARES Each Account's shares are bought and sold at the current share price. The share price of each Account is calculated each day the New York Stock Exchange ("NYSE") is open (shares are not priced on the days on which the NYSE is closed for trading). The share price is determined at the close of business of the NYSE (normally 3:00 p.m. Central time). When an order to buy or sell shares is received, the share price used to fill the order is the next price calculated after the order is received. For all Accounts, except the Money Market Account, the share price is calculated by: . taking the current market value of the total assets of the Account . subtracting liabilities of the Account . dividing the remainder by the total number of shares owned by the Account. The securities of the Money Market Account are valued at amortized cost. The calculation procedure is described in the SAI. The Money Market Account reserves the right to determine a share price more than once each day. NOTES: 76 Principal Variable Contracts Fund 1-800-247-4123 . If current market values are not readily available for a security owned by an Account, its fair value is determined using a policy adopted by the Directors. . An Account's securities may be traded on foreign securities markets that generally complete trading at various times during the day prior to the close of the NYSE. Generally, the values of foreign securities used in computing a Fund's NAV are determined at the time the foreign market closes. Foreign securities and currencies are converted to U.S. dollars using the exchange rate in effect at the close of the London Exchange (generally 11:00 a.m. Eastern Time). Occasionally, events affecting the value of foreign securities occur when the foreign market is closed and the NYSE is open. The Account has adopted policies and procedures to "fair value" some or all securities held by an Account if significant events occur after the close of the market on which the foreign securities are traded but before the Account's NAV is calculated. Significant events can be specific to a single security or can include events that affect a particular foreign market or markets. A significant event can also include a general market movement in the U.S. securities markets. If the Manager believes that the market value of any or all of the foreign securities is materially affected by such an event, the securities will be valued, and the Account's NAV will be calculated, using the policy adopted by the Account. These fair valuation procedures are intended to discourage shareholders from investing in the Account for the purpose of engaging in market timing or arbitrage transactions. The trading of foreign securities generally or in a particular country or countries may not take place on all days the NYSE is open, or may trade on days the NYSE is closed. Thus, the value of the foreign securities held by the Account may change on days when shareholders are unable to purchase or redeem shares. . Certain securities issued by companies in emerging market countries may have more than one quoted valuation at any point in time. These may be referred to as local price and premium price. The premium price is often a negotiated price that may not consistently represent a price at which a specific transaction can be effected. The Fund has a policy to value such securities at a price at which the Sub-Advisor expects the securities may be sold. DIVIDENDS AND DISTRIBUTIONS The Accounts earn dividends, interest and other income from investments and distribute this income (less expenses) as dividends. The Accounts also realize capital gains from investments and distribute these gains (less any losses) as capital gain distributions. The Accounts normally make dividends and capital gain distributions at least annually, in February. Dividends and capital gain distributions are automatically reinvested in additional shares of the Account making the distribution. MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE THE MANAGER Principal Management Corporation serves as the manager for the Fund. In its handling of the business affairs of the Fund, the Manager provides clerical, recordkeeping and bookkeeping services, and keeps the required financial and accounting records. THE SUB-ADVISORS The Manager has signed a contract with a Sub-Advisor under which the Sub-Advisor agrees to assume the obligations of the Manager to provide investment advisory service for the Account. For these services, the Sub-Advisor is paid a fee by the Manager. Information regarding Sub-Advisors and individual portfolio managers is set forth below. The Statement of Additional Information provides additional information about each portfolio manager's compensation, other accounts managed by the portfolio manager and the portfolio manager's ownership of securities in the Account. MANAGER: The Manager is an indirect subsidiary of Principal Financial Services, Inc. and has managed mutual funds since 1969. As of December 31, 2005, the mutual funds it manages had assets of approximately $28.6 billion. The Manager's address is Principal Financial Group, Des Moines, Iowa 50392-2080. Principal Variable Contracts Fund 77 www.principal.com SUB-ADVISOR: Columbus Circle Investors ("CCI") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. CCI was founded in 1975. Its address is Metro Center, One Station Place, Stamford, CT 06902. As of December 31, 2005, CCI had approximately $5.9 billion in assets under management. The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Growth Anthony Rizza
ANTHONY RIZZA, CFA . Mr. Rizza, portfolio manager, joined CCI in 1991. He received a BS in Business from the University of Connecticut. Mr. Rizza has earned the right to use the Chartered Financial Analyst designation and is a member of the Hartford Society of Security Analysts. SUB-ADVISOR: Emerald Advisers, Inc. ("Emerald") is a wholly-owned subsidiary of Emerald Asset Management. Emerald provides professional investment advisory services to institutional investors, high net worth individuals and the general public. As of December 31, 2005, Emerald managed approximately $2.36 billion in assets. Emerald's offices are located at 1703 Oregon Pike Road, Suite 101, Lancaster, Pennsylvania 17601.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ SmallCap Growth Joseph W. Garner Kenneth G. Mertz Stacey L. Sears
JOSEPH W. GARNER . Mr. Garner is Director of Emerald Research and a member of the Portfolio Management team. He is also co-manager of the Forward Emerald Growth Fund and the Forward Emerald Opportunities Fund. Prior to joining Emerald, Mr. Garner was the Program Manager of the Pennsylvania Economic Development Financing Authority (PEDFA); an Economic Development Analyst with the PA Department of Commerce's Office of Technology Development; and an Industry Research Analyst with the Pittsburgh High Technology Council. Mr. Garner earned an MBA from the Katz Graduate School of Business, University of Pittsburgh, and graduated magna cum laude with a BA in Economics from Millersville University. KENNETH G. MERTZ II, CFA. . Mr. Mertz joined Emerald in 1992 and serves as President of Emerald Advisers, Inc.; Trustee, Vice President and Chief Investment Officer of the Emerald Mutual Funds; and a Partner of the Emerald Organization (1992 - Present). Formerly he served as Chief Investment Officer, Pennsylvania State Employees' Retirement System (1985-1992). Mr. Mertz graduated from Millersville University with a BA in Economics. Mr. Mertz supervises the entire portfolio management and trading process. As Chief Investment Officer, he has full discretion over all portfolios. Mr. Mertz and Ms. Sears work as a team developing strategy. STACEY L. SEARS . Ms. Sears joined Emerald in 1991 and serves as Senior Vice President and Portfolio Manager of Emerald and a Partner in the Emerald Organization. She is co-manager of the Emerald Growth Fund and a member of the Portfolio Management team. Additionally, Ms. Sears maintains research coverage of retail, apparel, consumer goods and consumer technology companies. Ms. Sears received a BS in Business Administration from Millersville University and an MBA from Villanova University. 78 Principal Variable Contracts Fund 1-800-247-4123 Ms. Sears monitors all portfolios in wrap programs and works with Mr. Mertz in supervising the trading group staff. Mr. Mertz and Ms. Sears work as a team developing strategy. SUB-ADVISOR: Grantham, Mayo, Van Otterloo & Co. LLC ("GMO") is a privately held global investment management firm servicing clients in the corporate, public, endowment and foundation marketplace located at 40 Rowes Wharf, Boston, MA 02110. As of December 31, 2005, GMO managed $111 billion in client assets.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ LargeCap Growth Equity Sam Wilderman
Day-to-day management of the Partners LargeCap Growth Fund is the responsibility of GMO's U.S. Quantitative Division. The Division's members work collaboratively to manage the Account's portfolio, and no one person is primarily responsible for day-to-day management. The individual responsible for managing the implementation and monitoring of the overall portfolio management of the Account is Sam Wilderman. Mr. Wilderman allocates responsibility for portions of the Account's portfolio to various members of the Division, oversees the implementation of trades, reviews the overall composition of the Account's portfolio, including compliance with stated investment objectives and strategies and monitors cash flows. Mr. Wilderman is a member (partner) of GMO and is Director of GMO's U.S. Quantitative Division. Mr. Wilderman served as co-director of U.S. equity management in 2005. Prior to this position, he was responsible for research and portfolio management for the GMO Emerging Markets Fund, the GMO Emerging Countries Fund and the GMO Emerging Markets Quality Fund. He joined GMO in 1996 following the completion of his B.A. in Economics from Yale University. The SAI contains other information about how GMO determines the compensation of the Division's senior member, other accounts managed by the team's senior member, and ownership of mutual fund shares by the Division's senior member. SUB-ADVISOR: J.P. Morgan Investment Management Inc. ("Morgan"), 522 Fifth Avenue, New York, NY 10036 is an indirect wholly-owned subsidiary of JPMorgan Chase & Co. ("JPMorgan"), a bank holding company. Morgan offers a wide range of services to governmental, institutional, corporate and individual customers and acts as investment advisor to individual and institutional clients. As of December 31, 2005, Morgan had total combined assets under management of approximately $847 billion. The portfolio managers operate as a team, sharing responsibility for the day-to-day management of the portfolio, each strategy does, however, have lead portfolio managers with responsibility for implementing the insight of the team into individual portfolios. The Statement of Additional Information provides additional information about the portfolio managers' compensation, other accounts managed by the portfolio managers and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ SmallCap Value Christopher T. Blum Dennis S. Ruhl
CHRISTOPHER T. BLUM, CFA . Managing Director of Morgan. Mr. Blum is a portfolio manager in the U.S. Small Cap Equity Group. He rejoined the firm in 2001. Previously, he spent two years as a research analyst responsible for the Principal Variable Contracts Fund 79 www.principal.com valuation and acquisition of private equity assets at Pomona Capital. Prior to that, Mr. Blum spent over three years with Morgan where he focused on structured small-cap core and small-cap value accounts. He earned his BBA in Finance at the Bernard M. Baruch School for Business and is a holder of the CFA designation. DENNIS S. RUHL, CFA . Mr. Ruhl, Vice President of Morgan, joined the company in 1999. He is a portfolio manager in the U.S. Small Cap Equity Group. His current responsibilities include managing structured small cap core and value accounts. Previously, he worked on quantitative equity research (focusing on trading) as well as business development. Mr. Ruhl earned Bachelor's degrees in Mathematics and Computer Science and a Master's degree in Computer Science, all from MIT. He has earned the right to use the Chartered Financial Analyst designation. SUB-ADVISOR: Mellon Equity Associates, LLP ("Mellon Equity"), 500 Grant Street, Suite 4200, Pittsburgh, PA 15258. Mellon Equity is a wholly owned subsidiary of Mellon Financial Corporation ("Mellon"). Mellon has approximately $4.7 trillion in assets under management, administration or custody, including $781 billion under management. As of December 31, 2005, Mellon Equity managed approximately $21.3 billion in assets. The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ MidCap Growth Adam T. Logan John O'Toole SmallCap Value Ronald P. Gala Peter D. Goslin
RONALD P. GALA, CFA . Mr. Gala is a portfolio manager of Dreyfus and a Senior Vice President and a principal of Mellon Equity. Mr. Gala has 20 years experience managing equity portfolios, and he is a past president of the Pittsburgh Society of Financial Analysts. Mr. Gala earned his MBA in Finance from the University of Pittsburgh and his BS in Business Administration from Duquesne University. He is a Chartered Financial Analyst. PETER D. GOSLIN, CFA . Mr. Goslin is a Vice President and Portfolio Manager with Mellon Equity. Before joining Mellon Equity in 1999, Mr. Goslin spent over four years with Merrill Lynch. During his tenure with Merrill, he worked as a NASDAQ market maker and an equity index options proprietary trader. Prior to that, he ran Merrill's S&P options desk at the Chicago Mercantile Exchange. Mr. Goslin earned his MBA in Finance at the University of Notre Dame Graduate School of Business following a BS in Finance from St. Vincent College. He has earned the right to use the Chartered Financial Analyst designation. ADAM T. LOGAN, CFA . Joining the company in 1998, Mr. Logan is a portfolio manager and Vice President of Mellon Equity. Previously, he performed duties as a financial analyst in Mellon Financial Corporation's corporate finance department. He is currently responsible for the management of client portfolios with a specific focus on mid and small capitalization securities. He earned a BA in Finance from Westminster College and an MBA from the Katz Graduate School of Business at the University of Pittsburgh. He has earned the right to use the Chartered Financial Analyst designation. JOHN O'TOOLE, CFA . Senior Vice President of Mellon Equity since 1990. Mr. O'Toole holds an MBA in Finance from the University of Chicago and a BA in Economics from the University of Pennsylvania. He is a member of the Association for Investment Management and Research, and the Pittsburgh Society of Financial Analysts. He is a Chartered Financial Analyst. 80 Principal Variable Contracts Fund 1-800-247-4123 SUB-ADVISOR: Morgan Stanley Investment Management Inc. ("MSIM Inc."), doing business in certain instances (including its role as sub-advisor to the Asset Allocation Account) under the name "Van Kampen," is a registered investment adviser, located at 1221 Avenue of the Americas, New York, New York, 10020, and is a direct subsidiary of Morgan Stanley. As of December 31, 2005, Van Kampen, together with its affiliated asset management companies, had approximately $434.0 billion in asset under management. The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Asset Allocation Francine J. Bovich
FRANCINE J. BOVICH . Ms. Bovich is Managing Director of Morgan Stanley and Morgan Stanley & Co. Incorporated since 1997. Principal 1993-1996. Ms. Bovich holds a BA in Economics from Connecticut College, and an MBA in Finance from New York University. Ms. Bovich is co-head of Morgan Stanley's Global Tactical Asset Allocation Team. Ms. Bovich is responsible for the overall allocation of the Fund's assets among equities, bonds and money market instruments. SUB-ADVISOR: Neuberger Berman Management, Inc. ("Neuberger Berman") is an affiliate of Neuberger Berman, LLC. Neuberger Berman, LLC is located at 605 Third Avenue, 2nd Floor, New York, NY 10158-0180. Together with Neuberger Berman, the firms manage more than $105.9 billion in total assets (as of December 31, 2005) and continue an asset management history that began in 1939. Neuberger Berman Management, Inc. is an indirect, wholly owned subsidiary of Lehman Brothers Holdings, Inc. Lehman Brothers is located at 745 Seventh Avenue, New York, NY 10019.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ MidCap Value S. Basu Mullick
S. BASU MULLICK . Mr. Mullick, Managing Director, Portfolio Manager, joined Neuberger Berman in 1998. He is manager of mid- to large-cap value Partners Fund and mid-cap value strategy totaling $5.4 billion in assets. Prior to joining the company, Mr. Mullick was a portfolio manager at Ark Asset Management. He earned a BA in Economics from the Presidency College, India. He also earned a MA in Economics and a Ph.D., ABD Finance from Rutgers University. SUB-ADVISOR: Principal Global Investors, LLC ("Principal") is an indirectly wholly-owned subsidiary of Principal Life Insurance Company and an affiliate of the Manager. Principal manages equity, fixed-income and real estate investments primarily for institutional investors, including Principal Life. As of December 31, 2005, Principal, together with its affiliated asset management companies, had approximately $159 billion in asset under management. Principal Global Investor's headquarters address is 801 Grand Avenue, Des Moines, Iowa 50392 and has other primary asset management offices in New York, London, Sydney and Singapore. The day-to-day portfolio management for some of the Accounts listed below is shared by two or more portfolio managers. In each such case, except where noted below, the portfolio managers operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio with no limitation on the authority of one Principal Variable Contracts Fund 81 www.principal.com portfolio manager in relation to another. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Balanced Dirk Laschanzky Bond William C. Armstrong Timothy R. Warrick Capital Value John Pihlblad Diversified International Paul H. Blankenhagen Juliet Cohn Christopher Ibach Equity Income Dirk Laschanzky Government & High Quality Bond Brad Fredericks Lisa Stange International Emerging Markets Michael A. Marusiak Michael L. Reynal International SmallCap Brian W. Pattinson LargeCap Stock Index Dirk Laschanzky Mariateresa Monaco MidCap K. William Nolin Money Market Tracy Reeg Alice Robertson SmallCap Thomas Morabito
WILLIAM C. ARMSTRONG, CFA . Mr. Armstrong is a portfolio manager for Principal. He manages multi-sector portfolios that invest in corporate bonds, mortgage-backed securities, commercial mortgage-backed securities, asset-backed securities, sovereigns, and agencies. He jointed the firm in 1992. Previously he served as a commissioned bank examiner at Federal Deposit Insurance Commission. He earned a Master's degree from the University of Iowa and a Bachelor's degree from Kearney State College. He has earned the right to use the Chartered Financial Analyst designation. PAUL H. BLANKENHAGEN, CFA . Mr. Blankenhagen joined the firm in 1992 and was named a portfolio manager in 2000. He is responsible for developing portfolio strategy and the ongoing management of core international equity portfolios. He earned a Master's degree from Drake University and a Bachelor's degree in Finance from Iowa State University. He has earned the right to use the Chartered Financial Analyst designation, and is a member of the Association for Investment Management and Research (AIMR) and the Iowa Society of Financial Analysts. JULIET COHN . Ms. Cohn is a portfolio manager at Principal. She co-manages the core international equity portfolios, with an emphasis on Europe and on the health care sector. Prior to joining the firm in 2003, she served as a director and senior portfolio manager at Allianz Dresdner Asset Management, managing both retail and institutional European accounts. Prior to that, she was a fund manager at London firms Capel Cure Myers and Robert Fleming. She earned a bachelor's degree in Mathematics from Trinity College, Cambridge England. BRAD FREDERICKS. . Mr. Fredericks is a portfolio manager at Principal. He is responsible for co-managing the government securities accounts. His responsibilities include general portfolio overview and security analysis. He joined the firm in 1998 as a financial accountant and was named a portfolio manager in 2002. Previously, Mr. Fredericks was an 82 Principal Variable Contracts Fund 1-800-247-4123 assistant trader at Norwest Mortgage. He earned a Bachelor's degree in Finance from Iowa State University. Mr. Fredericks is a Fellow of the Life Management Institute (FLMI). CHRISTOPHER IBACH, CFA . Mr. Ibach is an associate portfolio manager and equity research analyst at Principal. He specializes primarily in the analysis of international technology companies, with a particular emphasis on semi-conductor research. Prior to joining Principal in 2000, he gained six years of related industry experience with Motorola, Inc. Mr. Ibach earned an MBA in Finance and a Bachelor's degree in Electrical Engineering from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. DIRK LASCHANZKY, CFA . Mr. Laschanzky is a portfolio manager for Principal, responsible for portfolio implementation strategies, asset allocation and managing the midcap value and index portfolios. Prior to joining Principal in 1997, he was a portfolio manager and analyst for over seven years at AMR Investment Services. He earned an MBA and BA, both in Finance, from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. MICHAEL A. MARUSIAK . Mr. Marusiak is a portfolio manager for Principal. He specializes in the management of emerging markets portfolios, as well as regional Asian equity portfolios. Prior to joining Principal in 2000, he was an analyst at Trust Company of the West. He earned an MIA in International Finance from the Columbia University School of International and Public Affairs and a BA in Business Administration and Finance from Simon Fraser University of Burnaby, British Columbia. MARIATERESA MONACO . Ms. Monaco is an portfolio manager at Principal. She serves as portfolio manager for the firm's small-cap growth and index portfiols and as a member of the firm's asset allocation policy group. Prior to joining Principal in 2005, she was a quantitative equity analyst at Fidelity Management and Research supporting a family of institutional equity funds. Ms. Monaco earned an MBA from the Sloan School of Management at the Massachusetts Institute of Technology and a Master's degree in Electrical Engineering from Northeastern University. She also earned a Master's degree in Electrical Engineering from Politecnico di Torino, Italy, and a diploma in Piano from the Conservatorio di Torino, Italy. THOMAS MORABITO, CFA . Mr. Morabito leads the small-cap portfolio management team for Principal and is the portfolio manager on the small-cap value portfolios. Prior to joining Principal in 2000, he managed the Structured Small Cap Fund for Invesco Management & Research. He earned an MBA in Finance from Northeastern University and his BA in Economics from State University of New York. He has earned the right to use the Chartered Financial Analyst designation. K. WILLIAM NOLIN, CFA . Mr. Nolin is a portfolio manager for Principal. He serves as the portfolio manager for the firm's international small-cap equity portfolios. He joined the firm in 1994. He earned an MBA from the Yale School of Management and a Bachelor's degree in Finance from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. BRIAN W. PATTINSON, CFA . Mr. Pattinson is a portfolio manager at Principal. He serves as the portfolio manager for the firm's international small-cap equity portfolios. He joined Principal in 1994. Mr. Pattinson earned an MBA and Bachelor's degree in Finance from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. JOHN PIHLBLAD, CFA . Mr. Pihlblad is a portfolio manager at Principal. He joined the firm in 2000 and led the development of Principal Global Investors' Global Research Platform. He has over 25 years experience in creating and managing quantitative investment systems. Prior to joining Principal, Mr. Pihlblad was a partner and co-founder of GlobeFlex Capital in San Diego where he was responsible for the development and implementation of the investment process for both domestic and international products. He earned a BA from Westminster College. He has earned the right to use the Chartered Financial Analyst designation. TRACY REEG. . Ms. Reeg is a portfolio manager at Principal. She is involved in the portfolio management of money market portfolios. She joined the firm in 1993 and began trading and portfolio management duties in 2000. Ms. Reeg Principal Variable Contracts Fund 83 www.principal.com earned a Bachelor's degree in Finance from the University of Northern Iowa. She is a member of the Life Office Management Association (LOMA) and is a Fellow of the Life Management Institute (FLMI). MICHAEL L. REYNAL . Mr. Reynal is a portfolio manager at Principal. He specializes in the management of emerging markets portfolios, as well as regional Asian equity portfolios. Prior to joining Principal in 2001, he was responsible for equity investments in Latin America, the Mediterranean and the Balkans while at Wafra Investment Advisory Group, Inc. in New York. Mr. Reynal earned an MBA from the Amos Tuck School at Dartmouth College, an MA in History from Christ's College at the University of Cambridge and a BA in History from Middlebury College. ALICE ROBERTSON . Ms. Robertson is a trader for Principal on the corporate fixed-income trading desk. She joined the Principal Financial Group in 1990 as a credit analyst and moved to her current position in 1993. Previously, Ms. Robertson was an assistant vice president/commercial paper analyst with Duff & Phelps Credit Company. Ms. Robertson earned her Master's degree in Finance and Marketing from DePaul University and her Bachelor's degree in Economics from Northwestern University. LISA A. STANGE, CFA . Ms. Stange is a portfolio manager and strategist for Principal. She is responsible for managing the government securities portfolios and the mortgage-backed securities (MBS) within the multi-sector portfolios. As a strategies, Ms. Stange is involved in the formulation of broad investment strategy, quantitative research and product development. Previously, she was co-portfolio manager for U.S. multi-sector portfolios. She joined the firm in 1989. Ms. Stange earned an MBA and a Bachelor's degree from the University of Iowa. She has earned the right to use the Chartered Financial Analyst designation. TIMOTHY R. WARRICK, CFA . Mr. Warrick is a portfolio manager at Principal with responsibility for the corporate and U.S. multi-sector portfolios. He also serves as portfolio management team leader with responsibility for overseeing portfolio management function for all total return fixed income products. Prior to his portfolio management responsibilities with the firm, Mr. Warrick was a fixed income credit analyst and extensively involved in product development He joined the firm in 1990. He received an MBA in Finance from Drake University and a Bachelor's degree in Accounting and Economics from Simpson College. He has earned the right to use the Chartered Financial Analyst designation. SUB-ADVISOR: Principal Real Estate Investors, LLC ("Principal - REI"), an indirect wholly-owned subsidiary of Principal Life and an affiliate of the Manager, was founded in 2000. It manages investments for institutional investors, including Principal Life. As of December 31, 2005, Principal - REI, together with its affiliated asset management companies, had approximately $32.0 billion in asset under management. Principal - REI's address is 801 Grand Avenue, Des Moines, Iowa 50392. The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Real Estate Securities Kelly D. Rush
KELLY D. RUSH, CFA . As portfolio manager, Mr. Rush directs the Real Estate Investment Trust (REIT) activity for Principal Real Estate Investors, the dedicated real estate group of Principal. He has been managing real estate stock portfolio since 1997. Previously, Mr. Rush participated in structuring commercial mortgage loans for public real estate companies and the analysis of real estate investment trust issued bonds. He has been with the real estate investment area of the firm since 1987. He earned an MBA in Business Administration and a Bachelor's degree in Finance from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. 84 Principal Variable Contracts Fund 1-800-247-4123 SUB-ADVISOR: T. Rowe Price Associates, Inc. ("T. Rowe Price"), a wholly-owned subsidiary of T. Rowe Price Group, Inc., a financial services holding company, has over 68 years of investment management experience. Together with its affiliates, T. Rowe Price had approximately $269.5 billion in assets under management as of December 31, 2005. T. Rowe Price is located at 100 East Pratt Street, Baltimore, MD 21202. The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Equity Growth Robert W. Sharps
ROBERT W. SHARPS, CFA, CPA . Mr. Sharps is a Vice President of T. Rowe Price Group, Inc., and T. Rowe Price. He is also the lead Portfolio Manager with the Large-Cap Growth Strategy Team in the Equity Division. Prior to joining the firm in 1997, Mr. Sharps was a Senior Consultant at KPMG Peat Marwick. He earned a BS, summa cum laude, in Accounting from Towson University and an MBA in Finance from the Wharton School, University of Pennsylvania. He has also earned the Chartered Financial Analyst and Certified Public Accountant accreditations. SUB-ADVISOR: UBS Global Asset Management (Americas) Inc., a Delaware corporation located at One North Wacker, Chicago, IL 60606 ("UBS Global AM"), is a registered investment advisor. UBS Global AM, a subsidiary of UBS AG, is a member of the UBS Global Asset Management business group (the "Group") of UBS AG. As of December 31, 2005, UBS Global AM managed approximately $66.12 billion in assets and the Group managed approximately $581.49 billion in assets. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ SmallCap Growth Paul A. Graham, Jr. David N. Wabnik
PAUL A. GRAHAM, JR., CFA . Mr. Graham joined UBS Global AM in 1994 and has had portfolio management responsibilities since 1994. Mr. Graham is Managing Director, Head of Growth Investors and Co-Head of U.S. Small Cap Growth Equity. For eight years prior to joining the firm, he served as a small cap portfolio manager and research analyst at Value Line Asset Management. Mr. Graham received his BA from Dartmouth College. He has earned the right to use the Chartered Financial Analyst designation and is a member of the New York Society of Security Analysts. DAVID N. WABNIK . Mr. Wabnik joined UBS Global AM in 1995 and has been a portfolio manager since 1995. Mr. Wabnik is Executive Director, Co-Head of U.S. SmallCap Growth Equity. For four years prior to joining the firm, he served as a small cap portfolio manager/senior research analyst at Value Line Asset Management. Mr. Wabnik received his BS from Binghamton University and his MBA from Columbia Business School. He has completed the Certified Financial Analyst Level I exam. Principal Variable Contracts Fund 85 www.principal.com THE SUB-SUB-ADVISORS Principal Global Investors, LLC ("Principal") has entered into sub-sub-advisory agreements for various Accounts. Under these agreements, each sub-sub-advisor has agreed to assume the obligations of Principal for a certain portion of the Account's assets. The sub-sub-advisor is paid a fee by Principal. Principal is the sub-advisor for the Bond Account. Day-to-day management decisions concerning a portion of the Bond Account's portfolio are made by Spectrum Asset Management, Inc. ("Spectrum"), and Post Advisory Group, LLC ("Post") each of which serves as sub-sub-advisor. Principal is the sub-advisor for the Equity Income Account. Day-to-day management decisions concerning a portion of the Equity Income Account's portfolio are made by Principal Real Estate Investors LLC ("Principal - REI"), and Spectrum each of which serves as sub-sub-advisor. See the discussion regarding Principal - REI provided in connection with the Real Estate Securities Account for a description of the firm and the individual who serves as portfolio manager. SUB-ADVISOR: Post Advisory Group, LLC ("Post") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. Post was founded in April 1992. Its address is 11755 Wilshire Boulevard, Los Angeles, CA 90025. As of December 31, 2005, Post had $8.1 billion in asset under management. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account. LAWRENCE A. POST . Mr. Post is a chief executive office and chief investment officer for Post, an affiliate of Principal. He has over 35 years experience in the investment business, including 25 years in the high yield bond market. Prior to founding Post Advisory Group in 1992, he founded the high yield bond department at Smith Barney, and subsequently served as director of high yield research at Salomon Brothers and co-director of research and senior trader at Drexel Burnham Lambert. He earned an MBA in business administration from the University of Pennsylvania's Wharton School of Business and a Bachelor's degree from Lehigh University. ALLAN SCHWEITZER . Mr. Schweitzer is a Managing Director at Post. Prior to joining Post in 2000, he was a senior high yield analyst at Trust Company of the West ("TCW"). Prior to TCW, he was a high yield research analyst at Putnam Investments. Mr. Schweitzer earned a Bachelor's degree in Business Administration from Washington University at St. Louis and a Master's in Business Administration from the University of Chicago with a concentration in analytical finance and international economics. SUB-ADVISOR: Spectrum Asset Management, Inc. ("Spectrum") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. Spectrum was founded in 1987. Its address is 4 High Ridge Park, Stamford, CT 06905. As of December 31, 2005, Spectrum, together with its affiliated asset management companies, had approximately $13.2 billion in asset under management. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account. FERNANDO DIAZ. . Mr. Diaz is a vice president and assistant portfolio manager for Spectrum. Prior to joining Spectrum in 2000, Mr. Diaz was head of preferred trading at Spear, Leeds & Kellogg and Pershing, a division of DLJ, where he 86 Principal Variable Contracts Fund 1-800-247-4123 initiated preferred trading operations at both firms. Mr. Diaz has also worked at Goldman Sachs as an analyst in the Investment Banking division and in the Preferred Stock division as a trader and product analyst. L. PHILLIP JACOBY. . Mr. Jacoby is Sr. Vice President and Portfolio Manager for Spectrum and chairman of Spectrum's Investment Committee. Prior to joining Spectrum in 1995, he was a senior investment officer as USL Capital Corporation, a subsidiary of Ford Motor Corporate, and co-managed a $600 million preferred stock portfolio. He earned a earned a his BS in Finance from Boston University. BERNARD M. SUSSMAN. . Mr. Sussman is Chief Investment Officer of Spectrum and Chair of its Investment Committee. Prior to joining Spectrum in 1995, Mr. Sussman was a general partner and heard of the Preferred Stock area of Goldman Sachs & Co. He was responsible for sales, trading and underwriting for all preferred products and was instrumental in the development of the hybrid (MIPS) market. He earned both an MBA in Finance and a Bachelor's degree in Industrial Relations from Cornell University. JOSEPH J. URCIUOLI. . Mr. Urciuoli is a senior vice president and director of research for Spectrum and is responsible for all credit research supporting the client portfolios. He is also a portfolio manager. He joined Spectrum in 1998 from Presidential Life Insurance Company where he served as a fixed income analyst and assistant portfolio manager of a $2 billion portfolio. Mr. Urciuoli earned an MBA in Finance and a Bachelor's degree in finance from Long Island University. DUTIES OF THE MANAGER AND SUB-ADVISOR The Manager or Sub-Advisor provides the Directors of the Fund with a recommended investment program. The program must be consistent with the Account's investment objective and policies. Within the scope of the approved investment program, the Sub-Advisor advises the Account on its investment policy and determines which securities are bought or sold, and in what amounts. FEES PAID TO THE MANAGER The Manager is paid a fee by each Account for its services, which includes any fee paid to the Sub-Advisor. The fee paid by each Account (as a percentage of the average daily net assets) for the fiscal year ended December 31, 2005 was:
Asset Allocation 0.80% LargeCap Growth Equity 1.00% Balanced 0.59% LargeCap Stock Index 0.35% Bond 0.45% MidCap 0.57% Capital Value 0.60% MidCap Growth 0.90% Diversified International 0.85% MidCap Value 1.05% Equity Growth 0.76% Money Market 0.49% Equity Income 0.60% Real Estate Securities 0.88% Government & High Quality SmallCap Bond 0.44% 0.85% Growth 0.60% SmallCap Growth 1.00% International Emerging SmallCap Value Markets 1.25% 1.09% International SmallCap 1.19%
FEES PAID TO THE SUB-ADVISOR The Sub-Advisor fee paid by each Account (as a percentage of the average daily net assets) for the fiscal year ended December 31, 2005 was:
Asset Allocation LargeCap Growth Equity 0. 38 % Balanced LargeCap Stock Index 0.01% Bond MidCap 0.14% Capital Value MidCap Growth 0.3 6 % Diversified International MidCap Value 0.4 6 % Equity Growth Money Market 0.0 7 % Equity Income Real Estate Securities 0.54% Government & High Quality SmallCap 0. Bond 19 % Growth SmallCap Growth 0.5 4 % International Emerging SmallCap Value 0. Markets 49 % International SmallCap 0.48%
Principal Variable Contracts Fund 87 www.principal.com The Fund and the Manager, under an order received from the SEC, may enter into and materially amend agreements with Sub-Advisors, other than those affiliated with the Manager, without obtaining shareholder approval. For any Account that is relying on that order, the Manager may: . hire one or more Sub-Advisors; . change Sub-Advisors; and . reallocate management fees between itself and Sub-Advisors. The Manager will continue to have the ultimate responsibility for the investment performance of these Accounts due to its responsibility to oversee Sub-Advisors and recommend their hiring, termination and replacement. No Account will rely on the order until it receives approval from its shareholders or, in the case of a new Account, the Account's sole initial shareholder before the Account is available to the other purchasers, and the Account states in its prospectus that it intends to rely on the order. The Asset Allocation, Equity Growth, LargeCap Growth Equity, MidCap Growth, MidCap Value, SmallCap Growth and SmallCap Value Accounts have received the necessary shareholder approval and intend to rely on the order. 88 Principal Variable Contracts Fund 1-800-247-4123 GENERAL INFORMATION ABOUT AN ACCOUNT FREQUENT TRADING AND MARKET-TIMING (ABUSIVE TRADING PRACTICES) The Accounts of the Principal Variable Contracts Fund are not designed for frequent trading or market timing activity. The Fund has adopted fair valuation procedures to be used in the case of significant events, including broad market movements, occurring after the close of a foreign market in which securities are traded. The procedures will be followed if the Manager believes the events will impact the value of the foreign securities. These procedures are intended to discourage market timing transactions in shares of the Accounts. The Accounts do not knowingly accommodate frequent purchases and redemptions ("excessive trading") of Fund shares by investors. If you intend to trade frequently and/or use market timing investment strategies, do not purchase these Accounts. The Fund does not knowingly accommodate excessive trading. The Principal Variable Contracts Fund considers frequent trading and market timing activities to be abusive trading practices because they may: . Disrupt the management of the Accounts by; . forcing the Account to hold short-term (liquid) assets rather than investing for long term growth, which results in lost investment opportunities for the Account; and . causing unplanned portfolio turnover; . Hurt the portfolio performance of the Account; and . Increase expenses of the Account due to; . increased broker-dealer commissions; and . increased recordkeeping and related costs. If we are not able to identify such excessive trading practices, The Accounts may be negatively impacted and may cause investors to suffer the harms described. Certain Accounts may be at greater risk for abusive trading practices. For example, those Accounts that invest in foreign securities may appeal to investors attempting to take advantage of time-zone arbitrage. This risk is particularly relevant to the Diversified International, International Emerging Markets and International SmallCap Accounts but does apply to the purchase of foreign securities by any Account. As the Accounts of the Principal Variable Contracts Fund are only available through variable annuity or variable life contracts, the Principal Variable Contracts Fund must rely on Principal Life (as sponsor of the variable contract) to monitor customer trading activity to identify and take action against excessive trading. There can be no certainty that Principal Life will identify and prevent excessive trading in all instances. When Principal Life identifies excessive trading, Principal Life will act to curtail such trading in a fair and uniform manner. If Principal Life, or the Principal Variable Contracts Fund, deem excessive trading practices to be occurring, Principal Life will take action that may include, but is not limited to: . Rejecting exchange instructions from shareholder or other person authorized by the shareholder to direct exchanges; . Restricting submission of exchange requests by, for example, allowing exchange requests to be submitted by 1st class U.S. mail only and disallowing requests made via the internet, by facsimile, by overnight courier or by telephone; . Limiting the dollar amount of an exchange and/or the number of exchanges during a year; . Requiring a holding period of a minimum of 30 days before permitting exchanges among the Accounts where there is evidence of at least one round-trip exchange (exchange or redemption of shares that were purchased within 30 days of the exchange/redemption); and . Taking such other action as directed by the Principal Variable Contracts Fund. The Principal Variable Contracts Fund has reserved the right to accept or reject, without prior written notice, any exchange requests. In some instances, an exchange may be completed prior to a determination of abusive trading. In those instances, Principal Life will reverse an exchange (within three business days of the exchange) and return the account holdings to the positions held prior to the exchange. Principal Life will give you notice in writing in this instance. Principal Variable Contracts Fund 89 www.principal.com ELIGIBLE PURCHASERS Only certain eligible purchasers may buy shares of the Accounts. Eligible purchasers are limited to 1) separate accounts of Principal Life or of other insurance companies, 2) Principal Life or any of its subsidiaries or affiliates, 3) trustees of other managers of any qualified profit sharing, incentive or bonus plan established by Principal Life or any of its subsidiaries or affiliates for employees of such company, subsidiary or affiliate. Such trustees or managers may buy Account shares only in their capacities as trustees or managers and not for their personal accounts. The Board of Directors of the Fund reserves the right to broaden or limit the designation of eligible purchaser. Each Account serves as the underlying investment vehicle for variable annuity contracts and variable life insurance policies that are funded through separate accounts established by Principal Life. It is possible that in the future, it may not be advantageous for variable life insurance separate accounts and variable annuity separate accounts to invest in the Accounts at the same time. Although neither Principal Life nor the Fund currently foresees any such disadvantage, the Fund's Board of Directors monitors events in order to identify any material conflicts between such policy owners and contract holders. Material conflict could result from, for example, 1) changes in state insurance laws, 2) changes in Federal income tax law, 3) changes in the investment management of an Account, or 4) differences in voting instructions between those given by policy owners and those given by contract holders. Should it be necessary, the Board would determine what action, if any, should be taken. Such action could include the sale of Account shares by one or more of the separate accounts which could have adverse consequences. SHAREHOLDER RIGHTS The following information applies to each Account of the Principal Variable Contracts Fund, Inc. Each Account share is eligible to vote, either in person or by proxy, at all shareholder meetings for that Account. This includes the right to vote on the election of directors, selection of independent auditors and other matters submitted to meetings of shareholders of the Account. Each share has equal rights with every other share of the Account as to dividends, earnings, voting, assets and redemption. Shares are fully paid, non-assessable and have no preemptive or conversion rights. Shares of an Account are issued as full or fractional shares. Each fractional share has proportionately the same rights including voting as are provided for a full share. Shareholders of the Fund may remove any director with or without cause by the vote of a majority of the votes entitled to be case at a meeting of all Account shareholders. The bylaws of the Fund provide that the Board of Directors of the Fund may increase or decrease the aggregate number of shares that the Fund has the authority to issue, without a shareholder vote. The bylaws of the Fund also provide that the Fund does not need to hold an annual meeting of shareholders unless one of the following is required to be acted upon by shareholders under the Investment Company Act of 1940: election of directors; approval of an investment advisory agreement; ratification of the selection of independent auditors; and approval of the distribution agreement. The Fund intends to hold shareholder meetings only when required by law and at such other times when the Board of Directors deems it to be appropriate. Shareholder inquiries should be directed to: Principal Variable Contracts Fund, Inc., Principal Financial Group, Des Moines, Iowa 50392-2080. NON-CUMULATIVE VOTING The Fund's shares have non-cumulative voting rights. This means that the holders of more than 50% of the shares voting for the election of directors of the Fund can elect 100% of the directors if they choose to do so. In such event, the holders of the remaining shares voting for the election of directors will not be able to elect any directors. Principal Life votes each Account's shares allocated to each of its separate accounts registered under the Investment Company Act of 1940 and attributable to variable annuity contracts or variable life insurance policies participating in the separate accounts. The shares are voted in accordance with instructions received from contract holders, policy owners, participants and annuitants. Other shares of each Account held by each separate account, including shares for which no timely voting instructions are received, are voted in proportion to the instructions that are received with respect to contracts or policies participating that separate account. Shares of each of the Accounts held in the general account of Principal Life or in the unregistered separate accounts are voted in proportion to the instructions that are received with respect to contracts and policies participating in its registered and unregistered separate accounts. If Principal Life determines, under applicable law, that an Account's shares held in one or more separate accounts or in 90 Principal Variable Contracts Fund 1-800-247-4123 its general account need not be voted according to the instructions that are received, it may vote those Account shares in its own right. PURCHASE OF ACCOUNT SHARES Shares are purchased from Princor Financial Services Corporation, the Fund's principal underwriter. There are no sales charges on shares of the Accounts, however, your variable contract may impose a charge. There are no restrictions on amounts to be invested in shares of the Accounts. Shareholder accounts for each Account are maintained under an open account system. Under this system, an account is opened and maintained for each investor. Each investment is confirmed by sending the investor a statement of account showing the current purchase and the total number of shares owned. The statement of account is treated by each Account as evidence of ownership of Account shares. Share certificates are not issued. SALE OF ACCOUNT SHARES This section applies to eligible purchasers other than the separate accounts of Principal Life and its subsidiaries. Each Account sells its shares upon request. There is no charge for the sale. A shareholder sends a written request to the Account requesting the sale of any part or all of the shares. The letter must be signed exactly as the account is registered. If payment is to be made to the registered shareholder or joint shareholder, the Account does not require a signature guarantee. If payment is to be made to another party, the shareholder's signature(s) must be guaranteed by a commercial bank, trust company, credit union, savings and loan association, national securities exchange member or brokerage firm. Shares are redeemed at the net asset value per share next computed after the request is received by the Account in proper and complete form. Sales proceeds are generally sent within three business days after the request is received in proper form. However, the right to sell shares may be suspended during any period when 1) trading on the NYSE is restricted as determined by the SEC or when the NYSE is closed for other than weekends and holidays, or 2) an emergency exists, as determined by the SEC, as a result of which a) disposal by a fund of securities owned by it is not reasonably practicable, b) it is not reasonably practicable for a fund to fairly determine the value of its net assets, or c) the SEC permits suspension for the protection of security holders. If payments are delayed and the instruction is not canceled by the shareholder's written instruction, the amount of the transaction is determined as of the first valuation date following the expiration of the permitted delay. The transaction occurs within five days thereafter. In addition, payments on surrenders attributable to a premium payment made by check may be delayed up to 15 days. This permits payment to be collected on the check. RESTRICTED TRANSFERS Shares of each of the Accounts may be transferred to an eligible purchaser. However, if an Account is requested to transfer shares to other than an eligible purchaser, the Account has the right, at its election, to purchase the shares at the net asset value next calculated after the receipt of the transfer request. However, the Account must give written notification to the transferee(s) of the shares of the election to buy the shares within seven days of the request. Settlement for the shares shall be made within the seven-day period. FINANCIAL STATEMENTS You will receive an annual financial statement for the Fund, audited by the Fund's independent registered public accounting firm, Ernst & Young LLP. That report is a part of this prospectus. You will also receive a semiannual financial statement that is unaudited. FINANCIAL HIGHLIGHTS The following financial highlights tables are intended to help you understand the Fund's financial performance for the periods shown. Certain information reflects results for a single Fund share. The total returns in each table represent the Principal Variable Contracts Fund 91 www.principal.com rate that an investor would have earned or lost each period on an investment in the Fund (assuming reinvestment of all distributions). The financial statements for the Fund were audited by Ernst & Young LLP, whose report, along with the financial statements, is included in the most recent annual report for the Fund. To receive a copy of the latest annual or semiannual report for the Fund, you may telephone 1-800-247-4123. FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- ASSET ALLOCATION ACCOUNT ------------------------ Net Asset Value, Beginning of Period.. $12.28 $11.70 $9.82 $11.28 $12.02 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.19 0.14 0.15 0.20 0.24 Net Realized and Unrealized Gain (Loss) on Investments......... 0.51 0.82 1.92 (1.66) (0.71) ---- ---- ---- ----- ----- Total From Investment Operations 0.70 0.96 2.07 (1.46) (0.47) Less Dividends and Distributions: Dividends from Net Investment Income... (0.20) (0.38) (0.19) -- (0.24) Distributions from Realized Gains...... -- -- -- -- (0.03) ---- ----- Total Dividends and Distributions (0.20) (0.38) (0.19) -- (0.27) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $12.78 $12.28 $11.70 $9.82 $11.28 ====== ====== ====== ===== ====== Total Return /(a)/ ... 5.79% 8.49% 21.61% (12.94)% (3.92)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $100,637 $103,131 $98,006 $82,409 $101,904 Ratio of Expenses to Average Net Assets.. 0.86% 0.84% 0.85% 0.84% 0.85% Ratio of Net Investment Income to Average Net Assets.. 1.53% 1.19% 1.49% 1.79% 2.23% Portfolio Turnover Rate................ 83.5% 127.0% 186.0% 255.3% 182.4% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- BALANCED ACCOUNT ---------------- Net Asset Value, Beginning of Period.. $14.34 $13.31 $11.56 $13.73 $15.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.31 0.31 0.27 0.34 0.40/(c)/ Net Realized and Unrealized Gain (Loss) on Investments......... 0.64 1.00 1.83 (2.11) (1.42)/(c)/ ---- ---- ---- ----- ----- Total From Investment Operations 0.95 1.31 2.10 (1.77) (1.02) Less Dividends and Distributions: Dividends from Net Investment Income... (0.36) (0.28) (0.35) (0.40) (0.47) Distributions from Realized Gains...... -- -- -- -- (0.21) ---- ----- Total Dividends and Distributions (0.36) (0.28) (0.35) (0.40) (0.68) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $14.93 $14.34 $13.31 $11.56 $13.73 ====== ====== ====== ====== ====== Total Return /(a)/ ... 6.79% 10.05% 18.82% (13.18)% (6.96)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $116,927 $126,548 $124,735 $110,545 $144,214 Ratio of Expenses to Average Net Assets.. 0.64% 0.63% 0.65% 0.61% 0.61% Ratio of Gross Expenses to Average Net Assets.......... -- 0.63%/(b)/ 0.65%/(b)/ 0.62%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 2.19% 2.32% 2.23% 2.52% 2.73%/(c)/ Portfolio Turnover Rate................ 115.3% 128.3% 114.3% 87.8% 114.3%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. /(c) /Effective January 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies. The effect of this change for the year ended December 31, 2001 was to decrease net investment income per share by $.01, increase net realized and unrealized gains/losses per share by $.01, and decrease the ratio of net investment income to average net assets by .08%. Financial highlights for prior periods have not been restated to reflect this change in presentation. 67 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- BOND ACCOUNT ------------ Net Asset Value, Beginning of Period.. $12.31 $12.31 $12.32 $11.84 $11.78 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.50 0.51 0.52 0.51 0.56/(c)/ Net Realized and Unrealized Gain (Loss) on Investments......... (0.20) 0.08 0.02 0.54 0.35/(c)/ ----- ---- ---- ---- ---- Total From Investment Operations 0.30 0.59 0.54 1.05 0.91 Less Dividends and Distributions: Dividends from Net Investment Income... (0.57) (0.59) (0.55) (0.57) (0.85) ----- ----- ----- ----- ----- Total Dividends and Distributions (0.57) (0.59) (0.55) (0.57) (0.85) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $12.04 $12.31 $12.31 $12.32 $11.84 ====== ====== ====== ====== ====== Total Return /(a)/ ... 2.50% 4.98% 4.59% 9.26% 8.12% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $338,044 $286,684 $263,435 $232,839 $166,658 Ratio of Expenses to Average Net Assets.. 0.47% 0.47% 0.47% 0.49% 0.50% Ratio of Net Investment Income to Average Net Assets.. 4.21% 4.23% 4.32% 5.02% 5.73%/(c)/ Portfolio Turnover Rate................ 176.2% 143.6% 82.1% 63.3% 146.1% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- CAPITAL VALUE ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $32.39 $29.23 $23.60 $27.78 $30.72 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.54 0.44 0.38 0.39 0.34 Net Realized and Unrealized Gain (Loss) on Investments......... 1.66 3.17 5.63 (4.18) (2.80) ---- ---- ---- ----- ----- Total From Investment Operations 2.20 3.61 6.01 (3.79) (2.46) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.45) (0.38) (0.39) (0.34) Distributions from Realized Gains...... -- -- -- -- (0.14) ----- ----- Total Dividends and Distributions -- (0.45) (0.38) (0.39) (0.48) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $34.59 $32.39 $29.23 $23.60 $27.78 ====== ====== ====== ====== ====== Total Return /(a)/ ... 6.80% 12.36% 25.49% (13.66)% (8.05)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $258,490 $265,580 $248,253 $206,541 $254,484 Ratio of Expenses to Average Net Assets.. 0.61% 0.60% 0.61% 0.61% 0.61% Ratio of Gross Expenses to Average Net Assets.......... -- 0.60%/(b)/ 0.61%/(b)/ 0.61%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.62% 1.47% 1.47% 1.45% 1.20% Portfolio Turnover Rate................ 120.9% 183.3% 125.7% 142.6% 91.7%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. /(c) /Effective January 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies. The effect of this change for the year ended December 31, 2001 was to decrease net investment income per share by $.01, increase net realized and unrealized gains/losses per share by $.01, and decrease the ratio of net investment income to average net assets by .08%. Financial highlights for prior periods have not been restated to reflect this change in presentation. 68 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- DIVERSIFIED INTERNATIONAL ACCOUNT --------------------------------- Net Asset Value, Beginning of Period /(a)/ ............... $13.75 $11.48 $8.78 $10.51 $13.90 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.18 0.17 0.13 0.10 0.09 Net Realized and Unrealized Gain (Loss) on Investments......... 3.05 2.22 2.67 (1.78) (3.46) ---- ---- ---- ----- ----- Total From Investment Operations 3.23 2.39 2.80 (1.68) (3.37) Less Dividends and Distributions: Dividends from Net Investment Income... (0.15) (0.12) (0.10) (0.05) (0.02) ----- ----- ----- ----- ----- Total Dividends and Distributions (0.15) (0.12) (0.10) (0.05) (0.02) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $16.83 $13.75 $11.48 $8.78 $10.51 ====== ====== ====== ===== ====== Total Return /(b)/ ... 23.79% 21.03% 32.33% (16.07)% (24.27)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $293,647 $226,753 $167,726 $119,222 $145,848 Ratio of Expenses to Average Net Assets.. 0.97% 0.96% 0.92% 0.92% 0.92% Ratio of Gross Expenses to Average Net Assets.......... 0.97%/(c)/ 0.97%/(d)/ 0.93%/(d)/ 0.93%/(d)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.27% 1.39% 1.33% 1.03% 0.78% Portfolio Turnover Rate................ 121.2% 170.1% 111.5% 82.2% 84.3% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- EQUITY GROWTH ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $16.02 $14.73 $11.74 $16.29 $20.37 Income from Investment Operations: Net Investment Income (Operating Loss).... -- 0.09 0.06 0.03 0.01 Net Realized and Unrealized Gain (Loss) on Investments......... 1.21 1.28 2.99 (4.54) (2.82) ---- ---- ---- ----- ----- Total From Investment Operations 1.21 1.37 3.05 (4.51) (2.81) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.08) (0.06) (0.04) (0.02) Distributions from Realized Gains...... -- -- -- -- (1.25) ---- ----- Total Dividends and Distributions -- (0.08) (0.06) (0.04) (1.27) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $17.23 $16.02 $14.73 $11.74 $16.29 ====== ====== ====== ====== ====== Total Return /(b)/ ... 7.55% 9.33% 25.95% (27.72)% (14.86)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $274,192 $280,700 $272,831 $219,044 $334,401 Ratio of Expenses to Average Net Assets.. 0.77% 0.72% 0.74% 0.77% 0.75% Ratio of Gross Expenses to Average Net Assets.......... -- 0.77%/(e)/ 0.77%/(e)/ -- -- Ratio of Net Investment Income to Average Net Assets.. 0.00% 0.59% 0.47% 0.19% 0.06% Portfolio Turnover Rate................ 51.6% 147.7% 130.9% 138.8% 88.8%
/(a) /Effective May 1, 2005, International Account changed its name to Diversified International Account. /(b) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(c) /Expense ratio without custodian credits. /(d) /Expense ratio without commission rebates and custodian credits. /(e) /Expense ratio without commission rebates. 69 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- EQUITY INCOME ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $9.01 $7.93 $7.26 $8.73 $12.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.37 0.34 0.34 0.37 0.25 Net Realized and Unrealized Gain (Loss) on Investments......... 0.41 1.05 0.66 (1.47) (3.70) ---- ---- ---- ----- ----- Total From Investment Operations 0.78 1.39 1.00 (1.10) (3.45) Less Dividends and Distributions: Dividends from Net Investment Income... (0.01) (0.31) (0.33) (0.37) (0.25) ---- Total Dividends and Distributions (0.01) (0.31) (0.33) (0.37) (0.25) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $9.78 $9.01 $7.93 $7.26 $8.73 ===== ===== ===== ===== ===== Total Return /(b)/ ... 8.67% 17.60% 13.83% (12.61)% (27.70)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $91,489 $44,572 $30,255 $25,079 $33,802 Ratio of Expenses to Average Net Assets.. 0.66% 0.62% 0.61% 0.62% 0.62% Ratio of Net Investment Income to Average Net Assets.. 3.93% 4.13% 4.54% 4.40% 2.22% Portfolio Turnover Rate................ 84.7% 137.2% 22.5% 66.4% 104.2% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- GOVERNMENT & HIGH QUALITY BOND ACCOUNT /(A)/ -------------------------------------- Net Asset Value, Beginning of Period.. $11.64 $11.77 $12.00 $11.58 $11.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.44 0.44 0.45 0.43 0.51 Net Realized and Unrealized Gain (Loss) on Investments......... (0.21) (0.04) (0.24) 0.55 0.32 ---- ----- ----- ---- ---- Total From Investment Operations 0.23 0.40 0.21 0.98 0.83 Less Dividends and Distributions: Dividends from Net Investment Income... (0.51) (0.53) (0.44) (0.52) (0.68) Distributions from Realized Gains...... -- -- -- (0.04) -- ---- ----- Total Dividends and Distributions (0.51) (0.53) (0.44) (0.56) (0.68) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $11.36 $11.64 $11.77 $12.00 $11.58 ====== ====== ====== ====== ====== Total Return /(b)/ ... 2.01% 3.56% 1.84% 8.80% 7.61% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $316,047 $334,034 $368,564 $342,001 $193,254 Ratio of Expenses to Average Net Assets.. 0.46% 0.44% 0.44% 0.47% 0.49% Ratio of Net Investment Income to Average Net Assets.. 3.88% 3.82% 3.83% 4.87% 5.63% Portfolio Turnover Rate................ 262.1% 67.2% 110.4% 33.8% 45.9%
/(a) /Effective November 19, 2005, Government Securities Account changed its name to Government & High Quality Bond Account. /(b) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. 70 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- GROWTH ACCOUNT -------------- Net Asset Value, Beginning of Period.. $11.94 $10.95 $8.68 $12.24 $16.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.03 0.07 0.03 0.02 -- Net Realized and Unrealized Gain (Loss) on Investments......... 1.40 0.95 2.26 (3.58) (4.19) ---- ---- ---- ----- ----- Total From Investment Operations 1.43 1.02 2.29 (3.56) (4.19) Less Dividends and Distributions: Dividends from Net Investment Income... (0.08) (0.03) (0.02) -- -- ---- Total Dividends and Distributions (0.08) (0.03) (0.02) -- -- ---- ----- ----- ----- Net Asset Value, End of Period............ $13.29 $11.94 $10.95 $8.68 $12.24 ====== ====== ====== ===== ====== Total Return /(b)/ ... 12.09% 9.38% 26.46% (29.07)% (25.50)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $124,254 $134,956 $141,107 $124,079 $209,879 Ratio of Expenses to Average Net Assets.. 0.62% 0.60% 0.61% 0.61% 0.61% Ratio of Gross Expenses to Average Net Assets.......... -- 0.60%/(f)/ 0.61%/(f)/ 0.61%/(f)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.26% 0.67% 0.35% 0.18% 0.02% Portfolio Turnover Rate................ 78.3% 122.4% 40.8% 27.3% 39.0% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- INTERNATIONAL EMERGING MARKETS ACCOUNT -------------------------------------- Net Asset Value, Beginning of Period.. $14.78 $12.86 $8.24 $8.93 $9.37 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.22 0.12 0.11 0.02 0.08 Net Realized and Unrealized Gain (Loss) on Investments......... 4.46 3.04 4.60 (0.70) (0.48) ---- ---- ---- ----- ----- Total From Investment Operations 4.68 3.16 4.71 (0.68) (0.40) Less Dividends and Distributions: Dividends from Net Investment Income... (0.17) (0.10) (0.08) -- (0.04) Distributions from Realized Gains...... (3.27) (1.14) -- -- -- Tax Return of Capital Distributions /(a)/. -- -- (0.01) (0.01) -- ----- ----- ----- Total Dividends and Distributions (3.44) (1.24) (0.09) (0.01) (0.04) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $16.02 $14.78 $12.86 $8.24 $8.93 ====== ====== ====== ===== ===== Total Return /(b)/ ... 34.29% 24.89% 57.20% (7.63)% (4.24)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $71,639 $43,502 $23,972 $10,835 $6,964 Ratio of Expenses to Average Net Assets.. 1.60% 1.53% 1.71% 1.60% 1.35% Ratio of Gross Expenses to Average Net Assets /(c)/ ... 1.60%/(d)/ 1.55%/(e)/ 1.84%/(e)/ 2.26%/(e)/ 2.33% Ratio of Net Investment Income to Average Net Assets.. 1.45% 0.87% 1.16% 0.39% 0.97% Portfolio Turnover Rate................ 169.6% 171.0% 112.4% 147.7% 137.4%
/(a) /See "Dividends and Distributions to Shareholders" in Notes to Financial Statements. /(b) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(c) /Expense ratio without the Manager's voluntary expense limit. The expense limit was increased on May 1, 2002, and May 1, 2003, and ceased on May 1, 2004. /(d) /Expense ratio without custodian credits. /(e) /Expense ratio without commission rebates and custodian credits. /(f) /Expense ratio without commission rebates. 72 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- INTERNATIONAL SMALLCAP ACCOUNT ------------------------------ Net Asset Value, Beginning of Period.. $17.72 $13.73 $9.06 $10.84 $13.87 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.12 0.11 0.10 0.08 0.04 Net Realized and Unrealized Gain (Loss) on Investments......... 4.96 4.00 4.72 (1.83) (3.07) ---- ---- ---- ----- ----- Total From Investment Operations 5.08 4.11 4.82 (1.75) (3.03) Less Dividends and Distributions: Dividends from Net Investment Income... (0.11) (0.12) (0.15) (0.03) -- Distributions from Realized Gains...... (0.19) -- -- -- -- ---- ----- Total Dividends and Distributions (0.30) (0.12) (0.15) (0.03) -- ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $22.50 $17.72 $13.73 $9.06 $10.84 ====== ====== ====== ===== ====== Total Return /(a)/ ... 29.12% 30.20% 54.15% (16.20)% (21.85)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $143,454 $99,833 $66,242 $38,912 $43,674 Ratio of Expenses to Average Net Assets.. 1.33% 1.30% 1.33% 1.31% 1.41% Ratio of Gross Expenses to Average Net Assets.......... 1.33%/(c)/ 1.31%/(d)/ 1.33%/(d)/ 1.32%/(d)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.63% 0.75% 1.00% 0.77% 0.32% Portfolio Turnover Rate................ 132.3% 140.6% 128.9% 73.6% 123.8% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- LARGECAP GROWTH EQUITY ACCOUNT ------------------------------ Net Asset Value, Beginning of Period.. $4.60 $4.47 $3.63 $5.44 $7.78 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.01 0.01 -- (0.02) (0.03) Net Realized and Unrealized Gain (Loss) on Investments......... 0.16 0.13 0.84 (1.79) (2.31) ---- ---- ---- ----- ----- Total From Investment Operations 0.17 0.14 0.84 (1.81) (2.34) Less Dividends and Distributions: Dividends from Net Investment Income... (0.01) (0.01) -- -- -- ----- ----- ----- Total Dividends and Distributions (0.01) (0.01) -- -- -- ----- ----- ----- Net Asset Value, End of Period............ $4.76 $4.60 $4.47 $3.63 $5.44 ===== ===== ===== ===== ===== Total Return /(a)/ ... 3.63% 3.16% 23.14% (33.27)% (30.08)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $36,912 $31,179 $24,677 $5,572 $5,172 Ratio of Expenses to Average Net Assets.. 1.09% 1.04% 1.16% 1.05% 1.10% Ratio of Gross Expenses to Average Net Assets /(b)/ ... -- 1.05%/(e)/ 1.19%/(e)/ 1.09%/(e)/ 1.11% Ratio of Net Investment Income to Average Net Assets.. 0.18% 0.28% (0.13)% (0.49)% (0.62)% Portfolio Turnover Rate................ 91.2% 141.8% 51.1% 183.8% 121.2%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on May 1, 2002. /(c) /Expense ratio without custodian credits. /(d) /Expense ratio without commission rebates and custodian credits. /(e) /Expense ratio without commission rebates. 72 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- LARGECAP STOCK INDEX ACCOUNT ---------------------------- Net Asset Value, Beginning of Period.. $8.77 $8.06 $6.35 $8.29 $9.52 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.13 0.14 0.10 0.08 0.08 Net Realized and Unrealized Gain (Loss) on Investments......... 0.26 0.70 1.70 (1.94) (1.23) ---- ---- ---- ----- ----- Total From Investment Operations 0.39 0.84 1.80 (1.86) (1.15) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.13) (0.09) (0.08) (0.08) ----- Total Dividends and Distributions -- (0.13) (0.09) (0.08) (0.08) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $9.16 $8.77 $8.06 $6.35 $8.29 ===== ===== ===== ===== ===== Total Return /(a)/ ... 4.47% 10.39% 28.32% (22.44)% (12.10)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $179,143 $158,237 $118,638 $72,949 $73,881 Ratio of Expenses to Average Net Assets.. 0.38% 0.37% 0.39% 0.39% 0.40% Ratio of Gross Expenses to Average Net Assets /(b)/ ... 0.38% 0.37% 0.39% 0.39% 0.41% Ratio of Net Investment Income to Average Net Assets.. 1.52% 1.64% 1.42% 1.22% 1.05% Portfolio Turnover Rate................ 13.1% 20.5% 15.7% 15.1% 10.8% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MIDCAP ACCOUNT -------------- Net Asset Value, Beginning of Period.. $39.63 $37.56 $28.54 $32.09 $34.47 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.45 0.39 0.35 0.30 0.24 Net Realized and Unrealized Gain (Loss) on Investments......... 3.12 6.05 9.01 (3.08) (1.50) ---- ---- ---- ----- ----- Total From Investment Operations 3.57 6.44 9.36 (2.78) (1.26) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.39) (0.34) (0.30) (0.24) Distributions from Realized Gains...... (0.66) (3.98) -- (0.47) (0.88) ---- ----- ----- ----- ----- Total Dividends and Distributions (0.66) (4.37) (0.34) (0.77) (1.12) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $42.54 $39.63 $37.56 $28.54 $32.09 ====== ====== ====== ====== ====== Total Return /(a)/ ... 9.21% 17.76% 32.81% (8.75)% (3.71)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $420,812 $395,304 $334,204 $248,986 $278,707 Ratio of Expenses to Average Net Assets.. 0.58% 0.59% 0.61% 0.62% 0.62% Ratio of Gross Expenses to Average Net Assets.......... -- 0.59%/(c)/ 0.61%/(c)/ 0.62%/(c)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.13% 1.02% 1.09% 0.98% 0.77% Portfolio Turnover Rate................ 49.9% 38.9% 44.9% 67.9% 73.6%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on April 29, 2005. /(c) /Expense ratio without commission rebates. 74 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MIDCAP GROWTH ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $9.84 $8.80 $6.26 $8.49 $10.46 Income from Investment Operations: Net Investment Income (Operating Loss).... (0.02) (0.03) (0.03) (0.04) (0.05) Net Realized and Unrealized Gain (Loss) on Investments......... 1.37 1.07 2.57 (2.19) (1.68) ---- ---- ---- ----- ----- Total From Investment Operations 1.35 1.04 2.54 (2.23) (1.73) Less Dividends and Distributions: Distributions from Realized Gains...... -- -- -- -- (0.24) ---- ----- Total Dividends and Distributions -- -- -- -- (0.24) ---- ----- Net Asset Value, End of Period............ $11.19 $9.84 $8.80 $6.26 $8.49 ====== ===== ===== ===== ===== Total Return /(a)/ ... 13.72% 11.82% 40.58% (26.27)% (16.92)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $68,471 $59,674 $54,288 $21,934 $27,838 Ratio of Expenses to Average Net Assets.. 0.92% 0.86% 0.91% 0.91% 0.97% Ratio of Gross Expenses to Average Net Assets.......... -- 0.92%/(b)/ 0.94%/(b)/ 0.92%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. (0.15)% (0.30)% (0.39)% (0.55)% (0.66)% Portfolio Turnover Rate................ 97.0% 47.7% 67.5% 43.1% 55.2% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MIDCAP VALUE ACCOUNT -------------------- Net Asset Value, Beginning of Period.. $15.38 $14.13 $10.48 $11.68 $12.57 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.05 0.02 0.01 -- 0.01 Net Realized and Unrealized Gain (Loss) on Investments......... 1.53 3.10 3.81 (1.16) (0.35) ---- ---- ---- ----- ----- Total From Investment Operations 1.58 3.12 3.82 (1.16) (0.34) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.01) (0.01) -- (0.01) Distributions from Realized Gains...... (0.39) (1.86) (0.16) (0.04) (0.54) ----- ----- ----- ----- ----- Total Dividends and Distributions (0.39) (1.87) (0.17) (0.04) (0.55) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $16.57 $15.38 $14.13 $10.48 $11.68 ====== ====== ====== ====== ====== Total Return /(a)/ ... 10.55% 22.67% 36.49% (9.96)% (2.58)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $112,437 $78,166 $52,054 $24,766 $11,778 Ratio of Expenses to Average Net Assets.. 1.07% 1.05% 1.05% 1.04% 1.36% Ratio of Gross Expenses to Average Net Assets.......... -- 1.08%/(b)/ 1.08%/(b)/ 1.10%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.32% 0.11% 0.11% 0.03% 0.12% Portfolio Turnover Rate................ 90.6% 59.2% 55.5% 75.3% 208.8%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. 75 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MONEY MARKET ACCOUNT -------------------- Net Asset Value, Beginning of Period.. $1.000 $1.000 $1.000 $1.000 $1.000 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.027 0.009 0.007 0.014 0.039 ----- ----- ----- ----- ----- Total From Investment Operations 0.027 0.009 0.007 0.014 0.039 Less Dividends and Distributions: Dividends from Net Investment Income... (0.027) (0.009) (0.007) (0.014) (0.039) ------ ------ ------ ------ ------ Total Dividends and Distributions (0.027) (0.009) (0.007) (0.014) (0.039) ------ ------ ------ ------ ------ Net Asset Value, End of Period............ $1.000 $1.000 $1.000 $1.000 $1.000 ====== ====== ====== ====== ====== Total Return /(a)/ ... 2.69% 0.92% 0.74% 1.42% 3.92% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $150,653 $140,553 $151,545 $201,455 $180,923 Ratio of Expenses to Average Net Assets.. 0.61% 0.49% 0.49% 0.49% 0.50% Ratio of Net Investment Income to Average Net Assets.. 2.66% 0.91% 0.74% 1.40% 3.70% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- REAL ESTATE SECURITIES ACCOUNT ------------------------------ Net Asset Value, Beginning of Period.. $17.88 $14.90 $11.24 $10.77 $10.29 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.40 0.39 0.49 0.35 0.42 Net Realized and Unrealized Gain (Loss) on Investments......... 2.39 4.66 3.87 0.48 0.47 ---- ---- ---- ---- ---- Total From Investment Operations 2.79 5.05 4.36 0.83 0.89 Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.35) (0.42) (0.35) (0.41) Distributions from Realized Gains...... (0.16) (1.72) (0.28) (0.01) -- ---- ----- ----- ----- ----- Total Dividends and Distributions (0.16) (2.07) (0.70) (0.36) (0.41) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $20.51 $17.88 $14.90 $11.24 $10.77 ====== ====== ====== ====== ====== Total Return /(a)/ ... 15.85% 34.53% 38.91% 7.72% 8.75% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $178,922 $146,022 $93,018 $46,358 $22,457 Ratio of Expenses to Average Net Assets.. 0.89% 0.90% 0.91% 0.92% 0.92% Ratio of Gross Expenses to Average Net Assets ......... -- 0.90% 0.92% -- -- Ratio of Net Investment Income to Average Net Assets.. 2.16% 2.37% 3.83% 3.99% 4.55% Portfolio Turnover Rate................ 23.6% 58.8% 53.9% 54.4% 92.4%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. 80 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- SMALLCAP ACCOUNT ---------------- Net Asset Value, Beginning of Period.. $9.55 $7.97 $5.83 $8.03 $7.83 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.02 -- 0.01 0.01 -- Net Realized and Unrealized Gain (Loss) on Investments......... 0.65 1.58 2.14 (2.20) 0.20 ---- ---- ---- ----- ---- Total From Investment Operations 0.67 1.58 2.15 (2.19) 0.20 Less Dividends and Distributions: Dividends from Net Investment Income... -- -- (0.01) (0.01) -- ---- ----- ----- Total Dividends and Distributions -- -- (0.01) (0.01) -- ---- ----- ----- Net Asset Value, End of Period............ $10.22 $9.55 $7.97 $5.83 $8.03 ====== ===== ===== ===== ===== Total Return /(a)/ ... 7.04% 19.82% 36.82% (27.33)% 2.55% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $94,476 $85,115 $65,285 $32,201 $36,493 Ratio of Expenses to Average Net Assets.. 0.88% 0.86% 0.95% 0.97% 1.00% Ratio of Gross Expenses to Average Net Assets.......... -- 0.86%/(b)/ 0.95%/(b)/ 0.97%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.17% 0.03% 0.09% 0.12% (0.06)% Portfolio Turnover Rate................ 125.8% 188.7% 162.9% 215.5% 154.5% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- SMALLCAP GROWTH ACCOUNT ----------------------- Net Asset Value, Beginning of Period.. $9.30 $8.36 $5.74 $10.60 $15.59 Income from Investment Operations: Net Investment Income (Operating Loss).... (0.07) (0.06) (0.04) (0.05) (0.10) Net Realized and Unrealized Gain (Loss) on Investments......... 0.69 1.00 2.66 (4.81) (4.89) ---- ---- ---- ----- ----- Total From Investment Operations 0.62 0.94 2.62 (4.86) (4.99) ---- ---- ---- ----- ----- Net Asset Value, End of Period............ $9.92 $9.30 $8.36 $5.74 $10.60 ===== ===== ===== ===== ====== Total Return /(a)/ ... 6.67% 11.24% 45.64% (45.85)% (32.01)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $66,656 $63,453 $55,628 $32,754 $55,966 Ratio of Expenses to Average Net Assets.. 1.05% 0.99% 0.99% 0.95% 1.05% Ratio of Gross Expenses to Average Net Assets ......... -- 1.01%/(b)/ 1.02%/(b)/ 1.06%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. (0.77)% (0.70)% (0.64)% (0.68)% (0.92)% Portfolio Turnover Rate................ 68.2% 43.3% 54.1% 287.9% 152.2%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. / / 81 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- SMALLCAP VALUE ACCOUNT ---------------------- Net Asset Value, Beginning of Period.. $16.83 $15.04 $10.30 $11.37 $11.26 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.07 0.03 0.06 0.06 0.09 Net Realized and Unrealized Gain (Loss) on Investments......... 0.96 3.37 5.14 (1.07) 0.60 ---- ---- ---- ----- ---- Total From Investment Operations 1.03 3.40 5.20 (1.01) 0.69 Less Dividends and Distributions: Dividends from Net Investment Income... (0.01) (0.03) (0.05) (0.06) (0.09) Distributions from Realized Gains...... (0.24) (1.58) (0.41) -- (0.49) ---- ----- ----- ----- ----- Total Dividends and Distributions (0.25) (1.61) (0.46) (0.06) (0.58) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $17.61 $16.83 $15.04 $10.30 $11.37 ====== ====== ====== ====== ====== Total Return /(a)/ ... 6.22% 23.08% 50.61% (8.86)% 6.25% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $132,035 $107,206 $82,135 $44,217 $30,888 Ratio of Expenses to Average Net Assets.. 1.13% 1.12% 1.16% 1.28% 1.24% Ratio of Gross Expenses to Average Net Assets.......... -- 1.13%/(b)/ 1.18%/(b)/ 1.29%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.38% 0.21% 0.50% 0.68% 0.95% Portfolio Turnover Rate................ 45.3% 38.0% 54.0% 77.4% 67.8%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. 82 92 Principal Variable Contracts Fund 1-800-247-4123 ADDITIONAL INFORMATION Additional information about the Fund (including the Fund's policy regarding the disclosure of portfolio securities) is available in the Statement of Additional Information dated May 1, 2006 which is incorporated by reference into this prospectus. Additional information about the Funds' investments is available in the Fund's annual and semiannual reports to shareholders. In the Funds' annual report, you will find a discussion of the market conditions and investment strategies that significantly affected the Funds' performance during the last fiscal year. The Statement of Additional Information and the Fund's annual and semi-annual reports can be obtained free of charge by writing or telephoning Princor Financial Services Corporation, P.O. Box 10423, Des Moines, IA 50306. In addition, the Fund makes its Statement of Additional Information and annual and semi-annual reports available, free of charge, on http:// www.principal.com. To request this and other information about the Fund and to make shareholder inquiries, telephone 1-800-247-4123. Information about the Fund (including the Statement of Additional Information) can be reviewed and copied at the Commission's Public Reference Room in Washington, D.C. Information on the operation of the Public Reference Room may be obtained by calling the Commission at 1-202-942-8090. Reports and other information about the Fund are available on the EDGAR Database on the Commission's internet site at http://www.sec.gov. Copies of this information may be obtained, upon payment of a duplicating fee, by electronic request at the following E-mail address: publicinfo@sec.gov, or by writing the Commission's Public Reference Section, Washington, D.C. 20549-0102. The U.S. government does not insure or guarantee an investment in any of the Accounts. There can be no assurance that the Money Market Account will be able to maintain a stable share price of $1.00 per share. Shares of the Accounts are not deposits or obligations of, or guaranteed or endorsed by, any financial institution, nor are shares of the Accounts federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other agency. Principal Variable Contracts Fund, Inc. SEC File 811-01944 Principal Variable Contracts Fund 93 www.principal.com PRINCIPAL VARIABLE CONTRACTS FUND, INC.
ACCOUNTS OF THE FUND -------------------- BOND ACCOUNT MONEY MARKET ACCOUNT CAPITAL VALUE ACCOUNT PRINCIPAL LIFETIME 2010 ACCOUNT DIVERSIFIED INTERNATIONAL ACCOUNT PRINCIPAL LIFETIME 2020 ACCOUNT EQUITY GROWTH ACCOUNT PRINCIPAL LIFETIME 2030 ACCOUNT GOVERNMENT & HIGH QUALITY BOND PRINCIPAL LIFETIME 2040 ACCOUNT ACCOUNT (previously Government PRINCIPAL LIFETIME 2050 ACCOUNT Securities Account) GROWTH ACCOUNT PRINCIPAL LIFETIME STRATEGIC INCOME ACCOUNT INTERNATIONAL SMALLCAP ACCOUNT REAL ESTATE SECURITIES ACCOUNT LARGECAP BLEND ACCOUNT SHORT-TERM BOND ACCOUNT LARGECAP GROWTH EQUITY ACCOUNT (previously Limited Term Bond Account) LARGECAP VALUE ACCOUNT SMALLCAP ACCOUNT MIDCAP ACCOUNT SMALLCAP GROWTH ACCOUNT MIDCAP GROWTH ACCOUNT SMALLCAP VALUE ACCOUNT MIDCAP VALUE ACCOUNT
This Prospectus describes a mutual fund organized by Principal Life Insurance Company/(R)/ ("Principal Life"). The Fund provides a choice of investment objectives through the Accounts listed above. The date of this Prospectus is May 1, 2006. TABLE OF CONTENTS ACCOUNT DESCRIPTIONS....................................................3 Bond Account..........................................................5 Capital Value Account.................................................9 Diversified International Account.....................................12 Equity Growth Account.................................................15 Government & High Quality Bond Account (f/k/a Government Securities Account)...................................18 Growth Account........................................................22 International SmallCap Account........................................24 LargeCap Blend Account................................................27 LargeCap Growth Equity Account ........................................30 LargeCap Value Account................................................32 MidCap Account........................................................34 MidCap Growth Account.................................................37 MidCap Value Account..................................................40 Money Market Account..................................................43 Principal LifeTime 2010 Account.......................................46 Principal LifeTime 2020 Account.......................................49 Principal LifeTime 2030 Account.......................................53 Principal LifeTime 2040 Account.......................................57 Principal LifeTime 2050 Account.......................................61 Principal LifeTime Strategic Income Account...........................65 Real Estate Securities Account........................................68 Short-Term Bond Account...............................................71 SmallCap Account......................................................74 SmallCap Growth Account...............................................77 SmallCap Value Account................................................80 CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.........................83 PRICING OF ACCOUNT SHARES...............................................89 DIVIDENDS AND DISTRIBUTIONS.............................................90 MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE..........................90 The Manager...........................................................90 The Sub-Advisors......................................................90 Duties of the Manager and Sub-Advisors................................102 Fees Paid to the Manager..............................................102 Fees Paid to Sub-Advisor..............................................102 GENERAL INFORMATION ABOUT AN ACCOUNT....................................103 Frequent Trading and Market-Timing (Abusive Trading Practices)........103 Eligible Purchasers...................................................104 Shareholder Rights....................................................104 Non-Cumulative Voting.................................................105 Purchase of Account Shares............................................105 Sale of Account Shares................................................105 Restricted Transfers..................................................106 Financial Statements..................................................106 FINANCIAL HIGHLIGHTS....................................................106 ADDITIONAL INFORMATION..................................................120 ACCOUNT DESCRIPTIONS The Principal Variable Contracts Fund (the "Fund") is made up of Accounts. Each Account has its own investment objective. Principal Management Corporation*, the "Manager" of the Fund, has selected a Sub-Advisor for the Accounts based on the Sub-Advisor's experience with the investment strategy for which it was selected. The Manager seeks to provide a wide range of investment approaches through the Fund. The Sub-Advisors are: . AllianceBernstein L.P. ("AllianceBernstein") . Columbus Circle Investors ("CCI")* . Emerald Advisors, Inc. ("Emerald") . Grantham, Mayo, Van Otterloo & Co. LLC ("GMO") . J.P. Morgan Investment Management Inc. ("Morgan") . Mellon Equity Associates, LLP ("Mellon Equity") . Neuberger Berman Management Inc. ("Neuberger Berman") . Principal Global Investors, LLC ("Principal")* . Principal Real Estate Investors, LLC ("Principal - REI")* . T. Rowe Price Associates, Inc. ("T. Rowe Price") . UBS Global Asset Management (Americas) Inc. ("UBS Global AM") * CCI, Principal, Principal - REI, Principal Management Corporation and Princor Financial Services Corporation ("Princor") are affiliates of Principal Life Insurance Company and with it are subsidiaries of Principal Financial Group, Inc. and members of the Principal Financial Group/(R)/. In the description for each Account, there is important information about the Account's: MAIN STRATEGIES AND RISKS These sections describe each Account's investment objective and summarize how each Account intends to achieve its investment objective. The Board of Directors may change an Account's objective or the investment strategies without a shareholder vote if it determines such a change is in the best interests of the Account. If there is a material change to the Account's investment objective or investment strategies, you should consider whether the Account remains an appropriate investment for you. There is no guarantee that an Account will meet its objective. The sections also describe each Account's primary investment strategies (including the type or types of securities in which the Account invests), any policy of the Account to concentrate in securities of issuers in a particular industry or group of industries and the main risks associated with an investment in the Account. A fuller discussion of risks appears later in the Prospectus under the caption "Certain Investment Strategies and Related Risks." Each Account may invest up to 100% of its assets in cash and cash equivalents for temporary defensive purposes in response to adverse market, economic or political condition as more fully described under the caption "Certain Investment Strategies and Related Risks-Temporary Defensive Measures." Each Account is designed to be a portion of an investor's portfolio. None of the Accounts is intended to be a complete investment program. You should consider the risks of each Account before making an investment and be prepared to maintain the investment during periods of adverse market conditions. INVESTMENT RESULTS A bar chart and a table are included with each Account that has annual returns for a full calendar year. They show the Account's annual returns and its long-term performance. The chart shows how the Account's performance has varied from year-to-year. The table compares the Account's performance over time to that of: . a broad-based securities market index (An index measures the market price of a specific group of securities in a particular market or securities in a market sector. You cannot invest directly in an index. An index does not have an investment advisor and does not pay any commissions or expenses. If an index had expenses, its performance would be lower.); and . an average of mutual funds with a similar investment objective and management style. The averages used are prepared by independent statistical services. An Account's past performance is not necessarily an indication of how the Account will perform in the future. Call the Principal Variable Contracts Fund at 1-800-247-4123 to get the current 7-day yield for the Money Market Account. FEES AND EXPENSES The annual operating expenses for each Account are deducted from that Account's assets. Each Account's operating expenses are shown with the description of the Account and are stated as a percentage of Account assets. A discussion of fees and expenses appears later in the Prospectus under the caption "The Costs of Investing." The fees and expenses shown do not include the effect of any separate account expenses or other contract level expenses. If such charges were included, overall expenses would be higher and would lower performance. The description of each Account includes examples of the costs associated with investing in the Account. The examples are intended to help you compare the cost of investing in a particular Account with the cost of investing in other mutual funds. The examples assume you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The examples also assume that your investment has a 5% total return each year and that the Account's operating expenses remain the same. Your actual costs of investing in a particular Account may be higher or lower than the costs assumed for purposes of the examples. NOTES: . No salesperson, dealer or other person is authorized to give information or make representations about an Account other than those contained in this Prospectus. Information or representations not contained in this Prospectus may not be relied upon as having been made by the Principal Variable Contracts Fund, an Account, the Manager, any Sub-Advisor or Princor. . Investments in these Accounts are not deposits of a bank and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. BOND ACCOUNT The Account seeks to provide as high a level of income as is consistent with preservation of capital and prudent investment risk. MAIN STRATEGIES Under normal circumstances, the Account invests at least 80% of its assets in intermediate maturity fixed-income or debt securities rated BBB or higher by Standard & Poor's Rating Service ("S&P") or Baa or higher by Moody's Investors Service, Inc. ("Moody's"). The Account considers the term "bond" to mean any debt security. Under normal circumstances, the Account invests in: . securities issued or guaranteed by the U.S. government or its agencies or instrumentalities; . mortgage-backed securities representing an interest in a pool of mortgage loans; . debt securities and taxable municipal bonds rated, at the time of purchase, in one of the top four categories by S&P or Moody's or, if not rated, in the opinion of the Sub-Advisor, Principal, of comparable quality; and . securities issued or guaranteed by the governments of Canada (provincial or federal government) or the United Kingdom payable in U.S. dollars. The rest of the Account's assets may be invested in: . preferred and common stock that may be convertible (may be exchanged for a fixed number of shares of common stock of the same issuer) or may be non-convertible; or . securities rated less than the four highest grades of S&P or Moody's (i.e. less than investment grade (commonly known as "junk bonds")) but not lower than CCC- (S&P) or Caa (Moody's). The Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income. Under a reverse repurchase agreement, the Account sells securities and agrees to repurchase them at a specified date and price. The Account pays interest on this "secured financing" and attempts to make money on the difference between the financing rate and the interest it earns by investing the proceeds of the financing. While a reverse repurchase agreement is outstanding, the Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account may lend its portfolio securities to brokers, dealers and other financial institutions. In connection with such loans, the Account remains the owner of the loaned securities and continues to be entitled to payments in amounts equal to the interest, dividends or other distributions payable on the loaned securities. Loans of portfolio securities may not exceed 33 1/3% of the value of the Account's total assets (including the value of all assets received as collateral for loan). In connection with such loans the Account will receive collateral from the borrower equal to at least 100% of the value of the loaned securities. The Account may actively trade securities in an attempt to achieve its investment objective. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: MUNICIPAL SECURITIES . Principal and interest payments of municipal securities may not be guaranteed by the issuing body and may be payable only from monies derived from a particular source. If the source does not perform as expected, principal and income payments may not be made on time or at all. In addition, the market for municipal securities is often thin and may be temporarily affected by large purchases and sales, including those of the Account. General conditions in the financial markets and the size of a particular offering may also negatively affect the returns of a municipal security. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates. This may increase the volatility of the Account. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation maybe chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. REVERSE REPURCHASE AGREEMENTS. . This strategy involves the risk that interest costs on money borrowed may exceed the return on securities purchased with the borrowed money. In addition, reverse repurchase agreements may increase the volatility of the Fund. LENDING OF SECURITIES . If the Account lends its portfolio securities and the borrower of the securities fail financially, the Account may experience delays in recovering the loaned securities or exercising its rights in the collateral. Loans are made only to borrowers that are deemed by the Sub-Advisor to be of good financial standing. PORTFOLIO DURATION . The average portfolio duration of the Account normally varies within a three- to six-year time frame based on Sub-Advisor's forecast for interest rates. Duration is a measure of the expected life of a fixed-income security that is used to determine the sensitivity of a security's price to changes in interest rates. For example, if the portfolio duration of the Account is three years, a change of 1% in the market's yield results in a change of approximately 3% in the value of the Account's securities. The longer a security's duration, the more sensitive it is to changes in interest rates. An Account with a longer average portfolio duration will be more sensitive to changes in interest rates than an Account with a shorter average portfolio duration. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates. When interest rates rise, the value of fixed-income securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of fixed-income securities. Some fixed-income investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.) DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. COMMODITY-LINKED DERIVATIVE INSTRUMENTS . The use of commodity-linked derivative instruments may subject the Account to greater volatility than investments in traditional securities. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 176.2%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking diversification by investing in a fixed-income mutual fund. Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"2.36 "1997"10.6 "1998"7.69 "1999"-2.59 "2000"8.17 "2001"8.12 "2002"9.26 "2003"4.59 "2004"4.98 The Account's highest/lowest quarterly returns "2005"2.5 during this time period were: HIGHEST Q3 '97 4.37% LOWEST Q1 '96-3.24% LOGO The year-to-date return as of March 31, 2006 is -0.55%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* BOND ACCOUNT ......... 2.50 5.86 5.50 7.69 Lehman Brothers Aggregate Bond Index . 2.43 5.87 6.17 7.78 Morningstar Intermediate-Term Bond Category Average...... 1.79 5.32 5.38 7.11 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (December 18, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.45% Other Expenses................... 0.02% ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.47%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 BOND ACCOUNT $48 $151 $263 $591
CAPITAL VALUE ACCOUNT The Account seeks to provide long-term capital appreciation and secondarily growth of investment income. MAIN STRATEGIES The Account invests primarily in common stock and other equity securities of large capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with large market capitalizations (those with market capitalizations similar to companies in the Russell 1000/(R)// /Value Index (as of March 31, 2006 this range was between approximately $688 million and $387.4 billion) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Up to 25% of Account assets may be invested in foreign securities. The Account invests in stocks that, in the opinion of the Sub-Advisor, Principal, are undervalued in the marketplace at the time of purchase. Value stocks are often characterized by below average price/earnings ratios (P/E) and above average dividend yields relative to the overall market. Securities for the Account are selected by consideration of the quality and price of individual issuers rather than forecasting stock market trends. The selection process focuses on four key elements: . determination that a stock is selling below its fair market value; . early recognition of changes in a company's underlying fundamentals; . evaluation of the sustainability of fundamental changes; and . by monitoring a stock's behavior in the market, evaluation of the timeliness of the investment. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization value stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 120.9%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks, but who prefer investing in companies that appear to be considered undervalued relative to similar companies. Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"23.5 "1997"28.53 "1998"13.58 "1999"-4.29 "2000"2.16 "2001"-8.05 "2002"-13.66 "2003"25.49 "2004"12.36 The Account's highest/lowest quarterly returns "2005"6.8 during this time period were: HIGHEST Q2 '03 15.52% LOWEST Q3 '02 -15.10% LOGO The year-to-date return as of March 31, 2006 is 6.07%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT CAPITAL VALUE ACCOUNT 6.80 3.64 7.74 11.92* Russell 1000 Value Index................. 7.05 5.28 10.94 14.32** Morningstar Large Value Category Average 5.88 3.96 8.85 13.21** Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 13, 1970). ** Lifetime results are measured from December 31, 1978 (earliest date for which information is available).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.60% Other Expenses................... 0.01% ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.61%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 CAPITAL VALUE ACCOUNT $62 $195 $340 $762
DIVERSIFIED INTERNATIONAL ACCOUNT The Account seeks long-term growth of capital by investing in a portfolio of equity securities of companies established outside of the U.S. MAIN STRATEGIES The Account invests in a portfolio of equity securities of companies domiciled in any of the nations of the world. The Account invests in securities of: . companies with their principal place of business or principal office outside the U.S.; . companies for which the principal securities trading market is outside the U.S.; and . companies, regardless of where their securities are traded, that derive 50% or more of their total revenue from goods or services produced or sales made outside the U.S. The Account has no limitation on the percentage of assets that are invested in any one country or denominated in any one currency. However, under normal market conditions, the Account intends to have at least 80% of its assets invested in companies in at least three different countries. One of those countries may be the U.S. though currently the Account does not intend to invest in equity securities of U.S. companies. Investments may be made anywhere in the world. Primary consideration is given to securities of corporations of Western Europe, North America and Australasia (Australia, Japan and Far East Asia). Changes in investments are made as prospects change for particular countries, industries or companies. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. The Account may actively trade securities in an attempt to achieve its investment objective. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as companies in more developed countries. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 121.2%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital in markets outside of the U.S. who are able to assume the increased risks of higher price volatility and currency fluctuations associated with investments in international stocks which trade in non-U.S. currencies. Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"25.09 "1997"12.24 "1998"9.98 "1999"25.93 "2000"-8.34 "2001"-24.27 "2002"-16.07 "2003"32.33 "2004"21.03 The Account's highest/lowest quarterly returns "2005"23.79 during this time period were: HIGHEST Q2 '03 17.25% LOWEST Q3 '02 -18.68% LOGO The year-to-date return as of March 31, 2006 is 11.97%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS DIVERSIFIED INTERNATIONAL ACCOUNT. 23.79 4.73 8.43 Citigroup BMI Global ex-US Index/(1)/...... 19.59 8.09 7.79 MSCI EAFE (Europe, Australia, Far East) Index - ND ........... 13.54 4.56 5.84 Morningstar Foreign Large Blend Category Average .............. 14.55 2.93 6.47 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 2, 1994). ** Lifetime results are measured from the Index inception date (December 31, 1994). ///(1)/ This index is now the benchmark against which the Account measures its performance. The Manager and the portfolio manager believe it better represents the universe of investment choices open to the Account under its investment philosophy. The index formerly used is also shown. LIFE OF ACCOUNT* DIVERSIFIED 8.09 INTERNATIONAL ACCOUNT. Citigroup BMI Global 8.02** ex-US Index/(1)/...... MSCI EAFE (Europe, 5.94 Australia, Far East) Index - ND ........... Morningstar Foreign 6.27 Large Blend Category Average .............. Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured f the date the Account was first sold (May 2, 1994). ** Lifetime results are measured the Index inception date (December 31, 1994). ///(1)/ This index is now the benchmark against which the Account measures its performance. The Manager and the portfolio manager believe it better represents the universe of investment choices open to the Account under its investment philosophy. The index formerly used is also shown.
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES
Management Fees.................... 0.85% Other Expenses..................... 0.12 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.97%
(EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005 EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES -------------------------------------------------------------------------------------------- 1 3 5 10 DIVERSIFIED INTERNATIONAL ACCOUNT $99 $309 $536 $1,190
EQUITY GROWTH ACCOUNT The Account seeks to provide long-term capital appreciation by investing primarily in equity securities. MAIN STRATEGIES The Account seeks to maximize long-term capital appreciation by investing primarily in growth-oriented equity securities of U.S. and, to a limited extent, foreign companies that exhibit strong growth and free cash flow potential. These companies are generally characterized as "growth" companies. Under normal market conditions, the Account invests at least 80% of its net assets in equity securities of companies with market capitalizations within the range of companies in the Russell 1000/(R)// /Growth Index (as of March 31, 2006, this range was between approximately $952 million and $368.9 billion) at the time of purchase. The Account's investments in foreign companies will be limited to 25% of its total assets. The Account may also purchase futures and options, in keeping with Account objectives. The Sub-Advisor, T. Rowe Price, generally looks for companies with an above-average rate of earnings and cash flow growth and a lucrative niche in the economy that gives them the ability to sustain earnings momentum even during times of slow economic growth. As a growth investor, T. Rowe Price believes that when a company increases its earnings faster than both inflation and the overall economy, the market will eventually reward it with a higher stock price. In pursuing its investment objective, the Sub-Advisor has the discretion to purchase some securities that do not meet its normal investment criteria, as described above, when it perceives an unusual opportunity for gain. These special situations might arise when the Sub-Advisor believes a security could increase in value for a variety of reasons, including a change in management, an extraordinary corporate event, or a temporary imbalance in the supply of or demand for the securities. The Account may sell securities for a variety of reasons, such as to secure gains, limit losses, or redeploy assets into more promising opportunities. The Account may actively trade securities in an attempt to achieve its investment objective. Futures and options contracts may be bought or sold for any number of reasons, including: to manage exposure to changes in interest rates and foreign currencies; as an efficient means of increasing or decreasing fund overall exposure to a specific part or broad segment of the U.S. or a foreign market; in an effort to enhance income; to protect the value of portfolio securities; and to serve as a cash management tool. Call or put options may be purchased or sold on securities, financial indices, and foreign currencies. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization growth-oriented stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation, making returns more dependent on market increases and decreases. Growth stocks may therefore be more vulnerable than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed an Account's initial investment in such contracts. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 51.6%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks that may have greater risks than stocks of companies with lower potential for earnings growth. T. Rowe Price became the Sub-Advisor to the Account on August 24, 2004. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"28.05 "1997"30.86 "1998"18.95 "1999"39.5 "2000"-11.71 "2001"-14.86 "2002"-27.72 "2003"25.95 "2004"9.33 The Account's highest/lowest quarterly returns "2005"7.55 during this time period were: HIGHESTQ4 '9822.68% LOWEST Q1 '01-18.25% LOGO The year-to-date return as of March 31, 2006 is 1.57%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* EQUITY GROWTH ACCOUNT 7.55 -1.84 8.39 10.89 Russell 1000 Growth Index................. 5.26 -3.58 6.73 9.20 Morningstar Large Growth Category Average .............. 6.46 -3.36 6.95 9.09 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (June 1, 1994).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.76% Other Expenses................... 0.01 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.77%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 EQUITY GROWTH ACCOUNT $79 $246 $428 $954
GOVERNMENT & HIGH QUALITY BOND ACCOUNT F/K/A GOVERNMENT SECURITIES ACCOUNT The Account seeks a high level of current income, liquidity and safety of principal. MAIN STRATEGIES The Account seeks to achieve its investment objective by investing primarily (at least 80% of its assets) in securities that are issued by the U.S. Government, its agencies or instrumentalities. The Account may invest in mortgage-backed securities representing an interest in a pool of mortgage loans. These securities are rated AAA by Standard & Poor's Corporation or Aaa by Moody's Investor Services, Inc. or, if unrated, determined by the Sub-Advisor, Principal, to be of equivalent quality. The Account relies on the professional judgment of Principal to make decisions about the Account's portfolio securities. The basic investment philosophy of Principal is to seek undervalued securities that represent good long-term investment opportunities. Securities may be sold when Principal believes they no longer represent good long-term value. The Account may also hold cash and cash equivalents. The size of the Account's cash position depends on various factors, including market conditions and purchases and redemptions of Account shares. A large cash position could impact the ability of the Account to achieve its objective but it also would reduce the Account's exposure in the event of a market downturn and provide liquidity to make additional investments or to meet redemptions. The Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income. Under a reverse repurchase agreement, the Account sells securities and agrees to repurchase them at a specified date and price. The Account pays interest on this "secured financing" and attempts to make money on the difference between the financing rate and the interest it earns by investing the proceeds of the financing. While a reverse repurchase agreement is outstanding, the Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account may lend its portfolio securities to brokers, dealers and other financial institutions. In connection with such loans, the Account remains the owner of the loaned securities and continues to be entitled to payments in amounts equal to the interest, dividends or other distributions payable on the loaned securities. Loans of portfolio securities may not exceed 33 1/3% of the value of the Account's total assets (including the value of all assets received as collateral for loan). In connection with such loans the Account will receive collateral from the borrower equal to at least 100% of the value of the loaned securities. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: U.S. GOVERNMENT SECURITIES . U.S. Government securities do not involve the degree of credit risk associated with investments in lower quality fixed-income securities. As a result, the yields available from U.S. Government securities are generally lower than the yields available from many other fixed-income securities. Like other fixed-income securities, the values of U.S. Government securities change as interest rates fluctuate. Fluctuations in the value of the Account's securities do not affect interest income on securities already held by the Account, but are reflected in the Account's price per share. Since the magnitude of these fluctuations generally is greater at times when the Account's average maturity is longer, under certain market conditions the Account may invest in short-term investments yielding lower current income rather than investing in higher yielding longer term securities. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates. When interest rates rise, the value of fixed-income securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of fixed-income securities. Some fixed-income investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. U.S. GOVERNMENT SPONSORED SECURITIES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. Prepayments, unscheduled principal payments, may result from voluntary prepayment, refinancing or foreclosure of the underlying mortgage. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates and potentially increasing the volatility of the Account. In addition, prepayments may cause losses on securities purchased at a premium (dollar amount by which the price of the bond exceeds its face value). At times, mortgage-backed securities may have higher than market interest rates and are purchased at a premium. Unscheduled prepayments are made at par and cause the Account to experience a loss of some or all of the premium. DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. REVERSE REPURCHASE AGREEMENTS. . This strategy involves the risk that interest costs on money borrowed may exceed the return on securities purchased with the borrowed money. In addition, reverse repurchase agreements may increase the volatility of the Fund. LENDING OF SECURITIES . If the Account lends its portfolio securities and the borrower of the securities fail financially, the Account may experience delays in recovering the loaned securities or exercising its rights in the collateral. The Account lends its securities only to borrowers that the Sub-Advisor determines are creditworthy. PORTFOLIO DURATION . The average portfolio duration of the Account normally varies within a three- to six-year time frame based on Sub-Advisor's forecast for interest rates. Duration is a measure of the expected life of a fixed-income security that is used to determine the sensitivity of a security's price to changes in interest rates. For example, if the portfolio duration of the Account is three years, a change of 1% in the market's yield results in a change of approximately 3% in the value of the Account's securities. The longer a security's duration, the more sensitive it is to changes in interest rates. An Account with a longer average portfolio duration will be more sensitive to changes in interest rates than an Account with a shorter average portfolio duration. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading cost which may have an adverse impact on the Account's performance. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 262.1%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking diversification by investing in a fixed-income mutual fund. Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"3.35 "1997"10.39 "1998"8.27 "1999"-0.29 "2000"11.4 "2001"7.61 "2002"8.8 "2003"1.84 "2004"3.56 The Account's highest/lowest quarterly returns "2005"2.01 during this time period were: HIGHEST Q2 '97 4.52% LOWEST Q1 '96 -1.90% LOGO The year-to-date return as of March 31, 2006 is -0.45%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* GOVERNMENT & HIGH QUALITY BOND ACCOUNT . 2.01 4.72 5.62 7.30 Lehman Brothers Government/Mortgage Index................. 2.63 5.40 6.01 7.56 Morningstar Intermediate Government Category Average .............. 1.90 4.62 5.12 6.67 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (April 9, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.44% Other Expenses................... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.46%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 GOVERNMENT & HIGH QUALITY BOND ACCOUNT $47 $148 $258 $579
GROWTH ACCOUNT The Account seeks long-term growth of capital through the purchase primarily of common stocks, but the Account may invest in other securities. MAIN STRATEGIES The Account invests primarily in common stocks and other equity securities of large capitalization companies with strong earnings growth potential. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with large market capitalizations (those with market capitalizations similar to companies in the Russell 1000/(R)/ Growth Index (as of March 31, 2006 this range was between approximately $952 million and $368.9 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. The Sub-Advisor, CCI, uses a bottom-up approach (focusing on individual stock selection rather than forecasting stock market trends) in its selection of individual securities that it believes have an above average potential for earnings growth. Selection is based on the premise that companies doing better than expected will have rising securities prices, while companies producing less than expected results will not. CCI refers to its discipline as positive momentum and positive surprise. Through in-depth analysis of company fundamentals in the context of the prevailing economic environment, CCI seeks to select companies that meet the criteria of positive momentum and positive surprise in reported results. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization growth-oriented stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks that may have greater risks than stocks of companies with lower potential for earnings growth. CCI became the Sub-Advisor to the Account on January 5, 2005. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"12.51 "1997"26.96 "1998"21.36 "1999"16.44 "2000"-10.15 "2001"-25.5 "2002"-29.07 "2003"26.46 "2004"9.38 The Account's highest/lowest quarterly returns "2005"12.09 during this time period were: HIGHESTQ4 '9821.35% LOWEST Q1 '01-23.55% LOGO The year-to-date return as of March 31, 2006 is 4.86%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* GROWTH ACCOUNT ....... 12.09 -3.91 4.04 5.97 Russell 1000 Growth Index................. 5.26 -3.58 6.73 9.27 Morningstar Large Growth Category Average .............. 6.46 -3.36 6.95 9.05 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (May 2, 1994).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.60% Other Expenses................... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.62%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 GROWTH ACCOUNT $63 $199 $346 $774
INTERNATIONAL SMALLCAP ACCOUNT The Account seeks long-term growth of capital by investing in a portfolio of equity securities of companies established outside of the U.S. MAIN STRATEGIES The Account invests primarily in equity securities of non-U.S. companies with comparatively smaller market capitalizations. Under normal market conditions, the Account invests at least 80% of its assets in securities of companies similar in size to companies included in the Citigroup Extended Market Index (EMI) World ex US (as of March 31, 2006 this range was between approximately $3.3 million and $26.1 billion). Market capitalization is defined as total current market value of a company's outstanding common stock. The Account invests in securities of: . companies with their principal place of business or principal office outside the U.S.; . companies for which the principal securities trading market is outside the U.S.; and . companies, regardless of where their securities are traded, that derive 50% or more of their total revenue from goods or services produced or sales made outside the U.S. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 132.3%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital in smaller companies outside of the U.S. who are able to assume the increased risks of higher price volatility and currency fluctuations associated with investments in international stocks which trade in non-U.S. currencies. Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999"93.81 "2000"-11.5 "2001"-21.85 "2002"-16.2 "2003"54.15 "2004"30.2 The Account's highest/lowest quarterly returns "2005"29.12 during this time period were: HIGHESTQ4 '9936.59% LOWEST Q3 '01-21.49% LOGO The year-to-date return as of March 31, 2006 is 15.21%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* INTERNATIONAL SMALLCAP ACCOUNT 29.12 11.16 13.32 Citigroup Extended Market Index (EMI) World ex US ...... 11.70 4.32 9.36 Morningstar Foreign Small/Mid Growth Category Average ...... 24.79 8.46 12.37 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.19% Other Expenses............................. 0.14 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.33%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 INTERNATIONAL SMALLCAP ACCOUNT $135 $421 $729 $1,601
LARGECAP BLEND ACCOUNT The Account seeks long-term growth of capital. MAIN STRATEGIES The Account pursues its investment objective by investing primarily in equity securities of U.S. companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with large market capitalizations (those with market capitalizations within the range of companies in the Standard & Poor's 500 Stock Index ("S&P 500 Index") (as of March 31, 2006 this range was between approximately $579 million and $371.6 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. The market capitalization of companies in the Account's portfolio and the S&P 500 Index will change over time, and the Account will not automatically sell or cease to purchase a stock of a company it already owns just because the company's market capitalization grows or falls outside of the index range. In addition, the Account has the ability to purchase stocks whose market capitalization falls below the range of companies in the S&P 500 Index. The Account's Sub-Advisor, T. Rowe Price, uses a disciplined portfolio construction process whereby it weights each sector approximately the same as the S&P 500 Index. Individual holdings within each sector, and their weights within the portfolio, can vary substantially from the S&P 500 Index. A team of T. Rowe Price equity analysts is directly responsible for selecting stocks for the Account. Analysts select stocks from the industries they cover based on rigorous fundamental analysis that assesses the quality of the business franchise, earnings growth potential for the company, and stock valuation. The Account seeks to take full advantage of the analysts' focused expertise in their industries. A team of portfolio managers supervises the analysts and has the responsibility for the overall structure of the Account and coordinating Account investments. They also oversee the quantitative analysis that helps the analysts manage their industry-specific portfolios. In pursuing its investment objective, the Account's management has the discretion to purchase some securities that do not meet its normal investment criteria, as described above, when it perceives an unusual opportunity for gain. These special situations might arise when T. Rowe Price believes a security could increase in value for a variety of reasons, including a change in management, an extraordinary corporate event, or a temporary imbalance in the supply of or demand for the securities. The Account will generally remain fully invested (less than 5% cash reserves) and will be sector neutral when compared to the S&P 500 Index. While the majority of assets will be invested in large-capitalization U.S. common stocks, small- and mid-capitalization stocks and foreign stocks (up to 25% of total assets) may also be purchased in keeping with Account objectives. Securities may be sold for a variety of reasons, such as to secure gains, limit losses, or redeploy assets into more promising opportunities. Futures and options contracts may be bought or sold for any number of reasons, including: to manage exposure to changes in interest rates and foreign currencies; as an efficient means of increasing or decreasing fund overall exposure to a specific part or broad segment of the U.S. or a foreign market; in an effort to enhance income; to protect the value of portfolio securities; and to serve as a cash management tool. Call or put options may be purchased or sold on securities, financial indices, and foreign currencies. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's equity securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation, making returns more dependent on market increases and decreases. Growth stocks may therefore be more vulnerable than non-growth stocks to market changes. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. SECTOR RISK . The Sub-Advisor may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As the Sub-Advisor allocates more of the Account's portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in an aggressively managed portfolio of common stocks, but who prefer investing in larger, established companies. T. Rowe Price became the Sub-Advisor to the Account effective March 9, 2004. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2003"23.76 "2004"10.36 "2005"4.74 The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q2 '03 14.07% LOGO LOWEST Q1 '03 -3.91% The year-to-date return as of March 31, 2006 is 4.21%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF ACCOUNT* LARGECAP BLEND ACCOUNT...................... 4.74 5.31 S&P 500 Index ................... .......... 4.91 5.99 Morningstar Large Blend Category Average ... 5.77 5.57 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 2002).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees...................................... 0.75% Other Expenses....................................... 0.03 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.78%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. This Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 LARGECAP BLEND ACCOUNT $80 $249 $433 $966
LARGECAP GROWTH EQUITY ACCOUNT The Account seeks to achieve long-term growth of capital. MAIN STRATEGIES The Account invests primarily in common stock of U.S. companies, with a focus on growth stocks. Growth stocks are issues (or securities) that the Sub-Advisor, GMO, believes are fast-growing and whose earnings are believed to likely increase over time. Growth in earnings may lead to an increase in the price of the stock. The Sub-Advisor invests mainly in large companies, although investments can be made in companies of any size. Under normal market conditions, the Account invests at least 80% of its assets in equity securities of companies with large market capitalizations. The Account typically makes equity investments in companies chosen from among the 1,000 U.S. exchange-listed companies with the largest market capitalization. Market capitalization is defined as total current market value of a company's outstanding common stock. In addition, the Account may invest up to 25% of its assets in foreign securities, including American Depository Receipts (ADRs), at the time of purchase. When deciding whether to buy or sell stocks for the Account, GMO considers, among other factors, a company's valuation, financial strength, competitive position in its industry, projected future earnings, cash flows and dividends. In addition to the main investment strategies described above, GMO may make other investments, such as investments in preferred stocks, convertible securities and debt instruments. These investments may be subject to other risks as described later in this prospectus and/or the Statement of Additional Information. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization growth-oriented stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. INTEREST RATE CHANGES . Changes in interest rates may adversely affect the value of an investor's securities. When interest rates rise, the value of preferred securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of preferred securities. Some investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. INVESTOR PROFILE The Account may be an appropriate investment for investors who are seeking long-term growth and are willing to accept the potential for short-term, volatile fluctuations in the value of their investment. This Account is designed as a long-term investment with growth potential. GMO became the Sub-Advisor to the Account on March 31, 2004. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2001"-30.08 "2002"-33.27 "2003"23.14 "2004"3.16 The Account's highest/lowest quarterly returns "2005"3.63 during this time period were: HIGHESTQ4 '0112.16% LOWEST Q3 '01-21.14% LOGO The year-to-date return as of March 31, 2006 is 1.26%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* LARGECAP GROWTH EQUITY ACCOUNT 3.63 -9.29 -13.27 Russell 1000 Growth Index .... 5.26 -3.58 -6.99 Morningstar Large Growth Category Average.............. 6.46 -3.36 -5.29 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (October 24, 2000).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.00% Other Expenses............................. 0.09% ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.09%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------- 1 3 5 10 LARGECAP GROWTH EQUITY ACCOUNT $111 $347 $601 $1,329
LARGECAP VALUE ACCOUNT The Account seeks long-term growth of capital. MAIN STRATEGIES The Account invests primarily in undervalued equity securities of companies among the 750 largest by market capitalization that the Sub-Advisor, AllianceBernstein, believes offer above-average potential for growth in future earnings. Under normal market conditions, the Account generally invests at least 80% of its assets in companies with large market capitalizations (those with market capitalizations similar to companies in the Russell 1000/(R)/ Value Index (as of March 31, 2006, this range was between approximately $688 million and $387.4 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. The Account may invest up to 25% of its assets in securities of foreign companies. AllianceBernstein employs an investment strategy, generally described as "value" investing, that involves seeking securities that: . exhibit low financial ratios (particularly stock price-to-book value (liquidation value), but also stock price-to-earnings and stock price-to-cash flow); . can be acquired for less than what AllianceBernstein believes is the issuer's intrinsic value; or . whose price appears attractive relative to the value of the dividends expected to be paid by the issuer in the future. Value oriented investing entails a strong "sell discipline" in that it generally requires the sale of securities that have reached their intrinsic value or a target financial ratio. Value oriented investments may include securities of companies in cyclical industries during periods when such securities appear to AllianceBernstein to have strong potential for capital appreciation or securities of "special situation" companies. A special situation company is one that AllianceBernstein believes has potential for significant future earnings growth but has not performed well in the recent past. These situations include companies with management changes, corporate or asset restructuring or significantly undervalued assets. For AllianceBernstein, identifying special situation companies and establishing an issuer's intrinsic value involves fundamental research about such companies and issuers. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization value stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks but who prefer investing in companies that appear to be considered undervalued relative to similar companies. AllianceBernstein has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2003"28.05 "2004"13.09 "2005"5.44 The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q2 '03 16.19% LOGO LOWEST Q1 '03 -5.04% The year-to-date return as of March 31, 2006 is 5.20%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF ACCOUNT* LARGECAP VALUE ACCOUNT...................... 5.44 7.63 Russell 1000 Value Index ........ .......... 7.05 8.81 Morningstar Large Value Category Average ... 5.88 6.76 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 2002).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees...................................... 0.75% Other Expenses....................................... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.77%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 LARGECAP VALUE ACCOUNT $79 $246 $428 $954
MIDCAP ACCOUNT The Account seeks to achieve capital appreciation by investing primarily in securities of emerging and other growth-oriented companies. MAIN STRATEGIES The Account invests primarily in common stocks and other equity securities of medium capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with medium market capitalizations (those with market capitalizations similar to companies in the Russell MidCap/(R)/ Index (as of March 31, 2006, this range was between approximately $688 million and $22.1 billion) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Up to 25% of Account assets may be invested in foreign securities. In selecting securities for investment, the Sub-Advisor, Principal, looks at stocks with value and/or growth characteristics and constructs an investment portfolio that has a "blend" of stocks with these characteristics. In managing the assets of the Account, Principal does not have a policy of preferring one of these categories to the other. The value orientation emphasizes buying stocks at less than their inherent value and avoiding stocks whose price has been artificially built up. The growth orientation emphasizes buying stocks of companies whose potential for growth of capital and earnings is expected to be above average. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. MAIN RISKS The Account is subject to the risk that its principal market segment, medium capitalization stocks, may underperform compared to other market segments or to the equity markets as a whole. Because different types of stocks tend to shift in and out of favor depending on market and economic conditions, the Account's performance may sometimes be lower or higher than that of other types of funds. The value of the Account's equity securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. MEDIUM CAPITALIZATIONS . Companies with medium capitalizations may have a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the potential for short-term fluctuations in the value of investments. Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"21.11 "1997"22.75 "1998"3.69 "1999"13.04 "2000"14.59 "2001"-3.71 "2002"-8.75 "2003"32.81 "2004"17.76 The Account's highest/lowest quarterly returns "2005"9.21 during this time period were: HIGHESTQ4 '9923.31% LOWEST Q3 '98-20.01% LOGO The year-to-date return as of March 31, 2006 is 4.55%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* MIDCAP ACCOUNT ....... 9.21 8.46 11.60 14.11 Russell Midcap Index . 12.65 8.45 12.49 14.57 Morningstar Mid-Cap Blend Category Average 9.21 8.14 11.74 14.12 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (December 18, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.57% Other Expenses................... 0.01 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.58%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MIDCAP ACCOUNT $59 $186 $324 $726
MIDCAP GROWTH ACCOUNT The Account seeks long-term growth of capital. MAIN STRATEGIES Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with medium market capitalization (those with market capitalizations similar to companies in the Russell Midcap/(R)/ Growth Index (as of March 31, 2006, this range was between approximately $952 million and $21.9 billion)) at the time of purchase. In the view of the Sub-Advisor, Mellon Equity, many medium-sized companies: . are in fast growing industries; . offer superior earnings growth potential; and . are characterized by strong balance sheets and high returns on equity. The Account may also hold investments in large and small capitalization companies, including emerging and cyclical growth companies. The Account may invest up to 25% of its net assets in securities of foreign companies, including securities of issuers in emerging countries and securities quoted in foreign currencies. Mellon Equity uses valuation models designed to identify common stocks of companies that have demonstrated consistent earnings momentum and delivered superior results relative to market analyst expectations. Other considerations include profit margins, growth in cash flow and other standard balance sheet measures. The securities held are generally characterized by strong earnings momentum measures and higher expected earnings per share growth. The valuation model incorporates information about the relevant criteria as of the most recent period for which data are available. Once ranked, the securities are categorized under the headings "buy," "sell" or "hold." The decision to buy, sell or hold is made by Mellon Equity based primarily on output of the valuation model. However, that decision may be modified due to subsequently available or other specific relevant information about the security. In addition, Mellon Equity manages risk by diversifying across companies and industries, limiting the potential adverse impact from any one stock or industry. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. MEDIUM CAPITALIZATIONS . Companies with medium capitalizations may have a limited operating history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. EMERGING MARKET COUNTRIES . Investments in emerging market countries involve special risks. Certain emerging market countries have historically experienced, and may continue to experience, certain economic problems. These may include: high rates of inflation, high interest rates, exchange rate fluctuations, large amounts of debt, balance of payments and trade difficulties, and extreme poverty and unemployment. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth and willing to accept the potential for short-term fluctuations in the value of their investments. Mellon Equity has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999"10.67 "2000"8.1 "2001"-16.92 "2002"-26.27 "2003"40.58 "2004"11.82 The Account's highest/lowest quarterly returns "2005"13.72 during this time period were: HIGHESTQ4 '0124.12% LOWEST Q3 '01-25.25% LOGO The year-to-date return as of March 31, 2006 is 7.08%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* MIDCAP GROWTH ACCOUNT ........ 13.72 1.83 3.12 Russell Midcap Growth Index .. 12.10 1.38 5.30 Morningstar Mid-Cap Growth Category Average.............. 9.70 0.01 6.65 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.90% Other Expenses............................. 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.92%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MIDCAP GROWTH ACCOUNT $94 $293 $509 $1,131
MIDCAP VALUE ACCOUNT The Account seeks long-term growth of capital by investing primarily in equity securities of companies with value characteristics and medium market capitalizations. MAIN STRATEGIES The Account invests primarily in common stocks of medium capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with a medium market capitalization (those with market capitalizations similar to companies in the Russell Midcap/(R)/ Value Index (as of March 31, 2006, this range was between approximately $688 million and $22.1 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Companies may range from the well-established and well known to the new and unseasoned. The Account may invest up to 25% of its assets in securities of foreign companies. The stocks are selected using a value oriented investment approach by Neuberger Berman, the Sub-Advisor. Neuberger Berman identifies value stocks in several ways. Factors it considers in identifying value stocks may include: . strong fundamentals, such as a company's financial, operational and competitive positions; . consistent cash flow; and . a sound earnings record through all phases of the market cycle. Neuberger Berman may also look for other characteristics in a company, such as a strong position relative to competitors, a high level of stock ownership among management, and a recent sharp decline in stock price that appears to be the result of a short-term market overreaction to negative news. Neuberger Berman believes that, over time, securities that are undervalued are more likely to appreciate in price and are subject to less risk of price decline than securities whose market prices have already reached their perceived economic value. This approach also involves selling portfolio securities when Neuberger Berman believes they have reached their potential, when the securities fail to perform as expected or when other opportunities appear more attractive. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. MEDIUM CAPITALIZATIONS . Companies with medium capitalizations may have a limited operating history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth and willing to accept short-term fluctuations in the value of investments. Neuberger Berman has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2000"31.03 "2001"-2.58 "2002"-9.96 "2003"36.49 "2004"22.67 The Account's highest/lowest quarterly returns "2005"10.55 during this time period were: HIGHEST Q2 '03 14.93% LOWEST Q3 '02 -14.54% LOGO The year-to-date return as of March 31, 2006 is 4.70%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* MIDCAP VALUE ACCOUNT ......... 10.55 10.18 13.65 Russell Midcap Value Index ... 12.65 12.21 10.93 Morningstar Mid-Cap Value Category Average.............. 8.41 9.36 10.54 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 3, 1999).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees ................. ......... 1.05% Other Expenses .................. ......... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.07%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MIDCAP VALUE ACCOUNT $109 $340 $590 $1,306
MONEY MARKET ACCOUNT The Account has an investment objective of as high a level of current income available from investments in short-term securities as is consistent with preservation of principal and maintenance of liquidity. MAIN STRATEGIES The Account invests its assets in a portfolio of high quality, short-term money market instruments. The investments are U.S. dollar denominated securities which the Sub-Advisor, Principal, believes present minimal credit risks. At the time the Account purchases each security, it is an "eligible security" as defined in the regulations issued under the Investment Company Act of 1940, as amended. The Account maintains a dollar weighted average portfolio maturity of 90 days or less. It intends to hold its investments until maturity. However, the Account may sell a security before it matures: . to take advantage of market variations; . to generate cash to cover sales of Account shares by its shareholders; or . upon revised credit opinions of the security's issuer. The sale of a security by the Account before maturity may not be in the best interest of the Account. The sale of portfolio securities is usually a taxable event. The Account does have an ability to borrow money to cover the redemption of Account shares. It is the policy of the Account to be as fully invested as possible to maximize current income. Securities in which the Account invests include: . securities issued or guaranteed by the U.S. government, including treasury bills, notes and bonds; . securities issued or guaranteed by agencies or instrumentalities of the U.S. government. These are backed either by the full faith and credit of the U.S. government or by the credit of the particular agency or instrumentality; . bank obligations including: . certificates of deposit which generally are negotiable certificates against funds deposited in a commercial bank; or . bankers acceptances which are time drafts drawn on a commercial bank, usually in connection with international commercial transactions. . commercial paper which is short-term promissory notes issued by U.S. or foreign corporations primarily to finance short-term credit needs; . corporate debt consisting of notes, bonds or debentures which at the time of purchase by the Account has 397 days or less remaining to maturity; . repurchase agreements under which securities are purchased with an agreement by the seller to repurchase the security at the same price plus interest at a specified rate. Generally these have a short maturity (less than a week) but may also have a longer maturity; and . taxable municipal obligations which are short-term obligations issued or guaranteed by state and municipal issuers which generate taxable income. Among the certificates of deposit typically held by the Account are Eurodollar and Yankee obligations which are issued in U.S. dollars by foreign banks and foreign branches of U.S. banks. Before the Sub-Advisor selects a Eurodollar or Yankee obligation, however, the foreign issuer undergoes the same credit-quality analysis and tests of financial strength as an issuer of domestic securities. MAIN RISKS As with all mutual funds, the value of the Account's assets may rise or fall. Although the Account seeks to preserve the value of an investment at $1.00 per share, it is possible to lose money by investing in the Account. An investment in the Account is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. As with any security, the securities in which the Account invests have associated risks. These include risks of: CREDIT RISK . Credit risk pertains to the issuer's ability to make scheduled principal or interest payments. This may reduce the Account's stream of income and decrease the Account's yield. INTEREST RATE RISK . The value of the Account's shares is directly impacted by trends in interest rates. If interest rates rise, the value of debt securities generally will fall. REPURCHASE AGREEMENTS . The Account may invest in repurchase agreements with commercial banks, brokers and dealers considered by the Sub-Advisor to be creditworthy. Default or insolvency of the other party is a potential risk to the Account. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in securities issued by government-sponsored enterprises. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. EURODOLLAR AND YANKEE OBLIGATIONS . Eurodollar and Yankee obligations have risks similar to U.S. money market instruments, such as income risk and credit risk. Other risks of Eurodollar and Yankee obligations include the possibilities that: a foreign government will not let U.S. dollar-denominated assets leave the country; the banks that issue Eurodollar obligations may not be subject to the same regulations as U.S. banks; and adverse political or economic developments will affect investments in a foreign country. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking monthly dividends without incurring much principal risk. Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"5.07 "1997"5.04 "1998"5.2 "1999"4.84 "2000"6.07 "2001"3.92 "2002"1.42 "2003"0.74 "2004"0.92 "2005"2.69 TO OBTAIN THE ACCOUNT'S CURRENT YIELD INFORMATION, PLEASE CALL 1-800-247-4123 LOGO The year-to-date return as of March 31, 2006 is 1.00%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* Money Market Account . 2.69 1.93 3.60 3.15 *Lifetime results are measured from the date the Account was first sold (March 18, 1983).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.49% Other Expenses................... 0.12 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.61%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MONEY MARKET ACCOUNT $62 $195 $340 $762
PRINCIPAL LIFETIME 2010 ACCOUNT The Account seeks a total return consisting of long-term growth of capital and current income. MAIN STRATEGIES To pursue its goal, the Account invests in shares of other Principal Variable Contracts Fund Accounts (the "underlying funds"). The underlying funds are intended to give the Account broad exposure to the domestic and foreign equity and fixed-income markets. The Manager and the Sub-Advisor, Principal, both provide investment advisory services to the Account. The Manager has hired Principal to develop, implement, and monitor the strategic or long-term asset class targets and target ranges for the Account. In deciding how to allocate the Account's assets among several asset classes, Principal considers long-term asset class returns, volatility assumptions and the Account's target time horizon. Principal is also responsible for employing an active rebalancing strategy that, within the target ranges, directs cash flows or Account assets towards or away from asset classes that Principal determines to be attractive or unattractive over shorter time periods, so long as the target asset class ranges are not violated. The Manager is responsible for implementing the strategic asset allocation set by Principal. In this role, the Manager selects the underlying funds and their respective weights. The Manager is also responsible for monitoring the Sub-Advisor of each underlying fund and may, at any time, add or substitute underlying funds in which the Account invests. Over time, shifts in the asset class targets and underlying funds will be designed to accommodate investors progressing from asset accumulation years to income-generation years; shifts in the asset class targets or underlying funds may also occur when market forces or Account circumstances change allocations. In allocating Account assets among the underlying funds, the Manager relies on a combination of quantitative measures, such as past performance and style consistency, and qualitative factors. Qualitative factors that the Manager considers include the fund advisor's organizational stability, investment experience, consistency of investment process, risk management processes, and information, trading and compliance systems. There are no minimum or maximum percentages in which the Account must invest in a specific asset class or underlying fund. Principal intends to gradually shift the Account's asset allocation so that within five to ten years after the year 2010, the Account's asset allocation matches that of the Principal LifeTime Strategic Income Account. At that time, the Account may be combined with the Principal LifeTime Strategic Income Account if the Board of Directors determines that the combination is in the best interests of Account shareholders. MAIN RISKS The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The Account's investments are concentrated in the underlying funds and, as a result, the Account's performance is directly related to their performance. The Account's ability to meet its investment objective depends on the ability of the underlying funds to achieve their investment objectives. Consequently, the Account is subject to the particular risks of the underlying funds in the proportions in which the Account invests in them. The Account's broad diversification is designed to cushion severe losses in any one investment sector and moderate the Account's overall price swings. However, the Account's share prices will fluctuate as the prices of the underlying funds rise or fall with changing market conditions. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the underlying funds invest have associated risks. These include risks of: INTEREST RATE CHANGES . The value of fixed-income securities held by an underlying fund may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by an underlying fund may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. U.S. GOVERNMENT SPONSORED ENTERPRISES . An underlying fund may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. STOCK MARKET VOLATILITY . The prices of equity securities held by an underlying fund may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. FOREIGN INVESTING . The underlying funds may invest in foreign securities. Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. SMALL AND MEDIUM CAPITALIZATIONS . The underlying funds may invest in small and medium capitalization companies. Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. HEDGING STRATEGIES . The underlying funds may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The underlying funds may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the underlying funds and, therefore, the Account. However, the Account's performance could be worse than if the underlying funds had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; use of them by the underlying funds could lower Account total return; and the potential loss from the use of futures can exceed an underlying fund's initial investment in such contracts. INITIAL PUBLIC OFFERINGS ("IPOS") . An underlying fund's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors expecting to retire around the year 2010. UNDERLYING FUND ALLOCATION As of December 31, 2005, the Account's assets were allocated among the underlying funds as follows:
Bond 38.8 LargeCap Stock Index 10.1 Capital Value 3.0 LargeCap Value 5.1 Diversified International 5.6 Money Market 10.7 Equity Income 6.1 Real Estate Securities 8.5 LargeCap Growth Equity 8.1 SmallCap 4.0
Based on this allocation, the weighted average of the total account operating expenses of the underlying funds is 0.64%. The combined total expenses for the Account may be higher or lower depending on the allocation of its assets among the underlying funds. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2005"5.7 LOGO The Account's highest/lowest quarterly returns during this time period were: HIGHESTQ2 '053.59% LOWESTQ1 '05-1.64% The year-to-date return as of March 31, 2006 is 3.76%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF FUND* PRINCIPAL LIFETIME 2010 ACCOUNT ...... 5.70 11.41 S&P 500 Index ........................ 4.91 11.66 Lehman Brothers Aggregate Bond Index . 2.43 2.75 Morningstar Conservative Allocation Category Average...................... 3.05 5.88 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (August 30, 2004).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES
Management Fees....... 0.12% Other Expenses........ 0.08 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.20% Fee Reduction and/or Expense Reimbursement. 0.04 ---- NET EXPENSES 0.16% The Manager has contractually agreed to reimburse operating expenses so that the total Account operating expenses will not be greater than 0.16% through April 30, 2007. The Manager may choose not to continue this arrangement after April 30, 2007. As a shareholder in the underlying funds, the Account indirectly bears its pro rata share of the operating expenses incurred by each underlying fund. As of December 31, 2005, the operating expenses of the underlying funds ranged from 0.38% to 1.09%. The Account's investment return is net of the underlying funds' operating expenses.
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If the operating expenses of the underlying funds, separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 PRINCIPAL LIFETIME 2010 ACCOUNT $16 $59 $107 $250
PRINCIPAL LIFETIME 2020 ACCOUNT The Account seeks a total return consisting of long-term growth of capital and current income. MAIN STRATEGIES To pursue its goal, the Account invests in shares of other Principal Variable Contracts Fund Accounts (the "underlying funds"). The underlying funds are intended to give the Account broad exposure to the domestic and foreign equity and fixed-income markets. The Manager and the Sub-Advisor, Principal, both provide investment advisory services to the Account. The Manager has hired Principal to develop, implement, and monitor the strategic or long-term asset class targets and target ranges for the Account. In deciding how to allocate the Account's assets among several asset classes, Principal considers long-term asset class returns, volatility assumptions and the Account's target time horizon. Principal is also responsible for employing an active rebalancing strategy that, within the target ranges, directs cash flows or Account assets towards or away from asset classes that Principal determines to be attractive or unattractive over shorter time periods, so long as the target asset class ranges are not violated. The Manager is responsible for implementing the strategic asset allocation set by Principal. In this role, the Manager selects the underlying funds and their respective weights. The Manager is also responsible for monitoring the Sub-Advisor of each underlying fund and may, at any time, add or substitute underlying funds in which the Account invests. Over time, shifts in the asset class targets and underlying funds will be designed to accommodate investors progressing from asset accumulation years to income-generation years; shifts in the asset class targets or underlying funds may also occur when market forces or Account circumstances change allocations. In allocating Account assets among the underlying funds, the Manager relies on a combination of quantitative measures, such as past performance and style consistency, and qualitative factors. Qualitative factors that the Manager considers include the fund advisor's organizational stability, investment experience, consistency of investment process, risk management processes, and information, trading and compliance systems. There are no minimum or maximum percentages in which the Account must invest in a specific asset class or underlying fund. Principal intends to gradually shift the Account's asset allocation so that within five to ten years after the year 2020, the Account's asset allocation matches that of the Principal LifeTime Strategic Income Account. At that time, the Account may be combined with the Principal LifeTime Strategic Income Account if the Board of Directors determines that the combination is in the best interests of Account shareholders. MAIN RISKS The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The Account's investments are concentrated in the underlying funds and, as a result, the Account's performance is directly related to their performance. The Account's ability to meet its investment objective depends on the ability of the underlying funds to achieve their investment objectives. Consequently, the Account is subject to the particular risks of the underlying funds in the proportions in which the Account invests in them. The Account's broad diversification is designed to cushion severe losses in any one investment sector and moderate the Account's overall price swings. However, the Account's share prices will fluctuate as the prices of the underlying funds rise or fall with changing market conditions. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the underlying funds invest have associated risks. These include risks of: STOCK MARKET VOLATILITY . The prices of equity securities held by an underlying fund may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL AND MEDIUM CAPITALIZATIONS . The underlying funds may invest in small and medium capitalization companies. Companies with small or medium capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. SECTOR RISK . The underlying funds may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As the Sub-Advisor allocates more of the Account's portfolio holdings to an underlying fund that allocates more of its portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . The underlying funds may invest in foreign securities. Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. HEDGING STRATEGIES . The underlying funds may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The underlying funds may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the underlying funds and, therefore, the Account. However, the Account's performance could be worse than if the underlying funds had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; use of them by the underlying funds could lower Account total return; and the potential loss from the use of futures can exceed an underlying fund's initial investment in such contracts. INITIAL PUBLIC OFFERINGS ("IPOS") . An underlying fund's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INTEREST RATE CHANGES . The value of fixed-income securities held by an underlying fund may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by an underlying fund may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. U.S. GOVERNMENT SPONSORED ENTERPRISES . An underlying fund may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. INVESTOR PROFILE The Fund may be an appropriate investment for investors expecting to retire around the year 2020 or fund a cashflow need in the year 2020. UNDERLYING FUND ALLOCATION As of December 31, 2005, the Account's assets were allocated among the underlying funds as follows:
Bond 34.5 LargeCap Value 5.6 Capital Value 7.3 Real Estate Securities 8.8 Diversified International 9.9 SmallCap 2.0 Equity Income 6.1 SmallCap Growth 1.5 LargeCap Growth Equity 5.9 SmallCap Value 1.5 LargeCap Stock Index 16.9
Based on this allocation, the weighted average of the total account operating expenses of the underlying funds is 0.64%. The combined total expenses for the Account may be higher or lower depending on the allocation of its assets among the underlying funds. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2005"6.77 LOGO The Account's highest/lowest quarterly returns during this time period were: HIGHESTQ2 '053.27% LOWEST Q1 '05 -1.60% The year-to-date return as of March 31, 2006 is 5.00%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF FUND* PRINCIPAL LIFETIME 2020 ACCOUNT ...... 6.77 13.26 S&P 500 Index ........................ 4.91 11.66 Lehman Brothers Aggregate Bond Index . 2.43 2.75 Morningstar Moderate Allocation Category Average...................... 5.29 10.47 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (August 30, 2004).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees....... 0.12% Other Expenses........ 0.04 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.16% Fee Reduction and/or Expense Reimbursement. 0.03 ---- NET EXPENSES 0.13% The Manager has contractually agreed to reimburse operating expenses so that the total Account operating expenses will not be greater than 0.13% through April 30, 2007. The Manager may choose not to continue this arrangement after April 30, 2007. As a shareholder in the underlying funds, the Account indirectly bears its pro rata share of the operating expenses incurred by each underlying fund. As of December 31, 2005, the operating expenses of the underlying funds ranged from 0.38% to 1.13%. The Account's investment return is net of the underlying funds' operating expenses.
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If the operating expenses of the underlying funds, separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ------------------------------------------------------------------------------------------------- 1 3 5 10 PRINCIPAL LIFETIME 2020 ACCOUNT $13 $47 $86 $201
PRINCIPAL LIFETIME 2030 ACCOUNT The Account seeks a total return consisting of long-term growth of capital and current income. MAIN STRATEGIES To pursue its goal, the Account invests in shares of other Principal Variable Contracts Fund Accounts (the "underlying funds"). The underlying funds are intended to give the Account broad exposure to the domestic and foreign equity and fixed-income markets. The Manager and the Sub-Advisor, Principal, both provide investment advisory services to the Account. The Manager has hired Principal to develop, implement, and monitor the strategic or long-term asset class targets and target ranges for the Account. In deciding how to allocate the Account's assets among several asset classes, Principal considers long-term asset class returns, volatility assumptions and the Account's target time horizon. Principal is also responsible for employing an active rebalancing strategy that, within the target ranges, directs cash flows or Account assets towards or away from asset classes that Principal determines to be attractive or unattractive over shorter time periods, so long as the target asset class ranges are not violated. The Manager is responsible for implementing the strategic asset allocation set by Principal. In this role, the Manager selects the underlying funds and their respective weights. The Manager is also responsible for monitoring the Sub-Advisor of each underlying fund and may, at any time, add or substitute underlying funds in which the Account invests. Over time, shifts in the asset class targets and underlying funds will be designed to accommodate investors progressing from asset accumulation years to income-generation years; shifts in the asset class targets or underlying funds may also occur when market forces or Account circumstances change allocations. In allocating Account assets among the underlying funds, the Manager relies on a combination of quantitative measures, such as past performance and style consistency, and qualitative factors. Qualitative factors that the Manager considers include the fund advisor's organizational stability, investment experience, consistency of investment process, risk management processes, and information, trading and compliance systems. There are no minimum or maximum percentages in which the Account must invest in a specific asset class or underlying fund. Principal intends to gradually shift the Account's asset allocation so that within five to ten years after the year 2030, the Account's asset allocation matches that of the Principal LifeTime Strategic Income Account. At that time, the Account may be combined with the Principal LifeTime Strategic Income Account if the Board of Directors determines that the combination is in the best interests of Account shareholders. MAIN RISKS The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The Account's investments are concentrated in the underlying funds and, as a result, the Account's performance is directly related to their performance. The Account's ability to meet its investment objective depends on the ability of the underlying funds to achieve their investment objectives. Consequently, the Account is subject to the particular risks of the underlying funds in the proportions in which the Account invests in them. The Account's broad diversification is designed to cushion severe losses in any one investment sector and moderate the Account's overall price swings. However, the Account's share prices will fluctuate as the prices of the underlying funds rise or fall with changing market conditions. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the underlying funds invest have associated risks. These include risks of: STOCK MARKET VOLATILITY . The prices of equity securities held by an underlying fund may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL AND MEDIUM CAPITALIZATIONS . The underlying funds may invest in small and medium capitalization companies. Companies with small or medium capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. SECTOR RISK . The underlying funds may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As the Sub-Advisor allocates more of the Account's portfolio holdings to an underlying fund that allocates more of its portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . An underlying fund may invest in foreign securities. Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. HEDGING STRATEGIES . The underlying funds may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The underlying funds may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the underlying funds and, therefore, the Account. However, the Account's performance could be worse than if the underlying funds had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; use of them by the underlying funds could lower Account total return; and the potential loss from the use of futures can exceed an underlying fund's initial investment in such contracts. INITIAL PUBLIC OFFERINGS ("IPOS") . An underlying fund's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INTEREST RATE CHANGES . The value of fixed-income securities held by an underlying fund may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by an underlying fund may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. U.S. GOVERNMENT SPONSORED ENTERPRISES . An underlying fund may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. INVESTOR PROFILE The Fund may be an appropriate investment for investors expecting to retire around the year 2030 or fund a cashflow need in the year 2030. UNDERLYING FUND ALLOCATION As of December 31, 2005, the Account's assets were allocated among the underlying funds as follows:
Bond 24.8 LargeCap Value 9.0 Capital Value 5.0 Real Estate Securities 7.2 Diversified International 10.2 SmallCap 2.0 Equity Income 5.0 SmallCap Growth 2.0 LargeCap Growth Equity 14.4 SmallCap Value 2.0 LargeCap Stock Index 18.4
Based on this allocation, the weighted average of the total account operating expenses of the underlying funds is 0.70%. The combined total expenses for the Account may be higher or lower depending on the allocation of its assets among the underlying funds. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2005"6.76 LOGO The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q3 '05 3.35% LOWEST Q1 '05 -1.59% The year-to-date return as of March 31, 2006 is 5.02%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF FUND* PRINCIPAL LIFETIME 2030 ACCOUNT ...... 6.76 13.23 S&P 500 Index ........................ 4.91 11.66 Lehman Brothers Aggregate Bond Index . 2.43 2.75 Morningstar Moderate Allocation Category Average...................... 5.29 10.47 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (August 30, 2004).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees....... 0.12% Other Expenses........ 0.26 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.38% Fee Reduction and/or Expense Reimbursement. 0.22 ---- NET EXPENSES 0.16% The Manager has contractually agreed to reimburse operating expenses so that the total Account operating expenses will not be greater than 0.16% through April 30, 2007. The Manager may choose not to continue this arrangement after April 30, 2007. As a shareholder in the underlying funds, the Account indirectly bears its pro rata share of the operating expenses incurred by each underlying fund. As of December 31, 2005, the operating expenses of the underlying funds ranged from 0.38% to 1.13%. The Account's investment return is net of the underlying funds' operating expenses.
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If the operating expenses of the underlying funds, separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ------------------------------------------------------------------------------------------------- 1 3 5 10 PRINCIPAL LIFETIME 2030 ACCOUNT $16 $92 $183 $451
PRINCIPAL LIFETIME 2040 ACCOUNT The Account seeks a total return consisting of long-term growth of capital and current income. MAIN STRATEGIES To pursue its goal, the Account invests in shares of other Principal Variable Contracts Fund Accounts (the "underlying funds"). The underlying funds are intended to give the Account broad exposure to the domestic and foreign equity and fixed-income markets. The Manager and the Sub-Advisor, Principal, both provide investment advisory services to the Account. The Manager has hired Principal to develop, implement, and monitor the strategic or long-term asset class targets and target ranges for the Account. In deciding how to allocate the Account's assets among several asset classes, Principal considers long-term asset class returns, volatility assumptions and the Account's target time horizon. Principal is also responsible for employing an active rebalancing strategy that, within the target ranges, directs cash flows or Account assets towards or away from asset classes that Principal determines to be attractive or unattractive over shorter time periods, so long as the target asset class ranges are not violated. The Manager is responsible for implementing the strategic asset allocation set by Principal. In this role, the Manager selects the underlying funds and their respective weights. The Manager is also responsible for monitoring the Sub-Advisor of each underlying fund and may, at any time, add or substitute underlying funds in which the Account invests. Over time, shifts in the asset class targets and underlying funds will be designed to accommodate investors progressing from asset accumulation years to income-generation years; shifts in the asset class targets or underlying funds may also occur when market forces or Account circumstances change allocations. In allocating Account assets among the underlying funds, the Manager relies on a combination of quantitative measures, such as past performance and style consistency, and qualitative factors. Qualitative factors that the Manager considers include the fund advisor's organizational stability, investment experience, consistency of investment process, risk management processes, and information, trading and compliance systems. There are no minimum or maximum percentages in which the Account must invest in a specific asset class or underlying fund. Principal intends to gradually shift the Account's asset allocation so that within five to ten years after the year 2040, the Account's asset allocation matches that of the Principal LifeTime Strategic Income Account. At that time, the Account may be combined with the Principal LifeTime Strategic Income Account if the Board of Directors determines that the combination is in the best interests of Account shareholders. MAIN RISKS The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The Account's investments are concentrated in the underlying funds and, as a result, the Account's performance is directly related to their performance. The Account's ability to meet its investment objective depends on the ability of the underlying funds to achieve their investment objectives. Consequently, the Account is subject to the particular risks of the underlying funds in the proportions in which the Account invests in them. The Account's broad diversification is designed to cushion severe losses in any one investment sector and moderate the Account's overall price swings. However, the Account's share prices will fluctuate as the prices of the underlying funds rise or fall with changing market conditions. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the underlying funds invest have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of an underlying fund's shares is affected by changes in the value of the securities it owns. The prices of equity securities held by the underlying fund may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL AND MEDIUM CAPITALIZATIONS . An underlying fund may invest in small and medium capitalization companies. Companies with small or medium capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. SECTOR RISK . The underlying funds may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As the Sub-Advisor allocates more of the Account's portfolio holdings to an underlying fund that allocates more of its portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . The underlying funds may invest in foreign securities. Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. HEDGING STRATEGIES . The underlying funds may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The underlying funds may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the underlying funds and, therefore, the Account. However, the Account's performance could be worse than if the underlying funds had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; use of them by the underlying funds could lower Account total return; and the potential loss from the use of futures can exceed an underlying fund's initial investment in such contracts. INITIAL PUBLIC OFFERINGS ("IPOS") . An underlying fund's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. FIXED-INCOME RISKS . Interest rate changes. The value of fixed-income securities held by an underlying fund may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. . Credit risk. Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by an underlying fund may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. . High yield securities. Fixed-income securities in which an underlying fund may invest that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.). . U.S. Government Sponsored Enterprises. An underlying fund may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. INVESTOR PROFILE The Fund may be an appropriate investment for investors expecting to retire around the year 2040 or fund a cashflow need in the year 2040. UNDERLYING FUND ALLOCATION As of December 31, 2005, the Account's assets were allocated among the underlying funds as follows:
Bond 16.6 LargeCap Value 10.9 Capital Value 5.9 Real Estate Securities 4.8 Diversified International 13.1 SmallCap 3.5 Equity Income 2.7 SmallCap Growth 2.5 LargeCap Growth Equity 16.0 SmallCap Value 2.5 LargeCap Stock Index 21.5
Based on this allocation, the weighted average of the total account operating expenses of the underlying funds is 0.73%. The combined total expenses for the Account may be higher or lower depending on the allocation of its assets among the underlying funds. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2005"7.27 LOGO The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q3 '05 3.95% LOWESTQ1 '05-1.44% The year-to-date return as of March 31, 2006 is 5.40%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF FUND* PRINCIPAL LIFETIME 2040 ACCOUNT ...... 7.27 14.55 S&P 500 Index ........................ 4.91 11.66 Lehman Brothers Aggregate Bond Index . 2.43 2.75 Morningstar Moderate Allocation Category Average...................... 5.29 10.47 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (August 30, 2004).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees....... 0.12% Other Expenses........ 0.44 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.56% Fee Reduction and/or Expense Reimbursement. 0.43 ---- NET EXPENSES 0.13% The Manager has contractually agreed to reimburse operating expenses so that the total Account operating expenses will not be greater than 0.13% through April 30, 2007. The Manager may choose not to continue this arrangement after April 30, 2007. As a shareholder in the underlying funds, the Account indirectly bears its pro rata share of the operating expenses incurred by each underlying fund. As of December 31, 2005, the operating expenses of the underlying funds ranged from 0.38% to 1.13%. The Account's investment return is net of the underlying funds' operating expenses.
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If the operating expenses of the underlying funds, separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ------------------------------------------------------------------------------------------------- 1 3 5 10 PRINCIPAL LIFETIME 2040 ACCOUNT $13 $121 $255 $646
PRINCIPAL LIFETIME 2050 ACCOUNT The Account seeks a total return consisting of long-term growth of capital and current income. MAIN STRATEGIES To pursue its goal, the Account invests in shares of other Principal Variable Contracts Fund Accounts (the "underlying funds"). The underlying funds are intended to give the Account broad exposure to the domestic and foreign equity and fixed-income markets. The Manager and the Sub-Advisor, Principal, both provide investment advisory services to the Account. The Manager has hired Principal to develop, implement, and monitor the strategic or long-term asset class targets and target ranges for the Account. In deciding how to allocate the Account's assets among several asset classes, Principal considers long-term asset class returns, volatility assumptions and the Account's target time horizon. Principal is also responsible for employing an active rebalancing strategy that, within the target ranges, directs cash flows or Account assets towards or away from asset classes that Principal determines to be attractive or unattractive over shorter time periods, so long as the target asset class ranges are not violated. The Manager is responsible for implementing the strategic asset allocation set by Principal. In this role, the Manager selects the underlying funds and their respective weights. The Manager is also responsible for monitoring the Sub-Advisor of each underlying fund and may, at any time, add or substitute underlying funds in which the Account invests. Over time, shifts in the asset class targets and underlying funds will be designed to accommodate investors progressing from asset accumulation years to income-generation years; shifts in the asset class targets or underlying funds may also occur when market forces or Account circumstances change allocations. In allocating Account assets among the underlying funds, the Manager relies on a combination of quantitative measures, such as past performance and style consistency, and qualitative factors. Qualitative factors that the Manager considers include the fund advisor's organizational stability, investment experience, consistency of investment process, risk management processes, and information, trading and compliance systems. There are no minimum or maximum percentages in which the Account must invest in a specific asset class or underlying fund. Principal intends to gradually shift the Account's asset allocation so that within five to ten years after the year 2050, the Account's asset allocation matches that of the Principal LifeTime Strategic Income Account. At that time, the Account may be combined with the Principal LifeTime Strategic Income Account if the Board of Directors determines that the combination is in the best interests of Account shareholders. MAIN RISKS The Account's investments are concentrated in the underlying funds and, as a result, the Account's performance is directly related to their performance. The Account's ability to meet its investment objective depends on the ability of the underlying funds to achieve their investment objectives. Consequently, the Account is subject to the particular risks of the underlying funds in the proportions in which the Account invests in them. The Account's broad diversification is designed to cushion severe losses in any one investment sector and moderate the Account's overall price swings. However, the Account's share prices will fluctuate as the prices of the underlying funds rise or fall with changing market conditions. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the underlying funds invest have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of an underlying fund's shares is affected by changes in the value of the securities it owns. The prices of equity securities held by the underlying fund may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL AND MEDIUM CAPITALIZATIONS . The underlying funds may invest in small and medium capitalization companies. Companies with small or medium capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. SECTOR RISK . The underlying funds may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As the Sub-Advisor allocates more of the Account's portfolio holdings to an underlying fund that allocates more of its portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . The underlying funds may invest in foreign securities. Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. HEDGING STRATEGIES . The underlying funds may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The underlying funds may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the underlying funds and, therefore, the Account. However, the Account's performance could be worse than if the underlying funds had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; use of them by the underlying funds could lower Account total return; and the potential loss from the use of futures can exceed an underlying fund's initial investment in such contracts. INITIAL PUBLIC OFFERINGS ("IPOS") . The underlying fund's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. FIXED-INCOME RISKS . Interest rate changes. The value of fixed-income securities held by an underlying fund may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. . Credit risk. Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by an underlying fund may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. . High yield securities. Fixed-income securities in which an underlying fund may invest that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.). . U.S. Government Sponsored Enterprises. An underlying fund may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. INVESTOR PROFILE The Fund may be an appropriate investment for investors expecting to retire around the year 2050 or fund a cashflow need in the year 2050. UNDERLYING FUND ALLOCATION As of December 31, 2005, the Account's assets were allocated among the underlying funds as follows:
Bond 8.7 LargeCap Value 12.4 Capital Value 6.5 Real Estate Securities 2.1 Diversified International 14.8 SmallCap 4.0 Equity Income 2.0 SmallCap Growth 3.0 LargeCap Growth Equity 18.8 SmallCap Value 3.0 LargeCap Stock Index 24.7
Based on this allocation, the weighted average of the total account operating expenses of the underlying funds is 0.75%. The combined total expenses for the Account may be higher or lower depending on the allocation of its assets among the underlying funds. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2005"7.56 LOGO The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q3 '05 4.41% LOWESTQ1 '05-1.33% The year-to-date return as of March 31, 2006 is 5.69%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF FUND* PRINCIPAL LIFETIME 2050 ACCOUNT ...... 7.56 14.75 S&P 500 Index ........................ 4.91 11.66 Lehman Brothers Aggregate Bond Index . 2.43 2.75 Morningstar Large Blend Category Average .............................. 5.77 12.85 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (August 30, 2004).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees....... 0.12% Other Expenses........ 0.99 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.11% Fee Reduction and/or Expense Reimbursement. 0.99 ---- NET EXPENSES 0.12% The Manager has contractually agreed to reimburse operating expenses so that the total Account operating expenses will not be greater than 0.12% through April 30, 2007. The Manager may choose not to continue this arrangement after April 30, 2007. As a shareholder in the underlying funds, the Account indirectly bears its pro rata share of the operating expenses incurred by each underlying fund. As of December 31, 2005, the operating expenses of the underlying funds ranged from 0.38% to 1.13%. The Account's investment return is net of the underlying funds' operating expenses.
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If the operating expenses of the underlying funds, separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES --------------------------------------------------------------------------------------------------- 1 3 5 10 PRINCIPAL LIFETIME 2050 ACCOUNT $12 $220 $482 $1,232
PRINCIPAL LIFETIME STRATEGIC INCOME ACCOUNT The Account seeks current income. MAIN STRATEGIES To pursue its goal, the Account invests in shares of other Principal Variable Contracts Fund Accounts (the "underlying funds"). The underlying funds are intended to give the Account broad exposure to the domestic and foreign equity and fixed-income markets. The Manager and the Sub-Advisor, Principal, both provide investment advisory services to the Account. The Manager has hired Principal to develop, implement, and monitor the strategic or long-term asset class targets and target ranges for the Account. In deciding how to allocate the Account's assets among several asset classes, Principal considers long-term asset class returns, volatility assumptions and the Account's target time horizon. Principal is also responsible for employing an active rebalancing strategy that, within the target ranges, directs cash flows or Account assets towards or away from asset classes that Principal determines to be attractive or unattractive over shorter time periods, so long as the target asset class ranges are not violated. The Manager is responsible for implementing the strategic asset allocation set by Principal. In this role, the Manager selects the underlying funds and their respective weights. The Manager is also responsible for monitoring the Sub-Advisor of each underlying fund and may, at any time, add or substitute underlying funds in which the Account invests. In allocating Account assets among the underlying funds, the Manager relies on a combination of quantitative measures, such as past performance and style consistency, and qualitative factors. Qualitative factors that the Manager considers include the fund advisor's organizational stability, investment experience, consistency of investment process, risk management processes, and information, trading and compliance systems. MAIN RISKS The Account's investments are concentrated in the underlying funds and, as a result, the Account's performance is directly related to their performance. The Account's ability to meet its investment objective depends on the ability of the underlying funds to achieve their investment objectives. Consequently, the Account is subject to the particular risks of the underlying funds in the proportions in which the Account invests in them. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the underlying funds invest have associated risks. These include risks of: INTEREST RATE CHANGES . The value of fixed-income securities held by an underlying fund may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by an underlying fund may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. U.S. GOVERNMENT SPONSORED ENTERPRISES . An underlying fund may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. EQUITY SECURITY RISKS . Stock market volatility. The net asset value of the underlying fund shares is affected by change in the value of the securities it owns. The net asset value of the underlying fund shares is effected by changes in the value of the securities it owns. The prices of equity securities held by an underlying fund may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. . Foreign investing. The underlying funds may invest in foreign securities. Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries may negatively impact the portfolios of underlying funds. An underlying fund may make investments in instruments denominated in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. . Small and Medium Capitalizations. The underlying funds may invest in small and medium capitalization companies. Companies with small capitalizations are often companies with a limited operation history. Smaller capitalization companies securities may be more volatile in price than larger company securities, especially over the short-term. . Hedging strategies. Use of forward foreign currency exchange contracts, currency or index futures or other derivatives involves risks. . Initial Public Offerings ("IPOs"). An underlying fund's purchase of shares issued in IPOs exposes an underlying fund to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. INVESTOR PROFILE The Fund may be an appropriate investment for investors in retirement. UNDERLYING FUND ALLOCATION As of December 31, 2005, the Account's assets were allocated among the underlying funds as follows:
Bond 41.7 LargeCap Stock Index 5.5 Capital Value 1.5 LargeCap Value 3.0 Diversified International 3.4 Money Market 23.4 Equity Income 6.2 Real Estate Securities 9.3 LargeCap Growth Equity 4.0 SmallCap 2.0
Based on this allocation, the weighted average of the total account operating expenses of the underlying funds is 0.61%. The combined total expenses for the Account may be higher or lower depending on the allocation of its assets among the underlying funds. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2005"4.96 LOGO The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q2 '05 3.87% LOWESTQ1 '05-1.78% The year-to-date return as of March 31, 2006 is 3.00%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF FUND* PRINCIPAL LIFETIME STRATEGIC INCOME ACCOUNT .............................. 4.96 9.57 S&P 500 Index ........................ 4.91 11.66 Lehman Brothers Aggregate Bond Index . 2.43 2.75 Morningstar Conservative Allocation Category Average...................... 3.05 5.88 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (August 30, 2004).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES
Management Fees....... 0.12% Other Expenses........ 0.15 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.27% Fee Reduction and/or Expense Reimbursement. 0.13 ---- NET EXPENSES 0.14% The Manager has contractually agreed to reimburse operating expenses so that the total Account operating expenses will not be greater than 0.14% through April 30, 2007. The Manager may choose not to continue this arrangement after April 30, 2007. As a shareholder in the underlying funds, the Account indirectly bears its pro rata share of the operating expenses incurred by each underlying fund. As of December 31, 2005, the operating expenses of the underlying funds ranged from 0.38% to 1.09%. The Account's investment return is net of the underlying funds' operating expenses.
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If the operating expenses of the underlying funds, separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES --------------------------------------------------------------------------------------------- 1 3 5 10 PRINCIPAL LIFETIME STRATEGIC INCOME ACCOUNT $14 $69 $134 $326
REAL ESTATE SECURITIES ACCOUNT The Account seeks to generate a total return by investing primarily in equity securities of companies principally engaged in the real estate industry. MAIN STRATEGIES Under normal market conditions, the Account invests at least 80% of its net assets in equity securities of companies principally engaged in the real estate industry. For purposes of the Account's investment policies, a real estate company has at least 50% of its assets, income or profits derived from products or services related to the real estate industry. Real estate companies include real estate investment trusts and companies with substantial real estate holdings such as paper, lumber, hotel and entertainment companies. Companies whose products and services relate to the real estate industry include building supply manufacturers, mortgage lenders and mortgage servicing companies. Real estate investment trusts ("REITs") are corporations or business trusts that are permitted to eliminate corporate level federal income taxes by meeting certain requirements of the Internal Revenue Code. REITs are characterized as: . equity REITs, which primarily own property and generate revenue from rental income; . mortgage REITs, which invest in real estate mortgages; and . hybrid REITs, which combine the characteristics of both equity and mortgage REITs. In selecting securities for the Account, the Principal - REI, the Sub-Advisor focuses on equity REITs. The Account may invest up to 25% of its assets in securities of foreign real estate companies. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SECTOR RISK . Because the Account invests at least 80% of its net assets in securities of companies principally engaged in the real estate industry, the Account is also subject to sector risk; that is, the possibility that the real estate sector may underperform other sectors or the market as a whole. As more of the Account's portfolio holdings to the real estate sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. The share price of the Account may fluctuate more widely than the value of shares of a fund that invests in a broader range of industries. Securities of real estate companies are subject to securities market risks as well as risks similar to those of direct ownership of real estate. These include: . declines in the value of real estate . risks related to general and local economic conditions . dependency on management skills . heavy cash flow dependency . possible lack of available mortgage funds . overbuilding . extended vacancies in properties . increases in property taxes and operating expenses . changes in zoning laws . expenses incurred in the cleanup of environmental problems . casualty or condemnation losses . changes in interest rates In addition to the risks listed above, equity REITs are affected by the changes in the value of the properties owned by the trust. Mortgage REITs are affected by the quality of the credit extended. Both equity and mortgage REITs: . may not be diversified with regard to the types of tenants (thus subject to business developments of the tenant(s)); . may not be diversified with regard to the geographic locations of the properties (thus subject to regional economic developments); and . are subject to cash flow dependency of its tenants. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. INVESTOR PROFILE The Account may be an appropriate investment for investors who seek a total return, want to invest in companies engaged in the real estate industry and accept the potential for volatile fluctuations in the value of investments. Principal REI has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999"-4.48 "2000"30.97 "2001"8.75 "2002"7.72 "2003"38.91 "2004"34.53 The Account's highest/lowest quarterly returns "2005"15.85 during this time period were: HIGHEST Q4 '04 17.84% LOWEST Q3 '99-8.40% LOGO The year-to-date return as of March 31, 2006 is 16.34%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* REAL ESTATE SECURITIES ACCOUNT 15.85 20.46 15.23 MSCI US REIT Index ........... 12.52 18.80 12.60 Morningstar Specialty - Real Estate Category Average ...... 11.59 18.58 12.68 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.88% Other Expenses............................. 0.01 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.89%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ------------------------------------------------------------------------------------------ 1 3 5 10 REAL ESTATE SECURITIES ACCOUNT $91 $284 $493 $1,096
SHORT-TERM BOND ACCOUNT F/K/A LIMITED TERM BOND ACCOUNT The Account seeks to provide current income. MAIN STRATEGIES The Account invests primarily in short-term fixed-income securities. Under normal circumstances, the Account maintains a dollar-weighted effective maturity of not more than three years. In determining the average effective maturity of the Fund's assets, the maturity date of a callable security or prepayable securities may be adjusted to reflect the judgment of Principal, the Sub-Advisor, regarding the likelihood of the security being called or prepaid. The Account considers the term "bond" to mean any debt security. Under normal circumstances, it invests at least 80% of its assets in: . securities issued or guaranteed by the U.S. government or its agencies or instrumentalities; . debt securities of U.S. issuers rated in the three highest grades by Standard & Poor's Rating Service or Moody's Investors Service, Inc. or, if unrated, in the opinion of the Sub-Advisor, Principal, of comparable quality; and . mortgage-backed securities representing an interest in a pool of mortgage loans. The rest of the Account's assets may be invested in a variety of financial instruments, including securities in the fourth highest rating category or their equivalent. Securities in the fourth highest category are "investment grade." While they are considered to have adequate capacity to pay interest and repay principal, they do have speculative characteristics. Changes in economic and other conditions are more likely to affect the ability of the issuer to make principal and interest payments than is the case with issuers of higher rated securities. The Account may invest up to 15% of its assets in below-investment-grade fixed-income securities. Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (please see "High Yield Securities" in the section of the prospectus entitled "Certain Investment Strategies and Related Risks) The Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income. Under a reverse repurchase agreement, the Account sells securities and agrees to repurchase them at a specified date and price. The Account pays interest on this "secured financing" and attempts to make money on the difference between the financing rate and the interest it earns by investing the proceeds of the financing. While a reverse repurchase agreement is outstanding, the Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account may lend its portfolio securities to brokers, dealers and other financial institutions. In connection with such loans, the Account remains the owner of the loaned securities and continues to be entitled to payments in amounts equal to the interest, dividends or other distributions payable on the loaned securities. Loans of portfolio securities may not exceed 33 1/3% of the value of the Account's total assets (including the value of all assets received as collateral for loan). In connection with such loans the Account will receive collateral from the borrower equal to at least 100% of the value of the loaned securities. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates. When interest rates rise, the value of fixed-income securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of fixed-income securities. Some fixed-income investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. PORTFOLIO DURATION. . The average portfolio duration of the Account normally is less than three years and is based on Principal's forecast for interest rates. Duration is a measure of the expected life of a fixed-income security that is used to determine the sensitivity of a security's price to changes in interest rates. For example, if the portfolio duration of the Account is three years, a change of 1% in the market's yield results in a change of approximately 3% in the value of the Account's securities. The longer a security's duration, the more sensitive it is to changes in interest rates. An Account with a longer average portfolio duration will be more sensitive to changes in interest rates than an Account with a shorter average portfolio duration. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates. This may increase the volatility of the Account. REVERSE REPURCHASE AGREEMENTS. . This strategy involves the risk that interest costs on money borrowed may exceed the return on securities purchased with the borrowed money. In addition, reverse repurchase agreements may increase the volatility of the Fund. LENDING OF SECURITIES . If the Account lends its portfolio securities and the borrower of the securities fail financially, the Account may experience delays in recovering the loaned securities or exercising its rights in the collateral. Loans are made only to borrowers that are deemed by the Sub-Advisor to be of good financial standing. HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.) DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. COMMODITY-LINKED DERIVATIVE INSTRUMENTS . The use of commodity-linked derivative instruments may subject the Account to greater volatility than investments in traditional securities. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-- Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking diversification by investing in a fixed-income mutual fund. Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2004"1.3 "2005"1.8 The Account's highest/lowest quarterly returns LOGO during this time period were: HIGHEST Q1 '04 1.50% LOWEST Q2 '04 -1.58% The year-to-date return as of March 31, 2006 is 0.28%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF ACCOUNT* SHORT-TERM BOND ACCOUNT .................... 1.80 1.46 Lehman Brothers Mutual Fund 1-5 Gov't/Credit Index ...................................... 1.44 1.87 Morningstar Short-Term Bond Category Average 1.43 1.64 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 2003).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees...................................... 0.50% Other Expenses....................................... 0.07 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.57%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SHORT-TERM BOND ACCOUNT $58 $183 $318 $714
SMALLCAP ACCOUNT The Account seeks long-term growth of capital by investing primarily in equity securities of companies with comparatively small market capitalizations. MAIN STRATEGIES The Account invests primarily in common stocks of small capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with small market capitalizations (those with market capitalizations similar to companies in the Russell 2000/(R)/ Index (as of March 31, 2006, this range was between approximately $23 million and $5.4 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. The Account may invest up to 25% of its assets in securities of foreign companies. In selecting securities for investment, the Sub-Advisor, Principal, looks at stocks with value and/or growth characteristics and constructs an investment portfolio that has a "blend" of stocks with these characteristics. In managing the assets of the Account, Principal does not have a policy of preferring one of these categories to the other. The value orientation emphasizes buying stocks at less than their investment value and avoiding stocks whose price has been artificially built up. The growth orientation emphasizes buying stocks of companies whose potential for growth of capital and earnings is expected to be above average. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. Principal may purchase securities issued as part of, or a short period after, companies' initial public offerings ("IPOs"), and may at times dispose of those shares shortly after their acquisition. MAIN RISKS The Account's share price may fluctuate more than that of funds primarily invested in stocks of mid-sized and large companies and may underperform as compared to the securities of larger companies. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 125.8%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the potential for volatile fluctuations in the value of investments. Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999 "43.58 "2000"-11.73 "2001 "2.55 "2002"-27.33 "2003 "36.82 "2004 "19.82 The Account's highest/lowest quarterly returns "2005 "7.04 during this time period were: HIGHESTQ2 '9926.75% LOWEST Q3 '01-25.61% LOGO The year-to-date return as of March 31, 2006 is 11.13%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* SMALLCAP ACCOUNT ............. 7.04 5.51 3.66 Russell 2000 Index ........... 4.55 8.22 5.77 Morningstar Small Blend Category Average.............. 6.62 9.89 8.23 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.85% Other Expenses............................. 0.03 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.88%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SMALLCAP ACCOUNT $90 $281 $488 $1,084
SMALLCAP GROWTH ACCOUNT The Account seeks long-term growth of capital. The Manager has selected UBS Global AM and Emerald as Sub-Advisors to the Account. MAIN STRATEGIES The Account pursues its investment objective by investing primarily in equity securities. Under normal market conditions, the Account invests at least 80% of its assets in equity securities of companies with small market capitalizations (those with market capitalizations equal to or smaller than the greater of 1) $2.5 billion or 2) the highest market capitalization of the companies in the Russell 2000/(R)/ Growth Index at the time of purchase (as of March 31, 2005, this range was between approximately $23 million and $5.4 billion)). Market capitalization is defined as total current market value of a company's outstanding common stock. The Account may invest up to 25% of its assets in securities of foreign companies. UBS Global AM seeks to invest in companies that possess dominant market positions or franchises, a major technical edge, or a unique competitive advantage. To this end, UBS Global AM considers earnings revision trends, positive stock price momentum and strong fundamentals when selecting securities. The Account may also invest in securities of emerging growth companies which are companies that UBS Global AM expects to experience above average earnings or cash flow growth or meaningful changes in underlying asset values. Investments in equity securities may include common stock and preferred stock. Utilizing fundamental analysis, Emerald seeks to invest in the common stock of companies with distinct competitive advantages, strong management teams, leadership positions, high revenue and earnings growth rates versus peers, differentiated growth drivers and limited sell-side research. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. The Manager may, from time-to-time, reallocate Account assets among the Sub-Advisors. The decision to do so may be based on a variety of factors, including but not limited to: the investment capacity of each Sub-Advisor, portfolio diversification, volume of net cash flows, fund liquidity, investment performance, investment strategies, changes in each Sub-Advisor's firm or investment professionals, or changes in the number of Sub-Advisors. Ordinarily, reallocations of Account assets among Sub-Advisors will occur as a Sub-Advisor liquidates assets in the normal course of portfolio management and with net new cash flows; however, at times reallocations may occur by transferring assets in cash or in kind among Sub-Advisors. MAIN RISKS The Account's share price may fluctuate more than that of funds primarily invested in stocks of mid-sized and large companies and may underperform as compared to the securities of larger companies. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. SECTOR RISK . UBS Global AM may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As UBS Global AM allocates more of the Account's portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries . INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks that may have greater risks than stocks of companies with lower potential for earnings growth. UBS Global AM became the Sub-Advisor to the Account on October 1, 2002. On August 24, 2004, Emerald also became Sub-Advisor to the Account. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999 "95.69 "2000"-13.91 "2001"-32.01 "2002"-45.85 "2003 "45.64 The Account's highest/lowest quarterly returns "2004"11.24 during this time period were: HIGHESTQ4 '9959.52% LOWEST Q3 '01-37.66% LOGO The year-to-date return as of March 31, 2006 is 13.41%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* SMALLCAP GROWTH ACCOUNT ...... 6.67 -8.64 1.29 Russell 2000 Growth Index .... 4.15 2.28 1.46 Morningstar Small Growth Category Average.............. 5.74 2.17 6.26 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.00% Other Expenses............................. 0.05 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.05%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SMALLCAP GROWTH ACCOUNT $107 $334 $579 $1,283
SMALLCAP VALUE ACCOUNT The Account seeks long-term growth of capital. The Manager has selected Mellon Equity and Morgan as Sub-Advisors to the Account. MAIN STRATEGIES The Account invests primarily in a diversified group of equity securities of U.S. companies with small market capitalizations (those with market capitalizations similar to companies in the Russell 2000/(R)/ Value Index (as of March 31, 2006, this range was between approximately $29 million and $4.2 billion)) at the time of purchase. Under normal market conditions, the Account invests at least 80% of its assets in equity securities of such companies. Emphasis is given to those companies that exhibit value characteristics. Value securities generally have above average dividend yield and below average price to earnings (P/E) ratios. Up to 25% of the Account's assets may be invested in foreign securities. The Sub-Advisor, Morgan, uses quantitative and fundamental research, systematic stock valuation and a disciplined portfolio construction process. It seeks to enhance returns and reduce the volatility in the value of the Account relative to that of the U.S. small company value universe, represented by the Russell 2000/(R)/ Value Index. Morgan continuously screens the small company universe to identify for further analysis those companies that exhibit favorable factor rankings. Such factors include various valuation and momentum measures. Morgan ranks these companies within economic sectors according to their relative attractiveness. Morgan then selects for purchase the companies it feels to be most attractive within each economic sector. Under normal market conditions, the portion of the Account sub-advised by Morgan will have sector weightings comparable to that of the U.S. small company value universe though it may under or over-weight selected economic sectors. In addition, as a company moves out of the market capitalization range of the small company universe, it generally becomes a candidate for sale. Morgan may also purchase securities issued as part of, or a short period after, companies' initial public offerings ("IPOs"), and may at times dispose of those shares shortly after their acquisition. In selecting investments for the Account, the Sub-Advisor, Mellon Equity, uses a disciplined investment process that combines fundamental analysis and risk management with a multi-factor model that searches for undervalued stocks. Undervalued stocks are those selling at a low price relative to their profits and prospective earnings growth. The stock evaluation process uses several different characteristics, including changes in earnings estimates and change in price-to-earnings ratios, in an attempt to identify value among individual stocks. Rather than using broad economic or market trends, Mellon Equity selects stocks on a company-by-company basis. To ensure ample diversification, the portion of the Account's assets managed by Mellon Equity are allocated among industries and economic sectors in similar proportions to those of the Index. The portfolio is generally kept broadly diversified in an attempt to capture opportunities that may be realized quickly during periods of above-average market volatility. By maintaining such a diversified stance, stock selection drives performance. Since the Account has a long-term investment perspective, Mellon Equity does not intend to respond to short-term market fluctuations or to acquire securities for the purpose of short-term trading. The Manager may, from time-to-time, reallocate Account assets among the Sub-Advisors. The decision to do so may be based on a variety of factors, including but not limited to: the investment capacity of each Sub-Advisor, portfolio diversification, volume of net cash flows, fund liquidity, investment performance, investment strategies, changes in each Sub-Advisor's firm or investment professionals, or changes in the number of Sub-Advisors. Ordinarily, reallocations of Account assets among Sub-Advisors will occur as a Sub-Advisor liquidates assets in the normal course of portfolio management and with net new cash flows; however, at times reallocations may occur by transferring assets in cash or in kind among Sub-Advisors. MAIN RISKS The Account's share price may fluctuate more than that of funds primarily invested in stocks of mid-sized and large companies and may underperform as compared to the securities of larger companies. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operational history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities that may be more volatile in price than larger company securities, especially over the short-term. VALUE STOCKS . The Account's investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Companies doing business in emerging markets may not have the same range of opportunities as companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, neither Sub-Advisor can guarantee continued access to IPO offerings and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth and willing to accept volatile fluctuations in the value of their investment. The Account is not designed for investors seeking income or conservation of capital. Morgan has been the Account's Sub-Advisor since its inception. On August 8, 2005, Mellon Equity also became Sub-Advisor to the Account. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999 "21.45 "2000 "23.87 "2001"6.25 "2002"-8.86 "2003 "50.61 "2004 "23.08 The Account's highest/lowest quarterly returns "2005"6.22 during this time period were: HIGHEST Q2 '03 23.76% LOWEST Q3 '02 -17.74% LOGO The year-to-date return as of March 31, 2006 is 13.36%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* SMALLCAP VALUE ACCOUNT ....... 6.22 13.78 12.31 Russell 2000 Value Index ..... 4.71 13.55 9.19 Morningstar Small Value Category Average.............. 6.13 13.50 9.60 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees................. 1.09% Other Expenses.................. 0.04 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.13%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SMALLCAP VALUE ACCOUNT $115 $359 $622 $1,375
CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS The information in this section does not directly apply to the Principal LifeTime Accounts. It does apply to the underlying funds in which the LifeTime Accounts invest.The Statement of Additional Information (SAI) contains additional information about investment strategies and their related risks. SECURITIES AND INVESTMENT PRACTICES MARKET VOLATILITY . Equity securities include common stocks, preferred stocks, convertible securities, depositary receipts, rights and warrants. Common stocks, the most familiar type, represent an equity (ownership) interest in a corporation. The value of a company's stock may fall as a result of factors directly relating to that company, such as decisions made by its management or lower demand for the company's products or services. A stock's value may also fall because of factors affecting not just the company, but also companies in the same industry or in a number of different industries, such as increases in production costs. The value of a company's stock may also be affected by changes in financial markets that are relatively unrelated to the company or its industry, such as changes in interest rates or currency exchange rates. In addition, a company's stock generally pays dividends only after the company invests in its own business and makes required payments to holders of its bonds and other debt. For this reason, the value of a company's stock will usually react more strongly than its bonds and other debt to actual or perceived changes in the company's financial condition or prospects. Stocks of smaller companies may be more vulnerable to adverse developments than those of larger companies. Fixed-income securities include bonds and other debt instruments that are used by issuers to borrow money from investors. The issuer generally pays the investor a fixed, variable or floating rate of interest. The amount borrowed must be repaid at maturity. Some debt securities, such as zero coupon bonds, do not pay current interest, but are sold at a discount from their face values. INTEREST RATE CHANGES . Fixed-income securities are sensitive to changes in interest rates. In general, fixed-income security prices rise when interest rates fall and fall when interest rates rise. Longer term bonds and zero coupon bonds are generally more sensitive to interest rate changes. CREDIT RISK . Fixed-income security prices are also affected by the credit quality of the issuer. Investment grade debt securities are medium and high quality securities. Some bonds, such as lower grade or "junk" bonds, may have speculative characteristics and may be particularly sensitive to economic conditions and the financial condition of the issuers. REPURCHASE AGREEMENTS AND LOANED SECURITIES Although not a principal investment strategy, each of the Accounts may invest a portion of its assets in repurchase agreements. Repurchase agreements typically involve the purchase of debt securities from a financial institution such as a bank, savings and loan association or broker-dealer. A repurchase agreement provides that the Account sells back to the seller and that the seller repurchases the underlying securities at a specified price on a specific date. Repurchase agreements may be viewed as loans by an Account collateralized by the underlying securities. This arrangement results in a fixed rate of return that is not subject to market fluctuation while the Account holds the security. In the event of a default or bankruptcy by a selling financial institution, the affected Account bears a risk of loss. To minimize such risks, the Account enters into repurchase agreements only with large, well-capitalized and well-established financial institutions. In addition, the value of the securities collateralizing the repurchase agreement is, and during the entire term of the repurchase agreement remains, at least equal to the repurchase price, including accrued interest. Each of the Accounts may lend its portfolio securities to unaffiliated broker-dealers and other unaffiliated qualified financial institutions. REVERSE REPURCHASE AGREEMENTS An Account may use reverse repurchase agreements to obtain cash to satisfy unusually heavy redemption requests or for other temporary or emergency purposes without the necessity of selling portfolio securities, or to earn additional income on portfolio securities, such as Treasury bills or notes. In a reverse repurchase agreement, an Account sells a portfolio security to another party, such as a bank or broker-dealer, in return for cash and agrees to repurchase the instrument at a particular price and time. While a reverse repurchase agreement is outstanding, an Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account will enter into reverse repurchase agreements only with parties that the Sub-Advisor deems creditworthy. Using reverse repurchase agreements to earn additional income involves the risk that the interest earned on the invested proceeds is less than the expense of the reverse repurchase agreement transaction. This technique may also have a leveraging effect on the Account, although the Account's intent to segregate assets in the amount of the repurchase agreement minimizes this effect. CURRENCY CONTRACTS The Accounts may enter into currency contracts, currency futures contracts and options, and options on currencies for hedging and other purposes. A forward currency contract involves a privately negotiated obligation to purchase or sell a specific currency at a future date at a price set in the contract. An Account will not hedge currency exposure to an extent greater than the aggregate market value of the securities held or to be purchased by the Account (denominated or generally quoted or currently convertible into the currency). Hedging is a technique used in an attempt to reduce risk. If an Account's Sub-Advisor hedges market conditions incorrectly or employs a strategy that does not correlate well with the Account's investment, these techniques could result in a loss. These techniques may increase the volatility of an Account and may involve a small investment of cash relative to the magnitude of the risk assumed. In addition, these techniques could result in a loss if the other party to the transaction does not perform as promised. There is also a risk of government action through exchange controls that would restrict the ability of the Account to deliver or receive currency. FORWARD COMMITMENTS Although not a principal investment strategy, each of the Accounts may enter into forward commitment agreements. These agreements call for the Account to purchase or sell a security on a future date at a fixed price. Each of the Accounts may also enter into contracts to sell its investments either on demand or at a specific interval. WARRANTS Each of the Accounts may invest in warrants though none of the Accounts use such investments as a principal investment strategy. A warrant is a certificate granting its owner the right to purchase securities from the issuer at a specified price, normally higher than the current market price. HIGH YIELD SECURITIES The Bond, MidCap Value and Short-Term Bond may invest in debt securities rated lower than BBB by S&P or Baa by Moody's or, if not rated, determined to be of equivalent quality by the Manager or the Sub-Advisor. Such securities are sometimes referred to as high yield or "junk bonds" and are considered speculative. Investment in high yield bonds involves special risks in addition to the risks associated with investment in highly rated debt securities. High yield bonds may be regarded as predominantly speculative with respect to the issuer's continuing ability to meet principal and interest payments. Moreover, such securities may, under certain circumstances, be less liquid than higher rated debt securities. Analysis of the creditworthiness of issuers of high yield securities may be more complex than for issuers of higher quality debt securities. The ability of an Account to achieve its investment objective may, to the extent of its investment in high yield bonds, be more dependent on such credit analysis than would be the case if the Account were investing in higher quality bonds. High yield bonds may be more susceptible to real or perceived adverse economic and competitive industry conditions than higher-grade bonds. The prices of high yield bonds have been found to be less sensitive to interest rate changes than more highly rated investments, but more sensitive to adverse economic downturns or individual corporate developments. If the issuer of high yield bonds defaults, an Account may incur additional expenses to seek recovery. The secondary market on which high yield bonds are traded may be less liquid than the market for higher-grade bonds. Less liquidity in the secondary trading market could adversely affect the price at which an Account could sell a high yield bond and could adversely affect and cause large fluctuations in the daily price of the Account's shares. Adverse publicity and investor perceptions, whether or not based on fundamental analysis, may decrease the value and liquidity of high yield bonds, especially in a thinly traded market. The use of credit ratings for evaluating high yield bonds also involves certain risks. For example, credit ratings evaluate the safety of principal and interest payments, not the market value risk of high yield bonds. Also, credit rating agencies may fail to change credit ratings in a timely manner to reflect subsequent events. If a credit rating agency changes the rating of a portfolio security held by an Account, the Account may retain the security if the Manager or Sub-Advisor thinks it is in the best interest of shareholders. INITIAL PUBLIC OFFERINGS ("IPOS") Certain of the Accounts may invest in IPOs. An IPO is a company's first offering of stock to the public. IPO risk is that the market value of IPO shares will fluctuate considerably due to factors such as the absence of a prior public market, unseasoned trading, the small number of shares available for trading and limited information about the issuer. The purchase of IPO shares may involve high transaction costs. IPO shares are subject to market risk and liquidity risk. In addition, the market for IPO shares can be speculative and/or inactive for extended periods of time. The limited number of shares available for trading in some IPOs may make it more difficult for an Account to buy or sell significant amounts of shares without an unfavorable impact on prevailing prices. Investors in IPO shares can be affected by substantial dilution in the value of their shares by sales of additional shares and by concentration of control in existing management and principal shareholders. When an Account's asset base is small, a significant portion of the Account's performance could be attributable to investments in IPOs because such investments would have a magnified impact on the Account. As the Account's assets grow, the effect of the Account's investments in IPOs on the Account's performance probably will decline, which could reduce the Account's performance. Because of the price volatility of IPO shares, an Account may choose to hold IPO shares for a very short period of time. This may increase the turnover of the Account's portfolio and lead to increased expenses to the Account, such as commissions and transaction costs. By selling IPO shares, the Account may realize taxable gains it will subsequently distribute to shareholders. DERIVATIVES To the extent permitted by its investment objectives and policies, each of the Accounts (except Money Market) may invest in securities that are commonly referred to as derivative securities. Generally, a derivative is a financial arrangement, the value of which is derived from, or based on, a traditional security, asset, or market index. Certain derivative securities are described more accurately as index/structured securities. Index/structured securities are derivative securities whose value or performance is linked to other equity securities (such as depositary receipts), currencies, interest rates, indices or other financial indicators (reference indices). Some derivatives, such as mortgage-related and other asset-backed securities, are in many respects like any other investment, although they may be more volatile or less liquid than more traditional debt securities. There are many different types of derivatives and many different ways to use them. Futures and options are commonly used for traditional hedging purposes to attempt to protect an Account from exposure to changing interest rates, securities prices, or currency exchange rates and for cash management purposes as a low-cost method of gaining exposure to a particular securities market without investing directly in those securities. The Accounts may enter into put or call options, future contracts, options on futures contracts and over-the-counter swap contracts (e.g., interest rate swaps, total return swaps and credit default swaps) for both hedging and non-hedging purposes. Generally, no Account may invest in a derivative security unless the reference index or the instrument to which it relates is an eligible investment for the Account. The return on a derivative security may increase or decrease, depending upon changes in the reference index or instrument to which it relates. The risks associated with derivative investments include: . the risk that the underlying security, interest rate, market index or other financial asset will not move in the direction the Manager or Sub-Advisor anticipated; . the possibility that there may be no liquid secondary market which may make it difficult or impossible to close out a position when desired; . the risk that adverse price movements in an instrument can result in a loss substantially greater than an Account's initial investment; and . the counterparty may fail to perform its obligations. EXCHANGE TRADED FUNDS (ETFS) These are a type of index fund bought and sold on a securities exchange. An ETF trades like common stock and represents a fixed portfolio of securities designed to track a particular market index. The Accounts could purchase shares issued by an ETF to temporarily gain exposure to a portion of the U.S. or a foreign market while awaiting purchase of underlying securities. The risks of owning an ETF generally reflect the risks of owning the underlying securities they are designed to track, although ETFs have management fees that increase their costs. CONVERTIBLE SECURITIES Convertible securities are fixed-income securities that an Account has the right to exchange for equity securities at a specified conversion price. The option allows the Account to realize additional returns if the market price of the equity securities exceeds the conversion price. For example, the Account may hold fixed-income securities that are convertible into shares of common stock at a conversion price of $10 per share. If the market value of the shares of common stock reached $12, the Account could realize an additional $2 per share by converting its fixed-income securities. Convertible securities have lower yields than comparable fixed-income securities. In addition, at the time a convertible security is issued the conversion price exceeds the market value of the underlying equity securities. Thus, convertible securities may provide lower returns than non-convertible fixed-income securities or equity securities depending upon changes in the price of the underlying equity securities. However, convertible securities permit the Account to realize some of the potential appreciation of the underlying equity securities with less risk of losing its initial investment. The Accounts treat convertible securities as both fixed-income and equity securities for purposes of investment policies and limitations because of their unique characteristics. The Accounts may invest in convertible securities without regard to their ratings. FOREIGN INVESTING As a principal investment strategy, the Diversified International and International SmallCap Accounts may invest Account assets in securities of foreign companies. The other Accounts (except Government & High Quality Bond) may invest in securities of foreign companies but not as a principal investment strategy. For the purpose of this restriction, foreign companies are: . companies with their principal place of business or principal office outside the U.S.; and . companies for which the principal securities trading market is outside the U.S. Foreign companies may not be subject to the same uniform accounting, auditing and financial reporting practices as are required of U.S. companies. In addition, there may be less publicly available information about a foreign company than about a U.S. company. Securities of many foreign companies are less liquid and more volatile than securities of comparable U.S. companies. Commissions on foreign securities exchanges may be generally higher than those on U.S. exchanges, although each Account seeks the most favorable net results on its portfolio transactions. Foreign markets also have different clearance and settlement procedures than those in U.S. markets. In certain markets there have been times when settlements have been unable to keep pace with the volume of securities transactions, making it difficult to conduct these transactions. Delays in settlement could result in temporary periods when a portion of Account assets is not invested and earning no return. If an Account is unable to make intended security purchases due to settlement problems, the Account may miss attractive investment opportunities. In addition, an Account may incur a loss as a result of a decline in the value of its portfolio if it is unable to sell a security. With respect to certain foreign countries, there is the possibility of expropriation or confiscatory taxation, political or social instability, or diplomatic developments that could affect an Account's investments in those countries. In addition, an Account may also suffer losses due to nationalization, expropriation or differing accounting practices and treatments. Investments in foreign securities are subject to laws of the foreign country that may limit the amount and types of foreign investments. Changes of governments or of economic or monetary policies, in the U.S. or abroad, changes in dealings between nations, currency convertibility or exchange rates could result in investment losses for an Account. Finally, even though certain currencies may be convertible into U.S. dollars, the conversion rates may be artificial relative to the actual market values and may be unfavorable to Account investors. Foreign securities are often traded with less frequency and volume, and therefore may have greater price volatility, than is the case with many U.S. securities. Brokerage commissions, custodial services, and other costs relating to investment in foreign countries are generally more expensive than in the U.S. Though the Accounts intend to acquire the securities of foreign issuers where there are public trading markets, economic or political turmoil in a country in which an Account has a significant portion of its assets or deterioration of the relationship between the U.S. and a foreign country may negatively impact the liquidity of an Account's portfolio. An Account may have difficulty meeting a large number of redemption requests. Furthermore, there may be difficulties in obtaining or enforcing judgments against foreign issuers. An Account may choose to invest in a foreign company by purchasing depositary receipts. Depositary receipts are certificates of ownership of shares in a foreign-based issuer held by a bank or other financial institution. They are alternatives to purchasing the underlying security but are subject to the foreign securities to which they relate. Investments in companies of developing countries may be subject to higher risks than investments in companies in more developed countries. These risks include: . increased social, political and economic instability; . a smaller market for these securities and low or nonexistent volume of trading that results in a lack of liquidity and in greater price volatility; . lack of publicly available information, including reports of payments of dividends or interest on outstanding securities; . foreign government policies that may restrict opportunities, including restrictions on investment in issuers or industries deemed sensitive to national interests; . relatively new capital market structure or market-oriented economy; . the possibility that recent favorable economic developments may be slowed or reversed by unanticipated political or social events in these countries; . restrictions that may make it difficult or impossible for the Account to vote proxies, exercise shareholder rights, pursue legal remedies, and obtain judgments in foreign courts; and . possible losses through the holding of securities in domestic and foreign custodial banks and depositories. In addition, many developing countries have experienced substantial, and in some periods, extremely high rates of inflation for many years. Inflation and rapid fluctuations in inflation rates have had and may continue to have negative effects on the economies and securities markets of those countries. Repatriation of investment income, capital and proceeds of sales by foreign investors may require governmental registration and/or approval in some developing countries. An Account could be adversely affected by delays in or a refusal to grant any required governmental registration or approval for repatriation. Further, the economies of developing countries generally are heavily dependent upon international trade and, accordingly, have been and may continue to be adversely affected by trade barriers, exchange controls, managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries with which they trade. SMALL AND MEDIUM CAPITALIZATION COMPANIES The Accounts (except Bond, Government & High Quality Bond, Money Market and Short-Term Bond) may invest in securities of companies with small- or mid-sized market capitalizations. The Capital Value, LargeCap Blend, LargeCap Growth Equity and LargeCap Value Accounts may hold securities of small and medium capitalization companies but not as a principal investment strategy. Market capitalization is defined as total current market value of a company's outstanding common stock. Investments in companies with smaller market capitalizations may involve greater risks and price volatility (wide, rapid fluctuations) than investments in larger, more mature companies. Small companies may be less significant within their industries and may be at a competitive disadvantage relative to their larger competitors. While smaller companies may be subject to these additional risks, they may also realize more substantial growth than larger or more established companies. Smaller companies may be less mature than larger companies. At this earlier stage of development, the companies may have limited product lines, reduced market liquidity for their shares, limited financial resources or less depth in management than larger or more established companies. Unseasoned issuers are companies with a record of less than three years continuous operation, including the operation of predecessors and parents. Unseasoned issuers by their nature have only a limited operating history that can be used for evaluating the company's growth prospects. As a result, investment decisions for these securities may place a greater emphasis on current or planned product lines and the reputation and experience of the company's management and less emphasis on fundamental valuation factors than would be the case for more mature growth companies. TEMPORARY DEFENSIVE MEASURES From time to time, as part of its investment strategy, each Account (other than the Money Market Account which may invest in high quality money market securities at any time) may invest without limit in cash and cash equivalents for temporary defensive purposes in response to adverse market, economic or political conditions. To the extent that the Account is in a defensive position, it may lose the benefit of upswings and limit its ability to meet its investment objective. For this purpose, cash equivalents include: bank notes, bank certificates of deposit, bankers' acceptances, repurchase agreements, commercial paper, and commercial paper master notes which are floating rate debt instruments without a fixed maturity. In addition, an Account may purchase U.S. government securities, preferred stocks and debt securities, whether or not convertible into or carrying rights for common stock. LIFETIME ACCOUNTS The performance and risks of each LifeTime Account directly corresponds to the performance and risks of the underlying funds in which the Account invests. By investing in many underlying funds, the LifeTime Accounts have partial exposure to the risks of many different areas of the market. The more a LifeTime Account allocates to stock funds, the greater the expected risk. For Accounts that are farthest from their stated retirement dates, allocations to stocks are relatively high so that investors may benefit from their long-term growth potential, while allocations to fixed-income securities are relatively low. This approach is designed to help investors accumulate the assets needed during their retirement years. Principal intends to gradually shift each LifeTime Account's (except the Lifetime Strategic Income Account) allocation among the underlying funds so that within five to ten years after the stated retirement date, the Account's underlying fund allocation matches the underlying fund allocation of the Principal LifeTime Strategic Income Account. If you are considering investing in a LifeTime Account, you should take into account your estimated retirement date and risk tolerance. In general, each LifeTime Account is managed with the assumption that the investor will invest in a LifeTime Account whose stated date is closest to the date the shareholder retires. Choosing an Account targeting an earlier date represents a more conservative choice; targeting an Account with a later date represents a more aggressive choice. It is important to note that the retirement year of the Account you select should not necessarily represent the specific year you intend to start drawing retirement assets. It should be a guide only. Generally, the potential for higher returns over time is accompanied by the higher risk of a decline in the value of your principal. Investors should realize that the LifeTime Accounts are not a complete solution to their retirement needs. Investors must weigh many factors when considering when to retire, what their retirement needs will be, and what sources of income they may have. Each LifeTime Account indirectly bears its pro-rata share of the expenses of the underlying funds in which it invests, as well as directly incurring expenses. Therefore, investment in a LifeTime Account is more costly than investing directly in shares of the underlying funds. PORTFOLIO TURNOVER "Portfolio Turnover" is the term used in the industry for measuring the amount of trading that occurs in an Account's portfolio during the year. For example, a 100% turnover rate means that on average every security in the portfolio has been replaced once during the year. Accounts with high turnover rates (more than 100%) often have higher transaction costs (which are paid by the Account) and may have an adverse impact on the Account's performance. No turnover rate can be calculated for the Money Market Account because of the short maturities of the securities in which it invests. Turnover rates for each of the other Accounts may be found in the Account's Financial Highlights table. Please consider all the factors when you compare the turnover rates of different funds. A fund with consistently higher total returns and higher turnover rates than another fund may actually be achieving better performance precisely because the managers are active traders. You should also be aware that the "total return" line in the Financial Highlights section already includes portfolio turnover costs. PRICING OF ACCOUNT SHARES Each Account's shares are bought and sold at the current share price. The share price of each Account is calculated each day the New York Stock Exchange ("NYSE") is open (shares are not priced on the days on which the NYSE is closed for trading). The share price is determined at the close of business of the NYSE (normally 3:00 p.m. Central time). When an order to buy or sell shares is received, the share price used to fill the order is the next price calculated after the order is received. For all Accounts, except the Money Market Account, the share price is calculated by: . taking the current market value of the total assets of the Account . subtracting liabilities of the Account . dividing the remainder by the total number of shares owned by the Account. The securities of the Money Market Account are valued at amortized cost. The calculation procedure is described in the SAI. The Money Market Account reserves the right to determine a share price more than once each day. NOTES: . If current market values are not readily available for a security owned by an Account, its fair value is determined using a policy adopted by the Directors. . An Account's securities may be traded on foreign securities markets that generally complete trading at various times during the day prior to the close of the NYSE. Generally, the values of foreign securities used in computing a Fund's NAV are determined at the time the foreign market closes. Foreign securities and currencies are converted to U.S. dollars using the exchange rate in effect at the close of the London Exchange (generally 11:00 a.m. Eastern Time). Occasionally, events affecting the value of foreign securities occur when the foreign market is closed and the NYSE is open. The Account has adopted policies and procedures to "fair value" some or all securities held by an Account if significant events occur after the close of the market on which the foreign securities are traded but before the Account's NAV is calculated. Significant events can be specific to a single security or can include events that affect a particular foreign market or markets. A significant event can also include a general market movement in the U.S. securities markets. If the Manager believes that the market value of any or all of the foreign securities is materially affected by such an event, the securities will be valued, and the Account's NAV will be calculated, using the policy adopted by the Account. These fair valuation procedures are intended to discourage shareholders from investing in the Account for the purpose of engaging in market timing or arbitrage transactions. The trading of foreign securities generally or in a particular country or countries may not take place on all days the NYSE is open, or may trade on days the NYSE is closed. Thus, the value of the foreign securities held by the Account may change on days when shareholders are unable to purchase or redeem shares. . Certain securities issued by companies in emerging market countries may have more than one quoted valuation at any point in time. These may be referred to as local price and premium price. The premium price is often a negotiated price that may not consistently represent a price at which a specific transaction can be effected. The Fund has a policy to value such securities at a price at which the Sub-Advisor expects the securities may be sold. DIVIDENDS AND DISTRIBUTIONS The Accounts earn dividends, interest and other income from investments and distribute this income (less expenses) as dividends. The Accounts also realize capital gains from investments and distribute these gains (less any losses) as capital gain distributions. The Accounts normally make dividends and capital gain distributions at least annually, in February. Dividends and capital gain distributions are automatically reinvested in additional shares of the Account making the distribution. MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE THE MANAGER Principal Management Corporation serves as the manager for the Fund. In its handling of the business affairs of the Fund, the Manager provides clerical, recordkeeping and bookkeeping services, and keeps the required financial and accounting records. THE SUB-ADVISORS The Manager has signed a contract with a Sub-Advisor under which the Sub-Advisor agrees to assume the obligations of the Manager to provide investment advisory service for the Account. For these services, the Sub-Advisor is paid a fee by the Manager. Information regarding Sub-Advisors and individual portfolio managers is set forth below. The Statement of Additional Information provides additional information about each portfolio manager's compensation, other accounts managed by the portfolio manager and the portfolio manager's ownership of securities in the Account. MANAGER: The Manager is an indirect subsidiary of Principal Financial Services, Inc. and has managed mutual funds since 1969. As of December 31, 2005, the mutual funds it manages had assets of approximately $28.6 billion. The Manager's address is Principal Financial Group, Des Moines, Iowa 50392-2080.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Principal LifeTime 2010 Doug Loeffler Principal LifeTime 2020 Doug Loeffler Principal LifeTime 2030 Doug Loeffler Principal LifeTime 2040 Doug Loeffler Principal LifeTime 2050 Doug Loeffler Principal LifeTime Strategic Income Doug Loeffler
DOUG LOEFFLER, CFA . - Mr. Loeffler is a Vice President with Principal Management Corporation. He is the senior member of the Manager Research Team that is responsible for analyzing, interpreting and coordinating investment performance data and evaluation of the investment managers under the due diligence program. He is responsible for preparing periodic evaluation reports including both qualitative and quantitative analysis. Mr. Loeffler participates in the manager selection process and portfolio reviews. Joining Principal Management Corporation in 2004, he has 16 years of investment experience including 14 years in the mutual fund industry (Scudder and Founders Asset Management). His background includes quantitative analysis, fundamental analysis and portfolio management focusing on non-U.S. stocks. Mr. Loeffler earned an MBA in Finance at the University of Chicago and a degree in Economics from Washington State University. He has earned the right to use the Chartered Financial Analyst designation. Mr. Loeffler shares responsibility for the day-today management of the LifeTime Accounts with Mr. Laschanzky, a portfolio manager representing Principal. On behalf of Principal, Mr. Laschanzky develops, implements and monitors the Account's strategic or long-term asset class targets and target ranges. On behalf of the Manager, Mr. Loeffler implements the strategic asset allocation Mr. Laschanzky sets. SUB-ADVISOR: AllianceBernstein L.P. ("AllianceBernstein") managed $579 billion in assets as of December 31, 2005. AllianceBernstein is located at 1345 Avenue of the Americas, New York, NY 10105. The management of and investment decisions for the Account's portfolio are made by the US Value Investment Policy Group, comprised of senior US Value Investment Team members. The US Value Investment Policy Group relies heavily on the fundamental analysis and research of the Adviser's large internal research staff. No one person is principally responsible for making recommendations for the Account's portfolio. the members of the US Value Investment Policy Group with the most significant responsibility for the day-to-day management of the Account's portfolio are: Marilyn Fedak, John Mahedy, John Phillips and Chris Marx. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ LargeCap Value Marilyn Fedak John Mahedy Chris Marx John Phillips
MARILYN G. FEDAK, CFA . Ms. Fedak joined Bernstein in 1984 as a senior portfolio manager. An Executive Vice President of AllianceBernstein since 2000, she is Head of Global Value Equities and chair of the US Large Cap Value Equity Investment Policy Group. Ms. Fedak serves on AllianceBernstein's Management Executive Committee and is also a Director of SCB Inc. She earned a BA from Smith College and an MBA from Harvard University. She has also earned the right to use the Chartered Financial Analyst designation. JOHN MAHEDY, CPA . Mr. Mahedy was named Co-CIO-US Value equities in 2003. He continues to serve as director of research-US Value Equities, a position he has held since 2001. Previously, Mr. Mahedy was a senior research analyst at Bernstein's institutional research and brokerage unit, covering the domestic and international energy industry from 1995 to 2001. He earned a BS and an MBA from New York University. CHRISTOPHER W. MARX . Mr. Marx joined the firm in 1997 as a research analyst. He covered a variety of industries both domestically and internationally, including chemicals, food, supermarkets, beverages and tobacco. Mr. Marx earned an AB in Economics from Harvard, and an MBA from the Stanford Graduate School of Business. JOHN D. PHILLIPS, JR., CFA . Mr. Phillips joined the firm in 1994 and is a senior portfolio manager and member of the US Value Equities Investment Policy Group. He is also chairman of Bernstein's Proxy Voting Committee. Mr. Phillips earned a BA from Hamilton College and an MBA from Harvard University. He has also earned the right to use the Chartered Financial Analyst designation. SUB-ADVISOR: Columbus Circle Investors ("CCI") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. CCI was founded in 1975. Its address is Metro Center, One Station Place, Stamford, CT 06902. As of December 31, 2005, CCI had approximately $5.9 billion in assets under management. The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Growth Anthony Rizza
ANTHONY RIZZA, CFA . Mr. Rizza, portfolio manager, joined CCI in 1991. He received a BS in Business from the University of Connecticut. Mr. Rizza has earned the right to use the Chartered Financial Analyst designation and is a member of the Hartford Society of Security Analysts. SUB-ADVISOR: Emerald Advisers, Inc. ("Emerald") is a wholly-owned subsidiary of Emerald Asset Management. Emerald provides professional investment advisory services to institutional investors, high net worth individuals and the general public. As of December 31, 2005, Emerald managed approximately $2.36 billion in assets. Emerald's offices are located at 1703 Oregon Pike Road, Suite 101, Lancaster, Pennsylvania 17601.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ SmallCap Growth Joseph W. Garner Kenneth G. Mertz Stacey L. Sears
The portfolio management and strategy team have long tenures at Emerald, with Ms. Sears joining Emerald in 1991, Mr. Mertz in 1992 and Mr. Garner in 1994. JOSEPH W. GARNER . Mr. Garner joined Emerald in 1994 and serves as Director of Emerald Research and Portfolio Manager. Prior to joining Emerald, Mr. Garner was the Program Manager of the Pennsylvania Economic Development Financing Authority (PEDFA); an Economic Development Analyst with the PA Department of Commerce's Office of Technology Development; and an Industry Research Analyst with the Pittsburgh High Technology Council. Mr. Garner earned an MBA from the Katz Graduate School of Business, University of Pittsburgh, and graduated magna cum laude with a BA in Economics from Millersville University. KENNETH G. MERTZ II, CFA. . Mr. Mertz joined Emerald in 1992 and serves as President of Emerald Advisers, Inc. Formerly he served as Past Trustee, Vice President of the Emerald Mutual Funds (1992-2005) and Chief Investment Officer of the Pennsylvania State Employees' Retirement System (1985-1992). He earned a BA in Economics from Millersville University. Mr. Mertz supervises the entire portfolio management and trading process. As Chief Investment Officer, he has full discretion over all portfolios. Mr. Mertz, Ms. Sears and Mr. Garner work as a team developing strategy. STACEY L. SEARS . Ms. Sears joined Emerald in 1991 and serves as Senior Vice President and Portfolio Manager of Emerald Advisers, Inc. She is co-manager of the Forward Emerald Growth Fund and a member of the Portfolio Management team. Additionally, Ms. Sears maintains research coverage of retail, apparel, consumer goods and consumer technology companies. Ms. Sears earned a BS in Business Administration from Millersville University and an MBA from Villanova University. SUB-ADVISOR: Grantham, Mayo, Van Otterloo & Co. LLC ("GMO") is a privately held global investment management firm servicing clients in the corporate, public, endowment and foundation marketplace located at 40 Rowes Wharf, Boston, MA 02110. As of December 31, 2005, GMO managed $111 billion in client assets.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ LargeCap Growth Equity Sam Wilderman
Day-to-day management of the LargeCap Growth Equity Account is the responsibility of GMO's U.S. Quantitative Division. The Division's members work collaboratively to manage the Account's portfolio, and no one person is primarily responsible for day-to-day management. The individual responsible for managing the implementation and monitoring of the overall portfolio management of the Account is Sam Wilderman. Mr. Wilderman allocates responsibility for portions of the Account's portfolio to various members of the Division, oversees the implementation of trades, reviews the overall composition of the Account's portfolio, including compliance with stated investment objectives and strategies and monitors cash flows. Mr. Wilderman is a member (partner) of GMO and is Director of GMO's U.S. Quantitative Division. Mr. Wilderman served as co-director of U.S. equity management in 2005. Prior to this position, he was responsible for research and portfolio management for the GMO Emerging Markets Fund, the GMO Emerging Countries Fund and the GMO Emerging Markets Quality Fund. He joined GMO in 1996 following the completion of his B.A. in Economics from Yale University. The SAI contains other information about how GMO determines the compensation of the Division's senior member, other accounts managed by the team's senior member, and ownership of shares of the Account by the Division's senior member. SUB-ADVISOR: J.P. Morgan Investment Management Inc. ("Morgan"), 522 Fifth Avenue, New York, NY 10036 is an indirect wholly-owned subsidiary of JPMorgan Chase & Co. ("JPMorgan"), a bank holding company. Morgan offers a wide range of services to governmental, institutional, corporate and individual customers and acts as investment advisor to individual and institutional clients. As of December 31, 2005, Morgan had total combined assets under management of approximately $847 billion. The portfolio managers operate as a team, sharing responsibility for the day-to-day management of the portfolio, each strategy does, however, have lead portfolio managers with responsibility for implementing the insight of the team into individual portfolios. The Statement of Additional Information provides additional information about the portfolio managers' compensation, other accounts managed by the portfolio managers and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ SmallCap Value Christopher T. Blum Dennis S. Ruhl
CHRISTOPHER T. BLUM, CFA . Managing Director of Morgan. Mr. Blum is a portfolio manager in the U.S. Small Cap Equity Group. He rejoined the firm in 2001. Previously, he spent two years as a research analyst responsible for the valuation and acquisition of private equity assets at Pomona Capital. Prior to that, Mr. Blum spent over three years with Morgan where he focused on structured small-cap core and small-cap value accounts. He earned his BBA in Finance at the Bernard M. Baruch School for Business and is a holder of the CFA designation. DENNIS S. RUHL, CFA . Mr. Ruhl, Vice President of Morgan, joined the company in 1999. He is a portfolio manager in the U.S. Small Cap Equity Group. His current responsibilities include managing structured small cap core and value accounts. Previously, he worked on quantitative equity research (focusing on trading) as well as business development. Mr. Ruhl earned Bachelor's degrees in Mathematics and Computer Science and a Master's degree in Computer Science, all from MIT. He has earned the right to use the Chartered Financial Analyst designation. SUB-ADVISOR: Mellon Equity Associates, LLP ("Mellon Equity"), 500 Grant Street, Suite 4200, Pittsburgh, PA 15258. Mellon Equity is a wholly owned subsidiary of Mellon Financial Corporation ("Mellon"). Mellon has approximately $4.7 trillion in assets under management, administration or custody, including $781 billion under management. As of December 31, 2005, Mellon Equity managed approximately $21.3 billion in assets.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ MidCap Growth Adam T. Logan John O'Toole SmallCap Value Ronald P. Gala Peter D. Goslin
RONALD P. GALA, CFA . Mr. Gala is a portfolio manager of Dreyfus and a Senior Vice President and a principal of Mellon Equity. Mr. Gala has 20 years experience managing equity portfolios, and he is a past president of the Pittsburgh Society of Financial Analysts. Mr. Gala earned his MBA in Finance from the University of Pittsburgh and his BS in Business Administration from Duquesne University. He is a Chartered Financial Analyst. PETER D. GOSLIN, CFA . Mr. Goslin is a Vice President and Portfolio Manager with Mellon Equity. Before joining Mellon Equity in 1999, Mr. Goslin spent over four years with Merrill Lynch. During his tenure with Merrill, he worked as a NASDAQ market maker and an equity index options proprietary trader. Prior to that, he ran Merrill's S&P options desk at the Chicago Mercantile Exchange. Mr. Goslin earned his MBA in Finance at the University of Notre Dame Graduate School of Business following a BS in Finance from St. Vincent College. He has earned the right to use the Chartered Financial Analyst designation. ADAM T. LOGAN, CFA . Joining the company in 1998, Mr. Logan is a portfolio manager and Vice President of Mellon Equity. Previously, he performed duties as a financial analyst in Mellon Financial Corporation's corporate finance department. He is currently responsible for the management of client portfolios with a specific focus on mid and small capitalization securities. He earned a BA in Finance from Westminster College and an MBA from the Katz Graduate School of Business at the University of Pittsburgh. He has earned the right to use the Chartered Financial Analyst designation. JOHN O'TOOLE, CFA . Senior Vice President of Mellon Equity since 1990. Mr. O'Toole holds an MBA in Finance from the University of Chicago and a BA in Economics from the University of Pennsylvania. He is a member of the Association for Investment Management and Research, and the Pittsburgh Society of Financial Analysts. He is a Chartered Financial Analyst. SUB-ADVISOR: Neuberger Berman Management, Inc. ("Neuberger Berman") is an affiliate of Neuberger Berman, LLC. Neuberger Berman, LLC is located at 605 Third Avenue, 2nd Floor, New York, NY 10158-0180. Together with Neuberger Berman, the firms manage more than $105.9 billion in total assets (as of December 31, 2005) and continue an asset management history that began in 1939. Neuberger Berman Management, Inc. is an indirect, wholly owned subsidiary of Lehman Brothers Holdings, Inc. Lehman Brothers is located at 745 Seventh Avenue, New York, NY 10019. The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ MidCap Value S. Basu Mullick
S. BASU MULLICK . Mr. Mullick, Managing Director, Portfolio Manager, joined Neuberger Berman in 1998. He is manager of mid- to large-cap value Partners Fund and mid-cap value strategy totaling $5.4 billion in assets. Prior to joining the company, Mr. Mullick was a portfolio manager at Ark Asset Management. He earned a BA in Economics from the Presidency College, India. He also earned a MA in Economics and a Ph.D., ABD Finance from Rutgers University. SUB-ADVISOR: Principal Global Investors, LLC ("Principal") is an indirectly wholly-owned subsidiary of Principal Life Insurance Company and an affiliate of the Manager. Principal manages equity, fixed-income and real estate investments primarily for institutional investors, including Principal Life. As of December 31, 2005, Principal, together with its affiliated asset management companies, had approximately $159 billion in asset under management. Principal Global Investor's headquarters address is 801 Grand Avenue, Des Moines, Iowa 50392 and has other primary asset management offices in New York, London, Sydney and Singapore. The day-to-day portfolio management for some of the Accounts listed below is shared by two or more portfolio managers. In each such case, except where noted below, the portfolio managers operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio with no limitation on the authority of one portfolio manager in relation to another. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Bond William C. Armstrong Timothy R. Warrick Capital Value John Pihlblad Diversified International Paul H. Blankenhagen Juliet Cohn Christopher Ibach Government & High Quality Bond Brad Fredericks Lisa Stange International SmallCap Brian W. Pattinson Principal LifeTime 2010 Dirk Laschanzky Principal LifeTime 2020 Dirk Laschanzky Principal LifeTime 2030 Dirk Laschanzky Principal LifeTime 2040 Dirk Laschanzky Principal LifeTime 2050 Dirk Laschanzky MidCap K. William Nolin Money Market Tracy Reeg Alice Robertson Short-Term Bond Zeid Ayer Craig Dawson Martin J. Schafer SmallCap Thomas Morabito
WILLIAM C. ARMSTRONG, CFA . Mr. Armstrong is a portfolio manager for Principal. He manages multi-sector portfolios that invest in corporate bonds, mortgage-backed securities, commercial mortgage-backed securities, asset-backed securities, sovereigns, and agencies. He jointed the firm in 1992. Previously he served as a commissioned bank examiner at Federal Deposit Insurance Commission. He earned a Master's degree from the University of Iowa and a Bachelor's degree from Kearney State College. He has earned the right to use the Chartered Financial Analyst designation. ZEID AYER, PH.D., CFA . Mr. Ayer is a portfolio manager at Principal. he is a co-manager of the ultra short and short-term bond portfolios. He is also head of the Structured Debt group that covers asset-backed securities (ABS) and non-agency mortgage-backed securities (MBS). He joined Principal in 2001 and is the primary analyst responsible for mortgage-related ABS and non-agency MBS investments. Previously, Mr. Ayer was an assistant vice president at PNC Financial Services Group. He earned a doctorate in Physics from the University of Notre Dame, a master's in Computational Finance from Carnegie Mellon University and a Bachelor's degree in Physics from St. Xavier's College, Bombay University. He has earned the right to use the Chartered Financial Analyst designation. PAUL H. BLANKENHAGEN, CFA . Mr. Blankenhagen joined the firm in 1992 and was named a portfolio manager in 2000. He is responsible for developing portfolio strategy and the ongoing management of core international equity portfolios. He earned a Master's degree from Drake University and a Bachelor's degree in Finance from Iowa State University. He has earned the right to use the Chartered Financial Analyst designation, and is a member of the Association for Investment Management and Research (AIMR) and the Iowa Society of Financial Analysts. JULIET COHN . Ms. Cohn is a portfolio manager at Principal. She co-manages the core international equity portfolios, with an emphasis on Europe and on the health care sector. Prior to joining the firm in 2003, she served as a director and senior portfolio manager at Allianz Dresdner Asset Management, managing both retail and institutional European accounts. Prior to that, she was a fund manager at London firms Capel Cure Myers and Robert Fleming. She earned a bachelor's degree in Mathematics from Trinity College, Cambridge England. CRAIG DAWSON, CFA . Mr. Dawson is a portfolio manager at Principal. He is co-manager of the ultra short and short term bond portfolios. He joined the firm in 1998 as a research associate, then moved into a portfolio analyst role before moving into a portfoio manager position in 2002. He earned an MBA and a Bachelor's degree in Finance from the University of Iowa. Mr. Dawson has earned the right to use the Chartered Financial Analyst designation. BRAD FREDERICKS. . Mr. Fredericks is a portfolio manager at Principal. He is responsible for co-managing the government securities accounts. His responsibilities include general portfolio overview and security analysis. He joined the firm in 1998 as a financial accountant and was named a portfolio manager in 2002. Previously, Mr. Fredericks was an assistant trader at Norwest Mortgage. He earned a Bachelor's degree in Finance from Iowa State University. Mr. Fredericks is a Fellow of the Life Management Institute (FLMI). CHRISTOPHER IBACH, CFA . Mr. Ibach is an associate portfolio manager and equity research analyst at Principal. He specializes primarily in the analysis of international technology companies, with a particular emphasis on semi-conductor research. Prior to joining Principal in 2000, he gained six years of related industry experience with Motorola, Inc. Mr. Ibach earned an MBA in Finance and a Bachelor's degree in Electrical Engineering from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. DIRK LASCHANZKY, CFA . Mr. Laschanzky is a portfolio manager for Principal, responsible for portfolio implementation strategies, asset allocation and managing the midcap value and index portfolios. Prior to joining Principal in 1997, he was a portfolio manager and analyst for over seven years at AMR Investment Services. He earned an MBA and BA, both in Finance, from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. Mr. Laschanzky shares responsibility for the day-to-day management of the LifeTime Accounts with Mr. Loeffler, a portfolio manager representing the Manager. On behalf of Principal, Mr. Laschanzky develops, implements and monitors the Accounts' strategic or long-term asset class targets and target ranges. On behalf of the Manager, Mr. Loeffler implements the strategic asset allocation Mr. Laschanzky sets. THOMAS MORABITO, CFA . Mr. Morabito leads the small-cap portfolio management team for Principal and is the portfolio manager on the small-cap value portfolios. Prior to joining Principal in 2000, he managed the Structured Small Cap Fund for Invesco Management & Research. He earned an MBA in Finance from Northeastern University and his BA in Economics from State University of New York. He has earned the right to use the Chartered Financial Analyst designation. K. WILLIAM NOLIN, CFA . Mr. Nolin is a portfolio manager for Principal. He serves as the portfolio manager for the firm's international small-cap equity portfolios. He joined the firm in 1994. He earned an MBA from the Yale School of Management and a Bachelor's degree in Finance from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. BRIAN W. PATTINSON, CFA . Mr. Pattinson is a portfolio manager at Principal. He serves as the portfolio manager for the firm's international small-cap equity portfolios. He joined Principal in 1994. Mr. Pattinson earned an MBA and Bachelor's degree in Finance from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. JOHN PIHLBLAD, CFA . Mr. Pihlblad is a portfolio manager at Principal. He joined the firm in 2000 and led the development of Principal Global Investors' Global Research Platform. He has over 25 years experience in creating and managing quantitative investment systems. Prior to joining Principal, Mr. Pihlblad was a partner and co-founder of GlobeFlex Capital in San Diego where he was responsible for the development and implementation of the investment process for both domestic and international products. He earned a BA from Westminster College. He has earned the right to use the Chartered Financial Analyst designation. TRACY REEG. . Ms. Reeg is a portfolio manager at Principal. She is involved in the portfolio management of money market portfolios. She joined the firm in 1993 and began trading and portfolio management duties in 2000. Ms. Reeg earned a Bachelor's degree in Finance from the University of Northern Iowa. She is a member of the Life Office Management Association (LOMA) and is a Fellow of the Life Management Institute (FLMI). ALICE ROBERTSON . Ms. Robertson is a trader and portfolio manager for Principal. She is responsible for trading corporate bonds on the fixed income trading desk. In addition, she serves as co-portfolio manager of the money market funds and oversees the short-term trading operation. She joined the firm in 1990 after working as an assistance vice president/commercial paper analyst with Duff & Phelps Credit Company. Ms. Robertson served as a credit analyst for the firm before moving into her current role in 1993. She earned an MBA in Finance and Marketing from DePaul University and her Bachelor's degree in Economics from Northwestern University. MARTIN J. SCHAFER . Mr. Schafer is a portfolio manager for Principal. He specializes in short-term and long duration portfolios, as well as the Inflation Protection Fund and stable value mandates. He also has experience in managing mortgage-backed securities. Mr. Schafer joined the firm in 1977 and in the early 1980s he developed the firm's secondary mortgage marketing operation. In 1984, he assumed portfolio management responsibility for its residential mortgage portfolio. He began managing mutual fund assets in 1985, institutional portfolios in 1992 and stable value portfolios in 2000. He has earned a Bachelor's degree in Accounting and Finance from the University of Iowa. LISA A. STANGE, CFA . Ms. Stange is a portfolio manager and strategist for Principal. She is responsible for managing the government securities portfolios and the mortgage-backed securities (MBS) within the multi-sector portfolios. As a strategies, Ms. Stange is involved in the formulation of broad investment strategy, quantitative research and product development. Previously, she was co-portfolio manager for U.S. multi-sector portfolios. She joined the firm in 1989. Ms. Stange earned an MBA and a Bachelor's degree from the University of Iowa. She has earned the right to use the Chartered Financial Analyst designation. TIMOTHY R. WARRICK, CFA . Mr. Warrick is a portfolio manager at Principal with responsibility for the corporate and U.S. multi-sector portfolios. He also serves as portfolio management team leader with responsibility for overseeing portfolio management function for all total return fixed income products. Prior to his portfolio management responsibilities with the firm, Mr. Warrick was a fixed income credit analyst and extensively involved in product development He joined the firm in 1990. He received an MBA in Finance from Drake University and a Bachelor's degree in Accounting and Economics from Simpson College. He has earned the right to use the Chartered Financial Analyst designation. SUB-ADVISOR: Principal Real Estate Investors, LLC ("Principal - REI"), an indirect wholly-owned subsidiary of Principal Life and an affiliate of the Manager, was founded in 2000. It manages investments for institutional investors, including Principal Life. As of December 31, 2005, Principal - REI, together with its affiliated asset management companies, had approximately $32.0 billion in asset under management. Principal - REI's address is 801 Grand Avenue, Des Moines, Iowa 50392. The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Real Estate Securities Kelly D. Rush
KELLY D. RUSH, CFA . Mr. Rush directs the Real Estate Investment Trust (REIT) activity for a member company of the Principal Financial Group. Mr. Rush joined the Principal Financial Group in 1987 and has been dedicated to public real estate investments since 1995. His experience includes the structuring of public real estate transactions that included commercial mortgage loans and the issuance of unsecured bonds. He received his Master's degree and Bachelor's degree in Finance from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. SUB-ADVISOR: T. Rowe Price Associates, Inc. ("T. Rowe Price"), a wholly-owned subsidiary of T. Rowe Price Group, Inc., a financial services holding company, has over 68 years of investment management experience. Together with its affiliates, T. Rowe Price had approximately $269.5 billion in assets under management as of December 31, 2005. T. Rowe Price is located at 100 East Pratt Street, Baltimore, MD 21202.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Equity Growth Robert W. Sharps LargeCap Blend William J. Stromberg Richard T. Whitney
ROBERT W. SHARPS, CFA, CPA . Mr. Sharps is a Vice President of T. Rowe Price Group, Inc., and T. Rowe Price. He is also the lead Portfolio Manager with the Large-Cap Growth Strategy Team in the Equity Division. Prior to joining the firm in 1997, Mr. Sharps was a Senior Consultant at KPMG Peat Marwick. He earned a BS, summa cum laude, in Accounting from Towson University and an MBA in Finance from the Wharton School, University of Pennsylvania. He has also earned the Chartered Financial Analyst and Certified Public Accountant accreditations. WILLIAM J. STROMBERG, CFA . Mr. Stromberg is a Vice President of T. Rowe Price Group, Inc., and T. Rowe Price, Director of Global Equity Research, and Co-Director of Equities for T. Rowe Price. Prior to joining the firm in 1987, he was employed as a Systems Engineer for the Westinghouse Defense and Electronics Center. He earned a BA from Johns Hopkins University and an MBA from Tuck School of Business at Dartmouth College. He has earned the right to use the Chartered Financial Analyst designation. Mr. Stromberg serves as a portfolio coordinator for the Account. Instead of making stock selection decisions, he is responsible for ensuring adherence to portfolio constraints and risk controls, along with managing inter-analyst activity. As the lead portfolio coordinator, Mr. Stromberg has ultimate accountability for the Account. RICHARD T. WHITNEY, CFA . Mr. Whitney is a Vice President of T. Rowe Price Group, Inc. and T. Rowe Price, Director of the firm's Quantitative Equity Group and member of the Equity Steering Committee and Brokerage Control Committee. Prior to joining the firm in 1985, Mr. Whitney was employed by the Chicago Board of Trade and IBM. He earned a BS and an MEE in Electrical Engineering from Rice University and an MBA from the University of Chicago. He has earned the right to use the Chartered Financial Analyst designation. Mr. Whitney serves as a portfolio coordinator for the Fund. Instead of making stock selection decisions, he, along with Mr. Stromberg, is responsible for ensuring adherence to portfolio constraints and risk controls, as well as managing inter-analyst activity. SUB-ADVISOR: UBS Global Asset Management (Americas) Inc., a Delaware corporation located at One North Wacker, Chicago, IL 60606 ("UBS Global AM"), is a registered investment advisor. UBS Global AM, a subsidiary of UBS AG, is a member of the UBS Global Asset Management business group (the "Group") of UBS AG. As of December 31, 2005, UBS Global AM managed approximately $66.12 billion in assets and the Group managed approximately $581.49 billion in assets. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ SmallCap Growth Paul A. Graham, Jr. David N. Wabnik
PAUL A. GRAHAM, JR., CFA . Mr. Graham joined UBS Global AM in 1994 and has had portfolio management responsibilities since 1994. Mr. Graham is Managing Director, Head of Growth Investors and Co-Head of U.S. Small Cap Growth Equity. For eight years prior to joining the firm, he served as a small cap portfolio manager and research analyst at Value Line Asset Management. Mr. Graham received his BA from Dartmouth College. He has earned the right to use the Chartered Financial Analyst designation and is a member of the New York Society of Security Analysts. DAVID N. WABNIK . Mr. Wabnik joined UBS Global AM in 1995 and has been a portfolio manager since 1995. Mr. Wabnik is Executive Director, Co-Head of U.S. SmallCap Growth Equity. For four years prior to joining the firm, he served as a small cap portfolio manager/senior research analyst at Value Line Asset Management. Mr. Wabnik received his BS from Binghamton University and his MBA from Columbia Business School. He has completed the Certified Financial Analyst Level I exam. THE SUB-SUB-ADVISORS Principal Global Investors, LLC ("Principal") has entered into sub-sub-advisory agreements for various Accounts. Under these agreements, each sub-sub-advisor has agreed to assume the obligations of Principal for a certain portion of the Account's assets. The sub-sub-advisor is paid a fee by Principal. Principal is the sub-advisor for the Bond Account. Day-to-day management decisions concerning a portion of the Bond Account's portfolio are made by Spectrum Asset Management, Inc. ("Spectrum"), and Post Advisory Group, LLC ("Post") each of which serves as sub-sub-advisor. SUB-ADVISOR: Post Advisory Group, LLC ("Post") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. Post was founded in April 1992. Its address is 11755 Wilshire Boulevard, Los Angeles, CA 90025. As of December 31, 2005, Post had $8.1 billion in asset under management. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account. LAWRENCE A. POST . Mr. Post is a chief executive office and chief investment officer for Post, an affiliate of Principal. He has over 35 years experience in the investment business, including 25 years in the high yield bond market. Prior to founding Post Advisory Group in 1992, he founded the high yield bond department at Smith Barney, and subsequently served as director of high yield research at Salomon Brothers and co-director of research and senior trader at Drexel Burnham Lambert. He earned an MBA in business administration from the University of Pennsylvania's Wharton School of Business and a Bachelor's degree from Lehigh University. ALLAN SCHWEITZER . Mr. Schweitzer is a Managing Director at Post. Prior to joining Post in 2000, he was a senior high yield analyst at Trust Company of the West ("TCW"). Prior to TCW, he was a high yield research analyst at Putnam Investments. Mr. Schweitzer earned a Bachelor's degree in Business Administration from Washington University at St. Louis and a Master's in Business Administration from the University of Chicago with a concentration in analytical finance and international economics. SUB-ADVISOR: Spectrum Asset Management, Inc. ("Spectrum") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. Spectrum was founded in 1987. Its address is 4 High Ridge Park, Stamford, CT 06905. As of December 31, 2005, Spectrum, together with its affiliated asset management companies, had approximately $13.2 billion in asset under management. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account. L. PHILLIP JACOBY. . Mr. Jacoby is Sr. Vice President and Portfolio Manager for Spectrum and chairman of Spectrum's Investment Committee. Prior to joining Spectrum in 1995, he was a senior investment officer as USL Capital Corporation, a subsidiary of Ford Motor Corporate, and co-managed a $600 million preferred stock portfolio. He earned a earned a his BS in Finance from Boston University. BERNARD M. SUSSMAN. . Mr. Sussman is Chief Investment Officer of Spectrum and Chair of its Investment Committee. Prior to joining Spectrum in 1995, Mr. Sussman was a general partner and heard of the Preferred Stock area of Goldman Sachs & Co. He was responsible for sales, trading and underwriting for all preferred products and was instrumental in the development of the hybrid (MIPS) market. He earned both an MBA in Finance and a Bachelor's degree in Industrial Relations from Cornell University. DUTIES OF THE MANAGER AND SUB-ADVISOR The Manager or Sub-Advisor provides the Directors of the Fund with a recommended investment program. The program must be consistent with the Account's investment objective and policies. Within the scope of the approved investment program, the Sub-Advisor advises the Account on its investment policy and determines which securities are bought or sold, and in what amounts. FEES PAID TO THE MANAGER The Manager is paid a fee by each Account for its services, which includes any fee paid to the Sub-Advisor. The fee paid by each Account (as a percentage of the average daily net assets) for the fiscal year ended December 31, 2005 was:
Bond 0.45% Money Market 0.49% Capital Value 0.60% Principal LifeTime 2010 0.12% Diversified International 0.85% Principal LifeTime 2020 0.12% Equity Growth 0.76% Principal LifeTime 2030 0.12% Government & High Quality Principal LifeTime 2040 Bond 0.44% 0.12% Growth 0.60% Principal LifeTime 2050 0.12% International SmallCap Principal LifeTime Strategic 1.19% Income 0.12% LargeCap Blend 0.75% Real Estate Securities 0.88% LargeCap Growth Equity 1.00% Short-Term Bond 0.50% LargeCap Value 0.75% SmallCap 0.85% MidCap 0.57% SmallCap Growth 1.00% MidCap Growth 0.90% SmallCap Value 1.09% MidCap Value 1.05%
FEES PAID TO THE SUB-ADVISOR The Sub-Advisor fee paid by each Account (as a percentage of the average daily net assets) for the fiscal year ended December 31, 2005 was:
Bond 0.10% Money Market 0.08% Capital Value 0.14% Principal LifeTime 2010 0.00% Diversified Principal LifeTime 2020 International 0.10% 0.00% Equity Growth 0.34% Principal LifeTime 2030 0.02% Government & High Principal LifeTime 2040 Quality Bond 0.10% 0.03% Growth 0.13% Principal LifeTime 2050 0.04% International SmallCap Principal LifeTime Strategic 0.48% Income 0.00% LargeCap Blend 0.30% Real Estate Securities 0.54% LargeCap Growth Equity 0.38% Short-Term Bond 0.10% LargeCap Value 0.21% SmallCap 0.19% MidCap 0.14% SmallCap Growth 0.54% MidCap Growth 0.36% SmallCap Value 0.49% MidCap Value 0.46%
The Fund and the Manager, under an order received from the SEC, may enter into and materially amend agreements with Sub-Advisors, other than those affiliated with the Manager, without obtaining shareholder approval. For any Account that is relying on that order, the Manager may: . hire one or more Sub-Advisors; . change Sub-Advisors; and . reallocate management fees between itself and Sub-Advisors. The Manager will continue to have the ultimate responsibility for the investment performance of these Accounts due to its responsibility to oversee Sub-Advisors and recommend their hiring, termination and replacement. No Account will rely on the order until it receives approval from its shareholders or, in the case of a new Account, the Account's sole initial shareholder before the Account is available to the other purchasers, and the Account states in its prospectus that it intends to rely on the order. The Equity Growth, LargeCap Blend, LargeCap Growth Equity, LargeCap Value, MidCap Growth, MidCap Value, SmallCap Growth and SmallCap Value Accounts have received the necessary shareholder approval and intend to rely on the order. GENERAL INFORMATION ABOUT AN ACCOUNT FREQUENT TRADING AND MARKET-TIMING (ABUSIVE TRADING PRACTICES) The Accounts of the Principal Variable Contracts Fund are not designed for frequent trading or market timing activity. The Fund has adopted fair valuation procedures to be used in the case of significant events, including broad market movements, occurring after the close of a foreign market in which securities are traded. The procedures will be followed if the Manager believes the events will impact the value of the foreign securities. These procedures are intended to discourage market timing transactions in shares of the Accounts. The Accounts do not knowingly accommodate frequent purchases and redemptions ("excessive trading") of Fund shares by investors. If you intend to trade frequently and/or use market timing investment strategies, do not purchase these Accounts. The Fund does not knowingly accommodate excessive trading. The Principal Variable Contracts Fund considers frequent trading and market timing activities to be abusive trading practices because they may: . Disrupt the management of the Accounts by; . forcing the Account to hold short-term (liquid) assets rather than investing for long term growth, which results in lost investment opportunities for the Account; and . causing unplanned portfolio turnover; . Hurt the portfolio performance of the Account; and . Increase expenses of the Account due to; . increased broker-dealer commissions; and . increased recordkeeping and related costs. If we are not able to identify such excessive trading practices, The Accounts may be negatively impacted and may cause investors to suffer the harms described. Certain Accounts may be at greater risk for abusive trading practices. For example, those Accounts that invest in foreign securities may appeal to investors attempting to take advantage of time-zone arbitrage. This risk is particularly relevant to the Diversified International, International Emerging Markets and International SmallCap Accounts but does apply to the purchase of foreign securities by any Account. As the Accounts of the Principal Variable Contracts Fund are only available through variable annuity or variable life contracts, the Principal Variable Contracts Fund must rely on Principal Life (as sponsor of the variable contract) to monitor customer trading activity to identify and take action against excessive trading. There can be no certainty that Principal Life will identify and prevent excessive trading in all instances. When Principal Life identifies excessive trading, Principal Life will act to curtail such trading in a fair and uniform manner. If Principal Life, or the Principal Variable Contracts Fund, deem excessive trading practices to be occurring, Principal Life will take action that may include, but is not limited to: . Rejecting exchange instructions from shareholder or other person authorized by the shareholder to direct exchanges; . Restricting submission of exchange requests by, for example, allowing exchange requests to be submitted by 1st class U.S. mail only and disallowing requests made via the internet, by facsimile, by overnight courier or by telephone; . Limiting the dollar amount of an exchange and/or the number of exchanges during a year; . Requiring a holding period of a minimum of 30 days before permitting exchanges among the Accounts where there is evidence of at least one round-trip exchange (exchange or redemption of shares that were purchased within 30 days of the exchange/redemption); and . Taking such other action as directed by the Principal Variable Contracts Fund. The Principal Variable Contracts Fund has reserved the right to accept or reject, without prior written notice, any exchange requests. In some instances, an exchange may be completed prior to a determination of abusive trading. In those instances, Principal Life will reverse an exchange (within three business days of the exchange) and return the account holdings to the positions held prior to the exchange. Principal Life will give you notice in writing in this instance. ELIGIBLE PURCHASERS Only certain eligible purchasers may buy shares of the Accounts. Eligible purchasers are limited to 1) separate accounts of Principal Life or of other insurance companies, 2) Principal Life or any of its subsidiaries or affiliates, 3) trustees of other managers of any qualified profit sharing, incentive or bonus plan established by Principal Life or any of its subsidiaries or affiliates for employees of such company, subsidiary or affiliate. Such trustees or managers may buy Account shares only in their capacities as trustees or managers and not for their personal accounts. The Board of Directors of the Fund reserves the right to broaden or limit the designation of eligible purchaser. Each Account serves as the underlying investment vehicle for variable annuity contracts and variable life insurance policies that are funded through separate accounts established by Principal Life. It is possible that in the future, it may not be advantageous for variable life insurance separate accounts and variable annuity separate accounts to invest in the Accounts at the same time. Although neither Principal Life nor the Fund currently foresees any such disadvantage, the Fund's Board of Directors monitors events in order to identify any material conflicts between such policy owners and contract holders. Material conflict could result from, for example, 1) changes in state insurance laws, 2) changes in Federal income tax law, 3) changes in the investment management of an Account, or 4) differences in voting instructions between those given by policy owners and those given by contract holders. Should it be necessary, the Board would determine what action, if any, should be taken. Such action could include the sale of Account shares by one or more of the separate accounts which could have adverse consequences. SHAREHOLDER RIGHTS The following information applies to each Account of the Principal Variable Contracts Fund, Inc. Each Account share is eligible to vote, either in person or by proxy, at all shareholder meetings for that Account. This includes the right to vote on the election of directors, selection of independent auditors and other matters submitted to meetings of shareholders of the Account. Each share has equal rights with every other share of the Account as to dividends, earnings, voting, assets and redemption. Shares are fully paid, non-assessable and have no preemptive or conversion rights. Shares of an Account are issued as full or fractional shares. Each fractional share has proportionately the same rights including voting as are provided for a full share. Shareholders of the Fund may remove any director with or without cause by the vote of a majority of the votes entitled to be case at a meeting of all Account shareholders. The bylaws of the Fund provide that the Board of Directors of the Fund may increase or decrease the aggregate number of shares that the Fund has the authority to issue, without a shareholder vote. The bylaws of the Fund also provide that the Fund does not need to hold an annual meeting of shareholders unless one of the following is required to be acted upon by shareholders under the Investment Company Act of 1940: election of directors; approval of an investment advisory agreement; ratification of the selection of independent auditors; and approval of the distribution agreement. The Fund intends to hold shareholder meetings only when required by law and at such other times when the Board of Directors deems it to be appropriate. Shareholder inquiries should be directed to: Principal Variable Contracts Fund, Inc., Principal Financial Group, Des Moines, Iowa 50392-2080. NON-CUMULATIVE VOTING The Fund's shares have non-cumulative voting rights. This means that the holders of more than 50% of the shares voting for the election of directors of the Fund can elect 100% of the directors if they choose to do so. In such event, the holders of the remaining shares voting for the election of directors will not be able to elect any directors. Principal Life votes each Account's shares allocated to each of its separate accounts registered under the Investment Company Act of 1940 and attributable to variable annuity contracts or variable life insurance policies participating in the separate accounts. The shares are voted in accordance with instructions received from contract holders, policy owners, participants and annuitants. Other shares of each Account held by each separate account, including shares for which no timely voting instructions are received, are voted in proportion to the instructions that are received with respect to contracts or policies participating that separate account. Shares of each of the Accounts held in the general account of Principal Life or in the unregistered separate accounts are voted in proportion to the instructions that are received with respect to contracts and policies participating in its registered and unregistered separate accounts. If Principal Life determines, under applicable law, that an Account's shares held in one or more separate accounts or in its general account need not be voted according to the instructions that are received, it may vote those Account shares in its own right. PURCHASE OF ACCOUNT SHARES Shares are purchased from Princor Financial Services Corporation, the Fund's principal underwriter. There are no sales charges on shares of the Accounts, however, your variable contract may impose a charge. There are no restrictions on amounts to be invested in shares of the Accounts. Shareholder accounts for each Account are maintained under an open account system. Under this system, an account is opened and maintained for each investor. Each investment is confirmed by sending the investor a statement of account showing the current purchase and the total number of shares owned. The statement of account is treated by each Account as evidence of ownership of Account shares. Share certificates are not issued. SALE OF ACCOUNT SHARES This section applies to eligible purchasers other than the separate accounts of Principal Life and its subsidiaries. Each Account sells its shares upon request. There is no charge for the sale. A shareholder sends a written request to the Account requesting the sale of any part or all of the shares. The letter must be signed exactly as the account is registered. If payment is to be made to the registered shareholder or joint shareholder, the Account does not require a signature guarantee. If payment is to be made to another party, the shareholder's signature(s) must be guaranteed by a commercial bank, trust company, credit union, savings and loan association, national securities exchange member or brokerage firm. Shares are redeemed at the net asset value per share next computed after the request is received by the Account in proper and complete form. Sales proceeds are generally sent within three business days after the request is received in proper form. However, the right to sell shares may be suspended during any period when 1) trading on the NYSE is restricted as determined by the SEC or when the NYSE is closed for other than weekends and holidays, or 2) an emergency exists, as determined by the SEC, as a result of which a) disposal by a fund of securities owned by it is not reasonably practicable, b) it is not reasonably practicable for a fund to fairly determine the value of its net assets, or c) the SEC permits suspension for the protection of security holders. If payments are delayed and the instruction is not canceled by the shareholder's written instruction, the amount of the transaction is determined as of the first valuation date following the expiration of the permitted delay. The transaction occurs within five days thereafter. In addition, payments on surrenders attributable to a premium payment made by check may be delayed up to 15 days. This permits payment to be collected on the check. RESTRICTED TRANSFERS Shares of each of the Accounts may be transferred to an eligible purchaser. However, if an Account is requested to transfer shares to other than an eligible purchaser, the Account has the right, at its election, to purchase the shares at the net asset value next calculated after the receipt of the transfer request. However, the Account must give written notification to the transferee(s) of the shares of the election to buy the shares within seven days of the request. Settlement for the shares shall be made within the seven-day period. FINANCIAL STATEMENTS You will receive an annual financial statement for the Fund, audited by the Fund's independent registered public accounting firm, Ernst & Young LLP. That report is a part of this prospectus. You will also receive a semiannual financial statement that is unaudited. FINANCIAL HIGHLIGHTS The following financial highlights tables are intended to help you understand the Fund's financial performance for the periods shown. Certain information reflects results for a single Fund share. The total returns in each table represent the rate that an investor would have earned or lost each period on an investment in the Fund (assuming reinvestment of all distributions). The financial statements for the Fund were audited by Ernst & Young LLP, whose report, along with the financial statements, is included in the most recent annual report for the Fund. To receive a copy of the latest annual or semiannual report for the Fund, you may telephone 1-800-247-4123. FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- BOND ACCOUNT ------------ Net Asset Value, Beginning of Period.. $12.31 $12.31 $12.32 $11.84 $11.78 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.50 0.51 0.52 0.51 0.56/(c)/ Net Realized and Unrealized Gain (Loss) on Investments......... (0.20) 0.08 0.02 0.54 0.35/(c)/ ----- ---- ---- ---- ---- Total From Investment Operations 0.30 0.59 0.54 1.05 0.91 Less Dividends and Distributions: Dividends from Net Investment Income... (0.57) (0.59) (0.55) (0.57) (0.85) ----- ----- ----- ----- ----- Total Dividends and Distributions (0.57) (0.59) (0.55) (0.57) (0.85) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $12.04 $12.31 $12.31 $12.32 $11.84 ====== ====== ====== ====== ====== Total Return /(a)/ ... 2.50% 4.98% 4.59% 9.26% 8.12% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $338,044 $286,684 $263,435 $232,839 $166,658 Ratio of Expenses to Average Net Assets.. 0.47% 0.47% 0.47% 0.49% 0.50% Ratio of Net Investment Income to Average Net Assets.. 4.21% 4.23% 4.32% 5.02% 5.73%/(c)/ Portfolio Turnover Rate................ 176.2% 143.6% 82.1% 63.3% 146.1% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- CAPITAL VALUE ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $32.39 $29.23 $23.60 $27.78 $30.72 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.54 0.44 0.38 0.39 0.34 Net Realized and Unrealized Gain (Loss) on Investments......... 1.66 3.17 5.63 (4.18) (2.80) ---- ---- ---- ----- ----- Total From Investment Operations 2.20 3.61 6.01 (3.79) (2.46) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.45) (0.38) (0.39) (0.34) Distributions from Realized Gains...... -- -- -- -- (0.14) ----- ----- Total Dividends and Distributions -- (0.45) (0.38) (0.39) (0.48) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $34.59 $32.39 $29.23 $23.60 $27.78 ====== ====== ====== ====== ====== Total Return /(a)/ ... 6.80% 12.36% 25.49% (13.66)% (8.05)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $258,490 $265,580 $248,253 $206,541 $254,484 Ratio of Expenses to Average Net Assets.. 0.61% 0.60% 0.61% 0.61% 0.61% Ratio of Gross Expenses to Average Net Assets.......... -- 0.60%/(b)/ 0.61%/(b)/ 0.61%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.62% 1.47% 1.47% 1.45% 1.20% Portfolio Turnover Rate................ 120.9% 183.3% 125.7% 142.6% 91.7%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. /(c) /Effective January 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies. The effect of this change for the year ended December 31, 2001 was to decrease net investment income per share by $.01, increase net realized and unrealized gains/losses per share by $.01, and decrease the ratio of net investment income to average net assets by .08%. Financial highlights for prior periods have not been restated to reflect this change in presentation. 68 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- DIVERSIFIED INTERNATIONAL ACCOUNT --------------------------------- Net Asset Value, Beginning of Period /(a)/ ............... $13.75 $11.48 $8.78 $10.51 $13.90 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.18 0.17 0.13 0.10 0.09 Net Realized and Unrealized Gain (Loss) on Investments......... 3.05 2.22 2.67 (1.78) (3.46) ---- ---- ---- ----- ----- Total From Investment Operations 3.23 2.39 2.80 (1.68) (3.37) Less Dividends and Distributions: Dividends from Net Investment Income... (0.15) (0.12) (0.10) (0.05) (0.02) ----- ----- ----- ----- ----- Total Dividends and Distributions (0.15) (0.12) (0.10) (0.05) (0.02) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $16.83 $13.75 $11.48 $8.78 $10.51 ====== ====== ====== ===== ====== Total Return /(b)/ ... 23.79% 21.03% 32.33% (16.07)% (24.27)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $293,647 $226,753 $167,726 $119,222 $145,848 Ratio of Expenses to Average Net Assets.. 0.97% 0.96% 0.92% 0.92% 0.92% Ratio of Gross Expenses to Average Net Assets.......... 0.97%/(c)/ 0.97%/(d)/ 0.93%/(d)/ 0.93%/(d)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.27% 1.39% 1.33% 1.03% 0.78% Portfolio Turnover Rate................ 121.2% 170.1% 111.5% 82.2% 84.3% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- EQUITY GROWTH ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $16.02 $14.73 $11.74 $16.29 $20.37 Income from Investment Operations: Net Investment Income (Operating Loss).... -- 0.09 0.06 0.03 0.01 Net Realized and Unrealized Gain (Loss) on Investments......... 1.21 1.28 2.99 (4.54) (2.82) ---- ---- ---- ----- ----- Total From Investment Operations 1.21 1.37 3.05 (4.51) (2.81) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.08) (0.06) (0.04) (0.02) Distributions from Realized Gains...... -- -- -- -- (1.25) ---- ----- Total Dividends and Distributions -- (0.08) (0.06) (0.04) (1.27) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $17.23 $16.02 $14.73 $11.74 $16.29 ====== ====== ====== ====== ====== Total Return /(b)/ ... 7.55% 9.33% 25.95% (27.72)% (14.86)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $274,192 $280,700 $272,831 $219,044 $334,401 Ratio of Expenses to Average Net Assets.. 0.77% 0.72% 0.74% 0.77% 0.75% Ratio of Gross Expenses to Average Net Assets.......... -- 0.77%/(e)/ 0.77%/(e)/ -- -- Ratio of Net Investment Income to Average Net Assets.. 0.00% 0.59% 0.47% 0.19% 0.06% Portfolio Turnover Rate................ 51.6% 147.7% 130.9% 138.8% 88.8%
/(a) /Effective May 1, 2005, International Account changed its name to Diversified International Account. /(b) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(c) /Expense ratio without custodian credits. /(d) /Expense ratio without commission rebates and custodian credits. /(e) /Expense ratio without commission rebates. 69 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- GOVERNMENT & HIGH QUALITY BOND ACCOUNT /(A)/ -------------------------------------- Net Asset Value, Beginning of Period.. $11.64 $11.77 $12.00 $11.58 $11.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.44 0.44 0.45 0.43 0.51 Net Realized and Unrealized Gain (Loss) on Investments......... (0.21) (0.04) (0.24) 0.55 0.32 ---- ----- ----- ---- ---- Total From Investment Operations 0.23 0.40 0.21 0.98 0.83 Less Dividends and Distributions: Dividends from Net Investment Income... (0.51) (0.53) (0.44) (0.52) (0.68) Distributions from Realized Gains...... -- -- -- (0.04) -- ---- ----- Total Dividends and Distributions (0.51) (0.53) (0.44) (0.56) (0.68) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $11.36 $11.64 $11.77 $12.00 $11.58 ====== ====== ====== ====== ====== Total Return /(b)/ ... 2.01% 3.56% 1.84% 8.80% 7.61% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $316,047 $334,034 $368,564 $342,001 $193,254 Ratio of Expenses to Average Net Assets.. 0.46% 0.44% 0.44% 0.47% 0.49% Ratio of Net Investment Income to Average Net Assets.. 3.88% 3.82% 3.83% 4.87% 5.63% Portfolio Turnover Rate................ 262.1% 67.2% 110.4% 33.8% 45.9% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- GROWTH ACCOUNT -------------- Net Asset Value, Beginning of Period.. $11.94 $10.95 $8.68 $12.24 $16.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.03 0.07 0.03 0.02 -- Net Realized and Unrealized Gain (Loss) on Investments......... 1.40 0.95 2.26 (3.58) (4.19) ---- ---- ---- ----- ----- Total From Investment Operations 1.43 1.02 2.29 (3.56) (4.19) Less Dividends and Distributions: Dividends from Net Investment Income... (0.08) (0.03) (0.02) -- -- ---- Total Dividends and Distributions (0.08) (0.03) (0.02) -- -- ---- ----- ----- ----- Net Asset Value, End of Period............ $13.29 $11.94 $10.95 $8.68 $12.24 ====== ====== ====== ===== ====== Total Return /(b)/ ... 12.09% 9.38% 26.46% (29.07)% (25.50)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $124,254 $134,956 $141,107 $124,079 $209,879 Ratio of Expenses to Average Net Assets.. 0.62% 0.60% 0.61% 0.61% 0.61% Ratio of Gross Expenses to Average Net Assets.......... -- 0.60%/(c)/ 0.61%/(c)/ 0.61%/(c)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.26% 0.67% 0.35% 0.18% 0.02% Portfolio Turnover Rate................ 78.3% 122.4% 40.8% 27.3% 39.0%
/(a) /Effective November 19, 2005, Government Securities Account changed its name to Government & High Quality Bond Account. /(b) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(c) /Expense ratio without commission rebates. 71 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- INTERNATIONAL SMALLCAP ACCOUNT ------------------------------ Net Asset Value, Beginning of Period.. $17.72 $13.73 $9.06 $10.84 $13.87 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.12 0.11 0.10 0.08 0.04 Net Realized and Unrealized Gain (Loss) on Investments......... 4.96 4.00 4.72 (1.83) (3.07) ---- ---- ---- ----- ----- Total From Investment Operations 5.08 4.11 4.82 (1.75) (3.03) Less Dividends and Distributions: Dividends from Net Investment Income... (0.11) (0.12) (0.15) (0.03) -- Distributions from Realized Gains...... (0.19) -- -- -- -- ---- ----- Total Dividends and Distributions (0.30) (0.12) (0.15) (0.03) -- ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $22.50 $17.72 $13.73 $9.06 $10.84 ====== ====== ====== ===== ====== Total Return /(a)/ ... 29.12% 30.20% 54.15% (16.20)% (21.85)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $143,454 $99,833 $66,242 $38,912 $43,674 Ratio of Expenses to Average Net Assets.. 1.33% 1.30% 1.33% 1.31% 1.41% Ratio of Gross Expenses to Average Net Assets.......... 1.33%/(d)/ 1.31%/(e)/ 1.33%/(e)/ 1.32%/(e)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.63% 0.75% 1.00% 0.77% 0.32% Portfolio Turnover Rate................ 132.3% 140.6% 128.9% 73.6% 123.8% 2005 2004 2003 2002/(F)/ ---- ---- ---- ---- LARGECAP BLEND ACCOUNT ---------------------- Net Asset Value, Beginning of Period.. $10.73 $10.37 $8.43 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.10 0.13 0.10 0.02 Net Realized and Unrealized Gain (Loss) on Investments......... 0.40 0.92 1.90 (1.57) ---- ---- ---- ----- Total From Investment Operations 0.50 1.05 2.00 (1.55) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.11) (0.06) (0.02) Distributions from Realized Gains...... (0.04) (0.58) -- -- ---- ----- ----- Total Dividends and Distributions (0.04) (0.69) (0.06) (0.02) ----- ----- ----- ----- Net Asset Value, End of Period............ $11.19 $10.73 $10.37 $8.43 ====== ====== ====== ===== Total Return /(a)/ ... 4.74% 10.36% 23.76% (15.47)%/(g)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $135,072 $90,751 $54,632 $13,927 Ratio of Expenses to Average Net Assets.. 0.78% 0.76% 0.80% 1.00%/(h)/ Ratio of Gross Expenses to Average Net Assets /(b)/ ... -- 0.78%/(c)/ 0.83%/(c)/ 1.10%/(h)(c)/ Ratio of Net Investment Income to Average Net Assets.. 0.96% 1.23% 1.08% 0.86%/(h)/ Portfolio Turnover Rate................ 44.1% 75.6% 56.2% 49.1%/(h)/
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on May 1, 2004. /(c) /Expense ratio without commission rebates. /(d) /Expense ratio without custodian credits. /(e) /Expense ratio without commission rebates and custodian credits. /(f) /Period from May 1, 2002, date operations commenced, through December 31, 2002. /(g) /Total return amounts have not been annualized. /(h) /Computed on an annualized basis. 73 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- LARGECAP GROWTH EQUITY ACCOUNT ------------------------------ Net Asset Value, Beginning of Period.. $4.60 $4.47 $3.63 $5.44 $7.78 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.01 0.01 -- (0.02) (0.03) Net Realized and Unrealized Gain (Loss) on Investments......... 0.16 0.13 0.84 (1.79) (2.31) ---- ---- ---- ----- ----- Total From Investment Operations 0.17 0.14 0.84 (1.81) (2.34) Less Dividends and Distributions: Dividends from Net Investment Income... (0.01) (0.01) -- -- -- ----- ----- ----- Total Dividends and Distributions (0.01) (0.01) -- -- -- ----- ----- ----- Net Asset Value, End of Period............ $4.76 $4.60 $4.47 $3.63 $5.44 ===== ===== ===== ===== ===== Total Return /(a)/ ... 3.63% 3.16% 23.14% (33.27)% (30.08)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $36,912 $31,179 $24,677 $5,572 $5,172 Ratio of Expenses to Average Net Assets.. 1.09% 1.04% 1.16% 1.05% 1.10% Ratio of Gross Expenses to Average Net Assets /(b)/ ... -- 1.05%/(g)/ 1.19%/(g)/ 1.09%/(g)/ 1.11% Ratio of Net Investment Income to Average Net Assets.. 0.18% 0.28% (0.13)% (0.49)% (0.62)% Portfolio Turnover Rate................ 91.2% 141.8% 51.1% 183.8% 121.2% 2005 2004 2003 2002/(D)/ ---- ---- ---- ---- LARGECAP VALUE ACCOUNT ---------------------- Net Asset Value, Beginning of Period.. $11.88 $10.80 $8.52 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.18 0.19 0.16 0.06 Net Realized and Unrealized Gain (Loss) on Investments......... 0.46 1.22 2.23 (1.48) ---- ---- ---- ----- Total From Investment Operations 0.64 1.41 2.39 (1.42) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.16) (0.11) (0.06) Distributions from Realized Gains...... (0.07) (0.17) -- -- ----- ----- ----- Total Dividends and Distributions (0.07) (0.33) (0.11) (0.06) ----- ----- ----- ----- Net Asset Value, End of Period............ $12.45 $11.88 $10.80 $8.52 ====== ====== ====== ===== Total Return /(a)/ ... 5.44% 13.09% 28.05% (14.24)%/(e)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $122,221 $80,721 $47,221 $13,186 Ratio of Expenses to Average Net Assets.. 0.77% 0.75% 0.74% 0.96%/(f)/ Ratio of Gross Expenses to Average Net Assets /(c)/ ... -- 0.76%/(g)/ 0.79%/(g)/ 1.00%/(f)(g)/ Ratio of Net Investment Income to Average Net Assets.. 1.52% 1.65% 1.77% 1.79%/(f)/ Portfolio Turnover Rate................ 19.7% 23.2% 17.1% 5.9%/(f)/
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on May 1, 2002. /(c) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on May 1, 2004. /(d) /Period from May 1, 2002, date operations commenced, through December 31, 2002. /(e) /Total return amounts have not been annualized. /(f) /Computed on an annualized basis. /(g) /Expense ratio without commission rebates. 74 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MIDCAP ACCOUNT -------------- Net Asset Value, Beginning of Period.. $39.63 $37.56 $28.54 $32.09 $34.47 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.45 0.39 0.35 0.30 0.24 Net Realized and Unrealized Gain (Loss) on Investments......... 3.12 6.05 9.01 (3.08) (1.50) ---- ---- ---- ----- ----- Total From Investment Operations 3.57 6.44 9.36 (2.78) (1.26) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.39) (0.34) (0.30) (0.24) Distributions from Realized Gains...... (0.66) (3.98) -- (0.47) (0.88) ---- ----- ----- ----- ----- Total Dividends and Distributions (0.66) (4.37) (0.34) (0.77) (1.12) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $42.54 $39.63 $37.56 $28.54 $32.09 ====== ====== ====== ====== ====== Total Return /(a)/ ... 9.21% 17.76% 32.81% (8.75)% (3.71)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $420,812 $395,304 $334,204 $248,986 $278,707 Ratio of Expenses to Average Net Assets.. 0.58% 0.59% 0.61% 0.62% 0.62% Ratio of Gross Expenses to Average Net Assets.......... -- 0.59%/(b)/ 0.61%/(b)/ 0.62%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.13% 1.02% 1.09% 0.98% 0.77% Portfolio Turnover Rate................ 49.9% 38.9% 44.9% 67.9% 73.6% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MIDCAP GROWTH ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $9.84 $8.80 $6.26 $8.49 $10.46 Income from Investment Operations: Net Investment Income (Operating Loss).... (0.02) (0.03) (0.03) (0.04) (0.05) Net Realized and Unrealized Gain (Loss) on Investments......... 1.37 1.07 2.57 (2.19) (1.68) ---- ---- ---- ----- ----- Total From Investment Operations 1.35 1.04 2.54 (2.23) (1.73) Less Dividends and Distributions: Distributions from Realized Gains...... -- -- -- -- (0.24) ---- ----- Total Dividends and Distributions -- -- -- -- (0.24) ---- ----- Net Asset Value, End of Period............ $11.19 $9.84 $8.80 $6.26 $8.49 ====== ===== ===== ===== ===== Total Return /(a)/ ... 13.72% 11.82% 40.58% (26.27)% (16.92)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $68,471 $59,674 $54,288 $21,934 $27,838 Ratio of Expenses to Average Net Assets.. 0.92% 0.86% 0.91% 0.91% 0.97% Ratio of Gross Expenses to Average Net Assets.......... -- 0.92%/(b)/ 0.94%/(b)/ 0.92%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. (0.15)% (0.30)% (0.39)% (0.55)% (0.66)% Portfolio Turnover Rate................ 97.0% 47.7% 67.5% 43.1% 55.2%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. 75 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MIDCAP VALUE ACCOUNT -------------------- Net Asset Value, Beginning of Period.. $15.38 $14.13 $10.48 $11.68 $12.57 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.05 0.02 0.01 -- 0.01 Net Realized and Unrealized Gain (Loss) on Investments......... 1.53 3.10 3.81 (1.16) (0.35) ---- ---- ---- ----- ----- Total From Investment Operations 1.58 3.12 3.82 (1.16) (0.34) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.01) (0.01) -- (0.01) Distributions from Realized Gains...... (0.39) (1.86) (0.16) (0.04) (0.54) ----- ----- ----- ----- ----- Total Dividends and Distributions (0.39) (1.87) (0.17) (0.04) (0.55) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $16.57 $15.38 $14.13 $10.48 $11.68 ====== ====== ====== ====== ====== Total Return /(a)/ ... 10.55% 22.67% 36.49% (9.96)% (2.58)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $112,437 $78,166 $52,054 $24,766 $11,778 Ratio of Expenses to Average Net Assets.. 1.07% 1.05% 1.05% 1.04% 1.36% Ratio of Gross Expenses to Average Net Assets.......... -- 1.08%/(b)/ 1.08%/(b)/ 1.10%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.32% 0.11% 0.11% 0.03% 0.12% Portfolio Turnover Rate................ 90.6% 59.2% 55.5% 75.3% 208.8% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MONEY MARKET ACCOUNT -------------------- Net Asset Value, Beginning of Period.. $1.000 $1.000 $1.000 $1.000 $1.000 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.027 0.009 0.007 0.014 0.039 ----- ----- ----- ----- ----- Total From Investment Operations 0.027 0.009 0.007 0.014 0.039 Less Dividends and Distributions: Dividends from Net Investment Income... (0.027) (0.009) (0.007) (0.014) (0.039) ------ ------ ------ ------ ------ Total Dividends and Distributions (0.027) (0.009) (0.007) (0.014) (0.039) ------ ------ ------ ------ ------ Net Asset Value, End of Period............ $1.000 $1.000 $1.000 $1.000 $1.000 ====== ====== ====== ====== ====== Total Return /(a)/ ... 2.69% 0.92% 0.74% 1.42% 3.92% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $150,653 $140,553 $151,545 $201,455 $180,923 Ratio of Expenses to Average Net Assets.. 0.61% 0.49% 0.49% 0.49% 0.50% Ratio of Net Investment Income to Average Net Assets.. 2.66% 0.91% 0.74% 1.40% 3.70%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. 76 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004/(D)/ ---- ---- PRINCIPAL LIFETIME 2010 ACCOUNT ------------------------------- Net Asset Value, Beginning of Period.. $10.84 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.02 0.11 Net Realized and Unrealized Gain (Loss) on Investments......... 0.59 0.82 ---- ---- Total From Investment Operations 0.61 0.93 Less Dividends and Distributions: Dividends from Net Investment Income... (0.01) (0.09) Distributions from Realized Gains...... (0.07) -- ---- ----- Total Dividends and Distributions (0.08) (0.09) ----- ----- Net Asset Value, End of Period............ $11.37 $10.84 ====== ====== Total Return /(a)/ ... 5.70% 9.31%/(e)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $12,930 $11 Ratio of Expenses to Average Net Assets /(b)/ .............. 0.16% 0.16%/(f)/ Ratio of Gross Expenses to Average Net Assets /(b)/ /(c)/ .............. 0.20% 10.02%/(f)/ Ratio of Net Investment Income to Average Net Assets.. 0.22% 3.21%/(f)/ Portfolio Turnover Rate................ 4.3% 3.0%/(f)/ 2005 2004/(D)/ ---- ---- PRINCIPAL LIFETIME 2020 ACCOUNT ------------------------------- Net Asset Value, Beginning of Period.. $10.97 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... (0.01) 0.13 Net Realized and Unrealized Gain (Loss) on Investments......... 0.75 0.93 ---- ---- Total From Investment Operations 0.74 1.06 Less Dividends and Distributions: Dividends from Net Investment Income... (0.02) (0.09) Distributions from Realized Gains...... (0.08) -- ---- ----- Total Dividends and Distributions (0.10) (0.09) ----- ----- Net Asset Value, End of Period............ $11.61 $10.97 ====== ====== Total Return /(a)/ ... 6.77% 10.62%/(e)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $26,753 $15 Ratio of Expenses to Average Net Assets /(b)/ .............. 0.13% 0.13%/(f)/ Ratio of Gross Expenses to Average Net Assets /(b)/ /(c)/ .............. 0.16% 8.72%/(f)/ Ratio of Net Investment Income to Average Net Assets.. (0.10)% 3.65%/(f)/ Portfolio Turnover Rate................ 3.1% 2.6%/(f)/
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Does not include expenses of the investment companies in which the Account invests. /(c) /Expense ratio without the Manager's voluntary expense limit. The expense limit became a contractual limit on November 21, 2005. /(d) /Period from August 30, 2004, date operations commenced, through December 31, 2004. /(e) /Total return amounts have not been annualized. /(f) /Computed on an annualized basis. 77 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004/(E)/ ---- ---- PRINCIPAL LIFETIME 2030 ACCOUNT ------------------------------- Net Asset Value, Beginning of Period.. $10.97 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.01 0.30 Net Realized and Unrealized Gain (Loss) on Investments......... 0.73 0.76 ---- ---- Total From Investment Operations 0.74 1.06 Less Dividends and Distributions: Dividends from Net Investment Income... (0.02) (0.09) Distributions from Realized Gains...... (0.06) -- ---- ----- Total Dividends and Distributions (0.08) (0.09) ----- ----- Net Asset Value, End of Period............ $11.63 $10.97 ====== ====== Total Return /(a)/ ... 6.76% 10.60%/(f)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $3,918 $151 Ratio of Expenses to Average Net Assets /(b)/ .............. 0.16% 0.16%/(g)/ Ratio of Gross Expenses to Average Net Assets /(b) (c)/ 0.38% 2.14%/(g)/ Ratio of Net Investment Income to Average Net Assets.. 0.08% 8.58%/(g)/ Portfolio Turnover Rate................ 11.5% 4.8%/(g)/ 2005 2004/(E)/ ---- ---- PRINCIPAL LIFETIME 2040 ACCOUNT ------------------------------- Net Asset Value, Beginning of Period.. $11.09 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.01 0.19 Net Realized and Unrealized Gain (Loss) on Investments......... 0.79 0.99 ---- ---- Total From Investment Operations 0.80 1.18 Less Dividends and Distributions: Dividends from Net Investment Income... (0.02) (0.09) Distributions from Realized Gains...... (0.05) -- ---- ----- Total Dividends and Distributions (0.07) (0.09) ----- ----- Net Asset Value, End of Period............ $11.82 $11.09 ====== ====== Total Return /(a)/ ... 7.27% 11.78%/(f)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $1,893 $147 Ratio of Expenses to Average Net Assets /(b)/ .............. 0.13% 0.14%/(g)/ Ratio of Gross Expenses to Average Net Assets /(b) (d)/ 0.56% 1.47%/(g)/ Ratio of Net Investment Income to Average Net Assets.. 0.12% 5.35%/(g)/ Portfolio Turnover Rate................ 18.2% 9.4%/(g)/
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Does not include expenses of the investment companies in which the Account invests. /(c) /Expense ratio without the Manager's voluntary expense limit. The expense limit became a contractual limit on November 21, 2005. /(d) /Expense ratio without the Manager's voluntary expense limit. The expense limit was decreased on April 29, 2005, and became a contractual limit on November 21, 2005. /(e) /Period from August 30, 2004, date operations commenced, through December 31, 2004. /(f) /Total return amounts have not been annualized. /(g) /Computed on an annualized basis. 78 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004/(D)/ ---- ---- PRINCIPAL LIFETIME 2050 ACCOUNT ------------------------------- Net Asset Value, Beginning of Period.. $11.09 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.01 0.11 Net Realized and Unrealized Gain (Loss) on Investments......... 0.82 1.06 ---- ---- Total From Investment Operations 0.83 1.17 Less Dividends and Distributions: Dividends from Net Investment Income... (0.02) (0.08) Distributions from Realized Gains...... (0.05) -- ---- ----- Total Dividends and Distributions (0.07) (0.08) ----- ----- Net Asset Value, End of Period............ $11.85 $11.09 ====== ====== Total Return /(a)/ ... 7.56% 11.74%/(e)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $1,160 $88 Ratio of Expenses to Average Net Assets /(b)/ .............. 0.12% 0.13%/(f)/ Ratio of Gross Expenses to Average Net Assets /(b)/ /(c)/ .............. 1.11% 1.49%/(f)/ Ratio of Net Investment Income to Average Net Assets.. 0.11% 3.04%/(f)/ Portfolio Turnover Rate................ 4.2% 13.0%/(f)/ 2005 2004/(D)/ ---- ---- PRINCIPAL LIFETIME STRATEGIC INCOME ACCOUNT ------------------------------------------- Net Asset Value, Beginning of Period.. $10.68 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.06 0.12 Net Realized and Unrealized Gain (Loss) on Investments......... 0.46 0.65 ---- ---- Total From Investment Operations 0.52 0.77 Less Dividends and Distributions: Dividends from Net Investment Income... (0.03) (0.09) Distributions from Realized Gains...... (0.12) -- ---- ----- Total Dividends and Distributions (0.15) (0.09) ----- ----- Net Asset Value, End of Period............ $11.05 $10.68 ====== ====== Total Return /(a)/ ... 4.96% 7.66%/(e)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $5,463 $11 Ratio of Expenses to Average Net Assets /(b)/ .............. 0.14% 0.14%/(f)/ Ratio of Gross Expenses to Average Net Assets /(b)/ /(g)/ .............. 0.27% 10.09%/(f)/ Ratio of Net Investment Income to Average Net Assets.. 0.60% 3.30%/(f)/ Portfolio Turnover Rate................ 8.4% 2.9%/(f)/
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Does not include expenses of the investment companies in which the Account invests. /(c) /Expense ratio without the Manager's voluntary expense limit. The expense limit was decreased on April 29, 2005, and came to be contractual on November 21, 2005. /(d) /Period from August 30, 2004, date operations commenced, through December 31, 2004. /(e) /Total return amounts have not been annualized. /(f) /Computed on an annualized basis. /(g) /Expense ratio without the Manager's voluntary expense limit. The expense limit became a contractual limit on November 21, 2005. 79 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- REAL ESTATE SECURITIES ACCOUNT ------------------------------ Net Asset Value, Beginning of Period.. $17.88 $14.90 $11.24 $10.77 $10.29 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.40 0.39 0.49 0.35 0.42 Net Realized and Unrealized Gain (Loss) on Investments......... 2.39 4.66 3.87 0.48 0.47 ---- ---- ---- ---- ---- Total From Investment Operations 2.79 5.05 4.36 0.83 0.89 Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.35) (0.42) (0.35) (0.41) Distributions from Realized Gains...... (0.16) (1.72) (0.28) (0.01) -- ---- ----- ----- ----- ----- Total Dividends and Distributions (0.16) (2.07) (0.70) (0.36) (0.41) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $20.51 $17.88 $14.90 $11.24 $10.77 ====== ====== ====== ====== ====== Total Return /(a)/ ... 15.85% 34.53% 38.91% 7.72% 8.75% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $178,922 $146,022 $93,018 $46,358 $22,457 Ratio of Expenses to Average Net Assets.. 0.89% 0.90% 0.91% 0.92% 0.92% Ratio of Gross Expenses to Average Net Assets ......... -- 0.90% 0.92% -- -- Ratio of Net Investment Income to Average Net Assets.. 2.16% 2.37% 3.83% 3.99% 4.55% Portfolio Turnover Rate................ 23.6% 58.8% 53.9% 54.4% 92.4% 2005 2004 2003/(D)/ ---- ---- ---- SHORT-TERM BOND ACCOUNT ----------------------- Net Asset Value, Beginning of Period /(c)/ ............... $10.12 $9.99 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.33 0.25 0.13 Net Realized and Unrealized Gain (Loss) on Investments......... (0.15) (0.12) (0.05) ----- ----- ----- Total From Investment Operations 0.18 0.13 0.08 Less Dividends and Distributions: Dividends from Net Investment Income... (0.19) -- (0.09) ---- ----- ----- Total Dividends and Distributions (0.19) -- (0.09) ---- ----- ----- Net Asset Value, End of Period............ $10.11 $10.12 $9.99 ====== ====== ===== Total Return /(a)/ ... 1.80% 1.30% 0.78%/(e)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $83,822 $56,241 $20,552 Ratio of Expenses to Average Net Assets.. 0.57% 0.53% 0.57%/(f)/ Ratio of Gross Expenses to Average Net Assets/(b)/..... -- -- 0.57%/(f)/ Ratio of Net Investment Income to Average Net Assets.. 3.26% 2.53% 2.15%/(f)/ Portfolio Turnover Rate................ 74.3% 34.8% 5.0%/(f)/
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on May 1, 2004. /(c) /Effective November 19, 2005, Limited Term Bond Account changed its name to Short-Term Bond Account. /(d) /Period from May 1, 2003, date operations commenced, through December 31, 2003. /(e) /Total return amounts have not been annualized. /(f) /Computed on an annualized basis. 80 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- SMALLCAP ACCOUNT ---------------- Net Asset Value, Beginning of Period.. $9.55 $7.97 $5.83 $8.03 $7.83 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.02 -- 0.01 0.01 -- Net Realized and Unrealized Gain (Loss) on Investments......... 0.65 1.58 2.14 (2.20) 0.20 ---- ---- ---- ----- ---- Total From Investment Operations 0.67 1.58 2.15 (2.19) 0.20 Less Dividends and Distributions: Dividends from Net Investment Income... -- -- (0.01) (0.01) -- ---- ----- ----- Total Dividends and Distributions -- -- (0.01) (0.01) -- ---- ----- ----- Net Asset Value, End of Period............ $10.22 $9.55 $7.97 $5.83 $8.03 ====== ===== ===== ===== ===== Total Return /(a)/ ... 7.04% 19.82% 36.82% (27.33)% 2.55% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $94,476 $85,115 $65,285 $32,201 $36,493 Ratio of Expenses to Average Net Assets.. 0.88% 0.86% 0.95% 0.97% 1.00% Ratio of Gross Expenses to Average Net Assets.......... -- 0.86%/(b)/ 0.95%/(b)/ 0.97%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.17% 0.03% 0.09% 0.12% (0.06)% Portfolio Turnover Rate................ 125.8% 188.7% 162.9% 215.5% 154.5% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- SMALLCAP GROWTH ACCOUNT ----------------------- Net Asset Value, Beginning of Period.. $9.30 $8.36 $5.74 $10.60 $15.59 Income from Investment Operations: Net Investment Income (Operating Loss).... (0.07) (0.06) (0.04) (0.05) (0.10) Net Realized and Unrealized Gain (Loss) on Investments......... 0.69 1.00 2.66 (4.81) (4.89) ---- ---- ---- ----- ----- Total From Investment Operations 0.62 0.94 2.62 (4.86) (4.99) ---- ---- ---- ----- ----- Net Asset Value, End of Period............ $9.92 $9.30 $8.36 $5.74 $10.60 ===== ===== ===== ===== ====== Total Return /(a)/ ... 6.67% 11.24% 45.64% (45.85)% (32.01)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $66,656 $63,453 $55,628 $32,754 $55,966 Ratio of Expenses to Average Net Assets.. 1.05% 0.99% 0.99% 0.95% 1.05% Ratio of Gross Expenses to Average Net Assets ......... -- 1.01%/(b)/ 1.02%/(b)/ 1.06%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. (0.77)% (0.70)% (0.64)% (0.68)% (0.92)% Portfolio Turnover Rate................ 68.2% 43.3% 54.1% 287.9% 152.2%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. / / 81 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- SMALLCAP VALUE ACCOUNT ---------------------- Net Asset Value, Beginning of Period.. $16.83 $15.04 $10.30 $11.37 $11.26 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.07 0.03 0.06 0.06 0.09 Net Realized and Unrealized Gain (Loss) on Investments......... 0.96 3.37 5.14 (1.07) 0.60 ---- ---- ---- ----- ---- Total From Investment Operations 1.03 3.40 5.20 (1.01) 0.69 Less Dividends and Distributions: Dividends from Net Investment Income... (0.01) (0.03) (0.05) (0.06) (0.09) Distributions from Realized Gains...... (0.24) (1.58) (0.41) -- (0.49) ---- ----- ----- ----- ----- Total Dividends and Distributions (0.25) (1.61) (0.46) (0.06) (0.58) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $17.61 $16.83 $15.04 $10.30 $11.37 ====== ====== ====== ====== ====== Total Return /(a)/ ... 6.22% 23.08% 50.61% (8.86)% 6.25% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $132,035 $107,206 $82,135 $44,217 $30,888 Ratio of Expenses to Average Net Assets.. 1.13% 1.12% 1.16% 1.28% 1.24% Ratio of Gross Expenses to Average Net Assets.......... -- 1.13%/(b)/ 1.18%/(b)/ 1.29%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.38% 0.21% 0.50% 0.68% 0.95% Portfolio Turnover Rate................ 45.3% 38.0% 54.0% 77.4% 67.8%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. 82 ADDITIONAL INFORMATION Additional information about the Fund (including the Fund's policy regarding the disclosure of portfolio securities) is available in the Statement of Additional Information dated May 1, 2006 which is incorporated by reference into this prospectus. Additional information about the Funds' investments is available in the Fund's annual and semiannual reports to shareholders. In the Funds' annual report, you will find a discussion of the market conditions and investment strategies that significantly affected the Funds' performance during the last fiscal year. The Statement of Additional Information and the Fund's annual and semi-annual reports can be obtained free of charge by writing or telephoning Princor Financial Services Corporation, P.O. Box 10423, Des Moines, IA 50306. In addition, the Fund makes its Statement of Additional Information and annual and semi-annual reports available, free of charge, on http:// www.principal.com. To request this and other information about the Fund and to make shareholder inquiries, telephone 1-800-247-4123. Information about the Fund (including the Statement of Additional Information) can be reviewed and copied at the Commission's Public Reference Room in Washington, D.C. Information on the operation of the Public Reference Room may be obtained by calling the Commission at 1-202-942-8090. Reports and other information about the Fund are available on the EDGAR Database on the Commission's internet site at http://www.sec.gov. Copies of this information may be obtained, upon payment of a duplicating fee, by electronic request at the following E-mail address: publicinfo@sec.gov, or by writing the Commission's Public Reference Section, Washington, D.C. 20549-0102. The U.S. government does not insure or guarantee an investment in any of the Accounts. There can be no assurance that the Money Market Account will be able to maintain a stable share price of $1.00 per share. Shares of the Accounts are not deposits or obligations of, or guaranteed or endorsed by, any financial institution, nor are shares of the Accounts federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other agency. Principal Variable Contracts Fund, Inc. SEC File 811-01944 PRINCIPAL VARIABLE CONTRACTS FUND, INC.
ACCOUNTS OF THE FUND -------------------- BOND ACCOUNT MIDCAP GROWTH ACCOUNT CAPITAL VALUE ACCOUNT MIDCAP VALUE ACCOUNT DIVERSIFIED INTERNATIONAL ACCOUNT MONEY MARKET ACCOUNT GOVERNMENT & HIGH QUALITY BOND SHORT-TERM BOND ACCOUNT ACCOUNT (previously Government Securities (previously Limited Term Bond Account) Account) LARGECAP GROWTH EQUITY ACCOUNT SMALLCAP ACCOUNT LARGECAP STOCK INDEX ACCOUNT SMALLCAP GROWTH ACCOUNT MIDCAP ACCOUNT
This Prospectus describes a mutual fund organized by Principal Life Insurance Company/(R)/ ("Principal Life"). The Fund provides a choice of investment objectives through the Accounts listed above. The date of this Prospectus is May 1, 2006. As with all mutual funds, neither the Securities and Exchange Commission ("SEC") nor any State Securities Commission has approved or disapproved of these securities or determined if this prospectus is accurate or complete. It is a criminal offense to represent otherwise. TABLE OF CONTENTS ACCOUNT DESCRIPTIONS....................................................3 Bond Account..........................................................5 Capital Value Account.................................................9 Diversified International Account.....................................12 Government & High Quality Bond Account (f/k/a Government Securities Account).....................................15 LargeCap Growth Equity Account ........................................19 LargeCap Stock Index Account..........................................21 MidCap Account........................................................23 MidCap Growth Account.................................................26 MidCap Value Account..................................................29 Money Market Account..................................................32 Short-Term Bond Account (f/k/a Limited Term Bond Account).............35 SmallCap Account......................................................38 SmallCap Growth Account...............................................41 CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.........................44 PRICING OF ACCOUNT SHARES...............................................49 DIVIDENDS AND DISTRIBUTIONS.............................................50 MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE..........................50 The Manager...........................................................50 The Sub-Advisors......................................................50 Duties of the Manager and Sub-Advisors................................57 Fees Paid to the Manager..............................................57 Fees Paid to the Sub-Advisor..........................................58 GENERAL INFORMATION ABOUT AN ACCOUNT....................................59 Frequent Trading and Market-timing (Abusive Trading Practices)........59 Eligible Purchasers...................................................60 Shareholder Rights....................................................60 Non-Cumulative Voting.................................................60 Purchase of Account Shares............................................61 Sale of Account Shares................................................61 Restricted Transfers..................................................61 Financial Statements..................................................61 FINANCIAL HIGHLIGHTS....................................................61 ADDITIONAL INFORMATION..................................................69 2 Principal Variable Contracts Fund 1-800-247-4123 ACCOUNT DESCRIPTIONS The Principal Variable Contracts Fund (the "Fund") is made up of Accounts. Each Account has its own investment objective. Principal Management Corporation*, the "Manager" of the Fund, has selected a Sub-Advisor for the Accounts based on the Sub-Advisor's experience with the investment strategy for which it was selected. The Manager seeks to provide a wide range of investment approaches through the Fund. The Sub-Advisors are: . Emerald Advisors, Inc. ("Emerald") . Grantham, Mayo, Van Otterloo & Co. LLC ("GMO") . Mellon Equity Associates, LLP ("Mellon Equity") . Neuberger Berman Management Inc. ("Neuberger Berman") . Principal Global Investors LLC ("Principal") . UBS Global Asset Management (Americas) Inc. ("UBS Global AM") * Principal, Principal Management Corporation and Princor Financial Services Corporation ("Princor") are affiliates of Principal Life Insurance Company and with it are subsidiaries of Principal Financial Group, Inc. and members of the Principal Financial Group/(R)/. In the description for each Account, there is important information about the Account's: MAIN STRATEGIES AND RISKS These sections describe each Account's investment objective and summarize how each Account intends to achieve its investment objective. The Board of Directors may change an Account's objective or the investment strategies without a shareholder vote if it determines such a change is in the best interests of the Account. If there is a material change to the Account's investment objective or investment strategies, you should consider whether the Account remains an appropriate investment for you. There is no guarantee that an Account will meet its objective. The sections also describe each Account's primary investment strategies (including the type or types of securities in which the Account invests), any policy of the Account to concentrate in securities of issuers in a particular industry or group of industries and the main risks associated with an investment in the Account. A fuller discussion of risks appears later in the Prospectus under the caption "Certain Investment Strategies and Related Risks." Each Account may invest up to 100% of its assets in cash and cash equivalents for temporary defensive purposes in response to adverse market, economic or political condition as more fully described under the caption "Certain Investment Strategies and Related Risks-Temporary Defensive Measures." Each Account is designed to be a portion of an investor's portfolio. None of the Accounts is intended to be a complete investment program. You should consider the risks of each Account before making an investment and be prepared to maintain the investment during periods of adverse market conditions. INVESTMENT RESULTS A bar chart and a table are included with each Account that has annual returns for a full calendar year. They show the Account's annual returns and its long-term performance. The chart shows how the Account's performance has varied from year-to-year. The table compares the Account's performance over time to that of: . a broad-based securities market index (An index measures the market price of a specific group of securities in a particular market or securities in a market sector. You cannot invest directly in an index. An index does not have an investment advisor and does not pay any commissions or expenses. If an index had expenses, its performance would be lower.); and . an average of mutual funds with a similar investment objective and management style. The averages used are prepared by independent statistical services. An Account's past performance is not necessarily an indication of how the Account will perform in the future. Call the Principal Variable Contracts Funds at 1-800-247-4123 to get the current 7-day yield for the Money Market Account. Principal Variable Contracts Fund 3 www.principal.com FEES AND EXPENSES The annual operating expenses for each Account are deducted from that Account's assets. Each Account's operating expenses are shown with the description of the Account and are stated as a percentage of Account assets. A discussion of fees and expenses appears later in the Prospectus under the caption "The Costs of Investing." The fees and expenses shown do not include the effect of any separate account expenses or other contract level expenses. If such charges were included, overall expenses would be higher and would lower performance. The description of each Account includes examples of the costs associated with investing in the Account. The examples are intended to help you compare the cost of investing in a particular Account with the cost of investing in other mutual funds. The examples assume you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The examples also assume that your investment has a 5% total return each year and that the Account's operating expenses remain the same. Your actual costs of investing in a particular Account may be higher or lower than the costs assumed for purposes of the examples. NOTES: . No salesperson, dealer or other person is authorized to give information or make representations about an Account other than those contained in this Prospectus. Information or representations not contained in this Prospectus may not be relied upon as having been made by the Principal Variable Contracts Funds, an Account, the Manager, any Sub-Advisor or Princor. . Investments in these Accounts are not deposits of a bank and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. 4 Principal Variable Contracts Fund 1-800-247-4123 BOND ACCOUNT The Account seeks to provide as high a level of income as is consistent with preservation of capital and prudent investment risk. MAIN STRATEGIES Under normal circumstances, the Account invests at least 80% of its assets in intermediate maturity fixed-income or debt securities rated BBB or higher by Standard & Poor's Rating Service ("S&P") or Baa or higher by Moody's Investors Service, Inc. ("Moody's"). The Account considers the term "bond" to mean any debt security. Under normal circumstances, the Account invests in: . securities issued or guaranteed by the U.S. government or its agencies or instrumentalities; . mortgage-backed securities representing an interest in a pool of mortgage loans; . debt securities and taxable municipal bonds rated, at the time of purchase, in one of the top four categories by S&P or Moody's or, if not rated, in the opinion of the Sub-Advisor, Principal, of comparable quality; and . securities issued or guaranteed by the governments of Canada (provincial or federal government) or the United Kingdom payable in U.S. dollars. The rest of the Account's assets may be invested in: . preferred and common stock that may be convertible (may be exchanged for a fixed number of shares of common stock of the same issuer) or may be non-convertible; or . securities rated less than the four highest grades of S&P or Moody's (i.e. less than investment grade (commonly known as "junk bonds")) but not lower than CCC- (S&P) or Caa (Moody's). The Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income. Under a reverse repurchase agreement, the Account sells securities and agrees to repurchase them at a specified date and price. The Account pays interest on this "secured financing" and attempts to make money on the difference between the financing rate and the interest it earns by investing the proceeds of the financing. While a reverse repurchase agreement is outstanding, the Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account may lend its portfolio securities to brokers, dealers and other financial institutions. In connection with such loans, the Account remains the owner of the loaned securities and continues to be entitled to payments in amounts equal to the interest, dividends or other distributions payable on the loaned securities. Loans of portfolio securities may not exceed 33 1/3% of the value of the Account's total assets (including the value of all assets received as collateral for loan). In connection with such loans the Account will receive collateral from the borrower equal to at least 100% of the value of the loaned securities. The Account may actively trade securities in an attempt to achieve its investment objective. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: MUNICIPAL SECURITIES . Principal and interest payments of municipal securities may not be guaranteed by the issuing body and may be payable only from monies derived from a particular source. If the source does not perform as expected, principal and income payments may not be made on time or at all. In addition, the market for municipal securities is often thin and may be temporarily affected by large purchases and sales, including those of the Account. General conditions in the financial markets and the size of a particular offering may also negatively affect the returns of a municipal security. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining Principal Variable Contracts Fund 5 www.principal.com interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates. This may increase the volatility of the Account. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation maybe chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. REVERSE REPURCHASE AGREEMENTS. . This strategy involves the risk that interest costs on money borrowed may exceed the return on securities purchased with the borrowed money. In addition, reverse repurchase agreements may increase the volatility of the Fund. LENDING OF SECURITIES . If the Account lends its portfolio securities and the borrower of the securities fail financially, the Account may experience delays in recovering the loaned securities or exercising its rights in the collateral. Loans are made only to borrowers that are deemed by the Sub-Advisor to be of good financial standing. PORTFOLIO DURATION . The average portfolio duration of the Account normally varies within a three- to six-year time frame based on Sub-Advisor's forecast for interest rates. Duration is a measure of the expected life of a fixed-income security that is used to determine the sensitivity of a security's price to changes in interest rates. For example, if the portfolio duration of the Account is three years, a change of 1% in the market's yield results in a change of approximately 3% in the value of the Account's securities. The longer a security's duration, the more sensitive it is to changes in interest rates. An Account with a longer average portfolio duration will be more sensitive to changes in interest rates than an Account with a shorter average portfolio duration. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates. When interest rates rise, the value of fixed-income securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of fixed-income securities. Some fixed-income investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.) DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. COMMODITY-LINKED DERIVATIVE INSTRUMENTS . The use of commodity-linked derivative instruments may subject the Account to greater volatility than investments in traditional securities. The value of commodity-linked derivative 6 Principal Variable Contracts Fund 1-800-247-4123 instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 176.2%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking diversification by investing in a fixed-income mutual fund. Principal Variable Contracts Fund 7 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"2.36 "1997"10.6 "1998"7.69 "1999"-2.59 "2000"8.17 "2001"8.12 "2002"9.26 "2003"4.59 "2004"4.98 The Account's highest/lowest quarterly returns "2005"2.5 during this time period were: HIGHEST Q3 '97 4.37% LOWEST Q1 '96-3.24% LOGO The year-to-date return as of March 31, 2006 is -0.55%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* BOND ACCOUNT ......... 2.50 5.86 5.50 7.69 Lehman Brothers Aggregate Bond Index . 2.43 5.87 6.17 7.78 Morningstar Intermediate-Term Bond Category Average...... 1.79 5.32 5.38 7.11 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (December 18, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.45% Other Expenses................... 0.02% ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.47%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 BOND ACCOUNT $48 $151 $263 $591
8 Principal Variable Contracts Fund 1-800-247-4123 CAPITAL VALUE ACCOUNT The Account seeks to provide long-term capital appreciation and secondarily growth of investment income. MAIN STRATEGIES The Account invests primarily in common stock and other equity securities of large capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with large market capitalizations (those with market capitalizations similar to companies in the Russell 1000/(R)// /Value Index (as of March 31, 2006 this range was between approximately $688 million and $387.4 billion) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Up to 25% of Account assets may be invested in foreign securities. The Account invests in stocks that, in the opinion of the Sub-Advisor, Principal, are undervalued in the marketplace at the time of purchase. Value stocks are often characterized by below average price/earnings ratios (P/E) and above average dividend yields relative to the overall market. Securities for the Account are selected by consideration of the quality and price of individual issuers rather than forecasting stock market trends. The selection process focuses on four key elements: . determination that a stock is selling below its fair market value; . early recognition of changes in a company's underlying fundamentals; . evaluation of the sustainability of fundamental changes; and . by monitoring a stock's behavior in the market, evaluation of the timeliness of the investment. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization value stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Principal Variable Contracts Fund 9 www.principal.com ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 120.9%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks, but who prefer investing in companies that appear to be considered undervalued relative to similar companies. 10 Principal Variable Contracts Fund 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"23.5 "1997"28.53 "1998"13.58 "1999"-4.29 "2000"2.16 "2001"-8.05 "2002"-13.66 "2003"25.49 "2004"12.36 The Account's highest/lowest quarterly returns "2005"6.8 during this time period were: HIGHEST Q2 '03 15.52% LOWEST Q3 '02 -15.10% LOGO The year-to-date return as of March 31, 2006 is 6.07%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT CAPITAL VALUE ACCOUNT 6.80 3.64 7.74 11.92* Russell 1000 Value Index................. 7.05 5.28 10.94 14.32** Morningstar Large Value Category Average 5.88 3.96 8.85 13.21** Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 13, 1970). ** Lifetime results are measured from December 31, 1978 (earliest date for which information is available).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.60% Other Expenses................... 0.01% ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.61%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 CAPITAL VALUE ACCOUNT $62 $195 $340 $762
Principal Variable Contracts Fund 11 www.principal.com DIVERSIFIED INTERNATIONAL ACCOUNT The Account seeks long-term growth of capital by investing in a portfolio of equity securities of companies established outside of the U.S. MAIN STRATEGIES The Account invests in a portfolio of equity securities of companies domiciled in any of the nations of the world. The Account invests in securities of: . companies with their principal place of business or principal office outside the U.S.; . companies for which the principal securities trading market is outside the U.S.; and . companies, regardless of where their securities are traded, that derive 50% or more of their total revenue from goods or services produced or sales made outside the U.S. The Account has no limitation on the percentage of assets that are invested in any one country or denominated in any one currency. However, under normal market conditions, the Account intends to have at least 80% of its assets invested in companies in at least three different countries. One of those countries may be the U.S. though currently the Account does not intend to invest in equity securities of U.S. companies. Investments may be made anywhere in the world. Primary consideration is given to securities of corporations of Western Europe, North America and Australasia (Australia, Japan and Far East Asia). Changes in investments are made as prospects change for particular countries, industries or companies. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. The Account may actively trade securities in an attempt to achieve its investment objective. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as companies in more developed countries. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more 12 Principal Variable Contracts Fund 1-800-247-4123 volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 121.2%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital in markets outside of the U.S. who are able to assume the increased risks of higher price volatility and currency fluctuations associated with investments in international stocks which trade in non-U.S. currencies. Principal Variable Contracts Fund 13 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"25.09 "1997"12.24 "1998"9.98 "1999"25.93 "2000"-8.34 "2001"-24.27 "2002"-16.07 "2003"32.33 "2004"21.03 The Account's highest/lowest quarterly returns "2005"23.79 during this time period were: HIGHEST Q2 '03 17.25% LOWEST Q3 '02 -18.68% LOGO The year-to-date return as of March 31, 2006 is 11.97%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS DIVERSIFIED INTERNATIONAL ACCOUNT. 23.79 4.73 8.43 Citigroup BMI Global ex-US Index/(1)/...... 19.59 8.09 7.79 MSCI EAFE (Europe, Australia, Far East) Index - ND ........... 13.54 4.56 5.84 Morningstar Foreign Large Blend Category Average .............. 14.55 2.93 6.47 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 2, 1994). ** Lifetime results are measured from the Index inception date (December 31, 1994). ///(1)/ This index is now the benchmark against which the Account measures its performance. The Manager and the portfolio manager believe it better represents the universe of investment choices open to the Account under its investment philosophy. The index formerly used is also shown. LIFE OF ACCOUNT* DIVERSIFIED 8.09 INTERNATIONAL ACCOUNT. Citigroup BMI Global 8.02** ex-US Index/(1)/...... MSCI EAFE (Europe, 5.94 Australia, Far East) Index - ND ........... Morningstar Foreign 6.27 Large Blend Category Average .............. Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured f the date the Account was first sold (May 2, 1994). ** Lifetime results are measured the Index inception date (December 31, 1994). ///(1)/ This index is now the benchmark against which the Account measures its performance. The Manager and the portfolio manager believe it better represents the universe of investment choices open to the Account under its investment philosophy. The index formerly used is also shown.
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES
Management Fees.................... 0.85% Other Expenses..................... 0.12 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.97%
(EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005 EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate 14 Principal Variable Contracts Fund 1-800-247-4123 account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES -------------------------------------------------------------------------------------------- 1 3 5 10 DIVERSIFIED INTERNATIONAL ACCOUNT $99 $309 $536 $1,190
Principal Variable Contracts Fund 15 www.principal.com GOVERNMENT & HIGH QUALITY BOND ACCOUNT F/K/A GOVERNMENT SECURITIES ACCOUNT The Account seeks a high level of current income, liquidity and safety of principal. MAIN STRATEGIES The Account seeks to achieve its investment objective by investing primarily (at least 80% of its assets) in securities that are issued by the U.S. Government, its agencies or instrumentalities. The Account may invest in mortgage-backed securities representing an interest in a pool of mortgage loans. These securities are rated AAA by Standard & Poor's Corporation or Aaa by Moody's Investor Services, Inc. or, if unrated, determined by the Sub-Advisor, Principal, to be of equivalent quality. The Account relies on the professional judgment of Principal to make decisions about the Account's portfolio securities. The basic investment philosophy of Principal is to seek undervalued securities that represent good long-term investment opportunities. Securities may be sold when Principal believes they no longer represent good long-term value. The Account may also hold cash and cash equivalents. The size of the Account's cash position depends on various factors, including market conditions and purchases and redemptions of Account shares. A large cash position could impact the ability of the Account to achieve its objective but it also would reduce the Account's exposure in the event of a market downturn and provide liquidity to make additional investments or to meet redemptions. The Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income. Under a reverse repurchase agreement, the Account sells securities and agrees to repurchase them at a specified date and price. The Account pays interest on this "secured financing" and attempts to make money on the difference between the financing rate and the interest it earns by investing the proceeds of the financing. While a reverse repurchase agreement is outstanding, the Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account may lend its portfolio securities to brokers, dealers and other financial institutions. In connection with such loans, the Account remains the owner of the loaned securities and continues to be entitled to payments in amounts equal to the interest, dividends or other distributions payable on the loaned securities. Loans of portfolio securities may not exceed 33 1/3% of the value of the Account's total assets (including the value of all assets received as collateral for loan). In connection with such loans the Account will receive collateral from the borrower equal to at least 100% of the value of the loaned securities. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: U.S. GOVERNMENT SECURITIES . U.S. Government securities do not involve the degree of credit risk associated with investments in lower quality fixed-income securities. As a result, the yields available from U.S. Government securities are generally lower than the yields available from many other fixed-income securities. Like other fixed-income securities, the values of U.S. Government securities change as interest rates fluctuate. Fluctuations in the value of the Account's securities do not affect interest income on securities already held by the Account, but are reflected in the Account's price per share. Since the magnitude of these fluctuations generally is greater at times when the Account's average maturity is longer, under certain market conditions the Account may invest in short-term investments yielding lower current income rather than investing in higher yielding longer term securities. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates. When interest rates rise, the value of fixed-income securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of fixed-income securities. Some fixed-income investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. 16 Principal Variable Contracts Fund 1-800-247-4123 CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. U.S. GOVERNMENT SPONSORED SECURITIES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. Prepayments, unscheduled principal payments, may result from voluntary prepayment, refinancing or foreclosure of the underlying mortgage. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates and potentially increasing the volatility of the Account. In addition, prepayments may cause losses on securities purchased at a premium (dollar amount by which the price of the bond exceeds its face value). At times, mortgage-backed securities may have higher than market interest rates and are purchased at a premium. Unscheduled prepayments are made at par and cause the Account to experience a loss of some or all of the premium. DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. REVERSE REPURCHASE AGREEMENTS. . This strategy involves the risk that interest costs on money borrowed may exceed the return on securities purchased with the borrowed money. In addition, reverse repurchase agreements may increase the volatility of the Fund. LENDING OF SECURITIES . If the Account lends its portfolio securities and the borrower of the securities fail financially, the Account may experience delays in recovering the loaned securities or exercising its rights in the collateral. The Account lends its securities only to borrowers that the Sub-Advisor determines are creditworthy. PORTFOLIO DURATION . The average portfolio duration of the Account normally varies within a three- to six-year time frame based on Sub-Advisor's forecast for interest rates. Duration is a measure of the expected life of a fixed-income security that is used to determine the sensitivity of a security's price to changes in interest rates. For example, if the portfolio duration of the Account is three years, a change of 1% in the market's yield results in a change of approximately 3% in the value of the Account's securities. The longer a security's duration, the more sensitive it is to changes in interest rates. An Account with a longer average portfolio duration will be more sensitive to changes in interest rates than an Account with a shorter average portfolio duration. Principal Variable Contracts Fund 17 www.principal.com ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading cost which may have an adverse impact on the Account's performance. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 262.1%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking diversification by investing in a fixed-income mutual fund. 18 Principal Variable Contracts Fund 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"3.35 "1997"10.39 "1998"8.27 "1999"-0.29 "2000"11.4 "2001"7.61 "2002"8.8 "2003"1.84 "2004"3.56 The Account's highest/lowest quarterly returns "2005"2.01 during this time period were: HIGHEST Q2 '97 4.52% LOWEST Q1 '96 -1.90% LOGO The year-to-date return as of March 31, 2006 is -0.45%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* GOVERNMENT & HIGH QUALITY BOND ACCOUNT . 2.01 4.72 5.62 7.30 Lehman Brothers Government/Mortgage Index................. 2.63 5.40 6.01 7.56 Morningstar Intermediate Government Category Average .............. 1.90 4.62 5.12 6.67 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (April 9, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.44% Other Expenses................... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.46%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 GOVERNMENT & HIGH QUALITY BOND ACCOUNT $47 $148 $258 $579
Principal Variable Contracts Fund 19 www.principal.com LARGECAP GROWTH EQUITY ACCOUNT The Account seeks to achieve long-term growth of capital. MAIN STRATEGIES The Account invests primarily in common stock of U.S. companies, with a focus on growth stocks. Growth stocks are issues (or securities) that the Sub-Advisor, GMO, believes are fast-growing and whose earnings are believed to likely increase over time. Growth in earnings may lead to an increase in the price of the stock. The Sub-Advisor invests mainly in large companies, although investments can be made in companies of any size. Under normal market conditions, the Account invests at least 80% of its assets in equity securities of companies with large market capitalizations. The Account typically makes equity investments in companies chosen from among the 1,000 U.S. exchange-listed companies with the largest market capitalization. Market capitalization is defined as total current market value of a company's outstanding common stock. In addition, the Account may invest up to 25% of its assets in foreign securities, including American Depository Receipts (ADRs), at the time of purchase. When deciding whether to buy or sell stocks for the Account, GMO considers, among other factors, a company's valuation, financial strength, competitive position in its industry, projected future earnings, cash flows and dividends. In addition to the main investment strategies described above, GMO may make other investments, such as investments in preferred stocks, convertible securities and debt instruments. These investments may be subject to other risks as described later in this prospectus and/or the Statement of Additional Information. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization growth-oriented stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. INTEREST RATE CHANGES . Changes in interest rates may adversely affect the value of an investor's securities. When interest rates rise, the value of preferred securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of preferred securities. Some investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. 20 Principal Variable Contracts Fund 1-800-247-4123 INVESTOR PROFILE The Account may be an appropriate investment for investors who are seeking long-term growth and are willing to accept the potential for short-term, volatile fluctuations in the value of their investment. This Account is designed as a long-term investment with growth potential. Principal Variable Contracts Fund 21 www.principal.com GMO became the Sub-Advisor to the Account on March 31, 2004. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2001"-30.08 "2002"-33.27 "2003"23.14 "2004"3.16 The Account's highest/lowest quarterly returns "2005"3.63 during this time period were: HIGHESTQ4 '0112.16% LOWEST Q3 '01-21.14% LOGO The year-to-date return as of March 31, 2006 is 1.26%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* LARGECAP GROWTH EQUITY ACCOUNT 3.63 -9.29 -13.27 Russell 1000 Growth Index .... 5.26 -3.58 -6.99 Morningstar Large Growth Category Average.............. 6.46 -3.36 -5.29 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (October 24, 2000).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.00% Other Expenses............................. 0.09% ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.09%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------- 1 3 5 10 LARGECAP GROWTH EQUITY ACCOUNT $111 $347 $601 $1,329
22 Principal Variable Contracts Fund 1-800-247-4123 LARGECAP STOCK INDEX ACCOUNT The Account seeks long-term growth of capital. MAIN STRATEGIES Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies that compose the Standard & Poor's ("S&P") 500 Index. The Sub-Advisor, Principal, attempts to mirror the investment performance of the Index by allocating the Account's assets in approximately the same weightings as the S&P 500. The S&P 500 is an unmanaged index of 500 common stocks chosen to reflect the industries of the U.S. economy and is often considered a proxy for the stock market in general. Each stock is weighted by its market capitalization which means larger companies have greater representation in the Index than smaller ones. As of March 31, 2006, the market capitalization range of the Index was between approximately $579 million and $371.6 billion. Over the long-term, Principal seeks a very close correlation between performance of the Account, before expenses, and that of the S&P 500. It is unlikely that a perfect correlation of 1.00 will be achieved. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. Because of the difficulty and expense of executing relatively small stock trades, the Account may not always be invested in the less heavily weighted S&P 500 stocks. At times, the Account's portfolio may be weighted differently from the S&P 500, particularly if the Account has a small level of assets to invest. In addition, the Account's ability to match the performance of the S&P 500 is affected to some degree by the size and timing of cash flows into and out of the Account. The Account is managed to attempt to minimize such effects. Principal reserves the right to omit or remove any of the S&P 500 stocks from the Account if it determines that the stock is not sufficiently liquid. In addition, a stock might be excluded or removed from the Account if extraordinary events or financial conditions lead Principal to believe that it should not be a part of the Account's assets. Principal may also elect to omit any S&P 500 stocks from the Account if such stocks are issued by an affiliated company. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's equity securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth stocks typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. Principal Variable Contracts Fund 23 www.principal.com INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital, willing to accept the potential for volatile fluctuations in the value of investments and preferring a passive, rather than active, management style. NOTE: "Standard & Poor's 500" and "S&P 500/(R)/" are trademarks of The McGraw-Hill Companies, Inc. and have been licensed by the Manager. The Account is not sponsored, endorsed, sold or promoted by Standard and Poor's and Standard & Poor's makes no representation regarding the advisability of investing in the Account. 24 Principal Variable Contracts Fund 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2000"-9.67 "2001"-12.1 "2002"-22.44 "2003"28.32 "2004"10.39 The Account's highest/lowest quarterly returns "2005"4.47 during this time period were: HIGHEST Q2 '03 15.28% LOWEST Q3 '02 -17.27% LOGO The year-to-date return as of March 31, 2006 is 4.17%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* LARGECAP STOCK INDEX ACCOUNT . 4.47 0.18 -0.11 S&P 500 Index ................ 4.91 0.54 0.54 Morningstar Large Blend Category Average.............. 5.77 0.50 1.55 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 3, 1999).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.25%* Other Expenses............................. 0.03 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.28% *Effective January 1, 2006.
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 LARGECAP STOCK INDEX ACCOUNT $29 $90 $157 $356
Principal Variable Contracts Fund 25 www.principal.com MIDCAP ACCOUNT The Account seeks to achieve capital appreciation by investing primarily in securities of emerging and other growth-oriented companies. MAIN STRATEGIES The Account invests primarily in common stocks and other equity securities of medium capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with medium market capitalizations (those with market capitalizations similar to companies in the Russell MidCap/(R)/ Index (as of March 31, 2006, this range was between approximately $688 million and $22.1 billion) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Up to 25% of Account assets may be invested in foreign securities. In selecting securities for investment, the Sub-Advisor, Principal, looks at stocks with value and/or growth characteristics and constructs an investment portfolio that has a "blend" of stocks with these characteristics. In managing the assets of the Account, Principal does not have a policy of preferring one of these categories to the other. The value orientation emphasizes buying stocks at less than their inherent value and avoiding stocks whose price has been artificially built up. The growth orientation emphasizes buying stocks of companies whose potential for growth of capital and earnings is expected to be above average. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. MAIN RISKS The Account is subject to the risk that its principal market segment, medium capitalization stocks, may underperform compared to other market segments or to the equity markets as a whole. Because different types of stocks tend to shift in and out of favor depending on market and economic conditions, the Account's performance may sometimes be lower or higher than that of other types of funds. The value of the Account's equity securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. 26 Principal Variable Contracts Fund 1-800-247-4123 MEDIUM CAPITALIZATIONS . Companies with medium capitalizations may have a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the potential for short-term fluctuations in the value of investments. Principal Variable Contracts Fund 27 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"21.11 "1997"22.75 "1998"3.69 "1999"13.04 "2000"14.59 "2001"-3.71 "2002"-8.75 "2003"32.81 "2004"17.76 The Account's highest/lowest quarterly returns "2005"9.21 during this time period were: HIGHESTQ4 '9923.31% LOWEST Q3 '98-20.01% LOGO The year-to-date return as of March 31, 2006 is 4.55%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* MIDCAP ACCOUNT ....... 9.21 8.46 11.60 14.11 Russell Midcap Index . 12.65 8.45 12.49 14.57 Morningstar Mid-Cap Blend Category Average 9.21 8.14 11.74 14.12 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (December 18, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.57% Other Expenses................... 0.01 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.58%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MIDCAP ACCOUNT $59 $186 $324 $726
28 Principal Variable Contracts Fund 1-800-247-4123 MIDCAP GROWTH ACCOUNT The Account seeks long-term growth of capital. MAIN STRATEGIES Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with medium market capitalization (those with market capitalizations similar to companies in the Russell Midcap/(R)/ Growth Index (as of March 31, 2006, this range was between approximately $952 million and $21.9 billion)) at the time of purchase. In the view of the Sub-Advisor, Mellon Equity, many medium-sized companies: . are in fast growing industries; . offer superior earnings growth potential; and . are characterized by strong balance sheets and high returns on equity. The Account may also hold investments in large and small capitalization companies, including emerging and cyclical growth companies. The Account may invest up to 25% of its net assets in securities of foreign companies, including securities of issuers in emerging countries and securities quoted in foreign currencies. Mellon Equity uses valuation models designed to identify common stocks of companies that have demonstrated consistent earnings momentum and delivered superior results relative to market analyst expectations. Other considerations include profit margins, growth in cash flow and other standard balance sheet measures. The securities held are generally characterized by strong earnings momentum measures and higher expected earnings per share growth. The valuation model incorporates information about the relevant criteria as of the most recent period for which data are available. Once ranked, the securities are categorized under the headings "buy," "sell" or "hold." The decision to buy, sell or hold is made by Mellon Equity based primarily on output of the valuation model. However, that decision may be modified due to subsequently available or other specific relevant information about the security. In addition, Mellon Equity manages risk by diversifying across companies and industries, limiting the potential adverse impact from any one stock or industry. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. MEDIUM CAPITALIZATIONS . Companies with medium capitalizations may have a limited operating history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency Principal Variable Contracts Fund 29 www.principal.com exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. EMERGING MARKET COUNTRIES . Investments in emerging market countries involve special risks. Certain emerging market countries have historically experienced, and may continue to experience, certain economic problems. These may include: high rates of inflation, high interest rates, exchange rate fluctuations, large amounts of debt, balance of payments and trade difficulties, and extreme poverty and unemployment. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth and willing to accept the potential for short-term fluctuations in the value of their investments. 30 Principal Variable Contracts Fund 1-800-247-4123 Mellon Equity has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999"10.67 "2000"8.1 "2001"-16.92 "2002"-26.27 "2003"40.58 "2004"11.82 The Account's highest/lowest quarterly returns "2005"13.72 during this time period were: HIGHESTQ4 '0124.12% LOWEST Q3 '01-25.25% LOGO The year-to-date return as of March 31, 2006 is 7.08%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* MIDCAP GROWTH ACCOUNT ........ 13.72 1.83 3.12 Russell Midcap Growth Index .. 12.10 1.38 5.30 Morningstar Mid-Cap Growth Category Average.............. 9.70 0.01 6.65 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.90% Other Expenses............................. 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.92%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MIDCAP GROWTH ACCOUNT $94 $293 $509 $1,131
Principal Variable Contracts Fund 31 www.principal.com MIDCAP VALUE ACCOUNT The Account seeks long-term growth of capital by investing primarily in equity securities of companies with value characteristics and medium market capitalizations. MAIN STRATEGIES The Account invests primarily in common stocks of medium capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with a medium market capitalization (those with market capitalizations similar to companies in the Russell Midcap/(R)/ Value Index (as of March 31, 2006, this range was between approximately $688 million and $22.1 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Companies may range from the well-established and well known to the new and unseasoned. The Account may invest up to 25% of its assets in securities of foreign companies. The stocks are selected using a value oriented investment approach by Neuberger Berman, the Sub-Advisor. Neuberger Berman identifies value stocks in several ways. Factors it considers in identifying value stocks may include: . strong fundamentals, such as a company's financial, operational and competitive positions; . consistent cash flow; and . a sound earnings record through all phases of the market cycle. Neuberger Berman may also look for other characteristics in a company, such as a strong position relative to competitors, a high level of stock ownership among management, and a recent sharp decline in stock price that appears to be the result of a short-term market overreaction to negative news. Neuberger Berman believes that, over time, securities that are undervalued are more likely to appreciate in price and are subject to less risk of price decline than securities whose market prices have already reached their perceived economic value. This approach also involves selling portfolio securities when Neuberger Berman believes they have reached their potential, when the securities fail to perform as expected or when other opportunities appear more attractive. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. MEDIUM CAPITALIZATIONS . Companies with medium capitalizations may have a limited operating history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency 32 Principal Variable Contracts Fund 1-800-247-4123 exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth and willing to accept short-term fluctuations in the value of investments. Principal Variable Contracts Fund 33 www.principal.com Neuberger Berman has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2000"31.03 "2001"-2.58 "2002"-9.96 "2003"36.49 "2004"22.67 The Account's highest/lowest quarterly returns "2005"10.55 during this time period were: HIGHEST Q2 '03 14.93% LOWEST Q3 '02 -14.54% LOGO The year-to-date return as of March 31, 2006 is 4.70%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* MIDCAP VALUE ACCOUNT ......... 10.55 10.18 13.65 Russell Midcap Value Index ... 12.65 12.21 10.93 Morningstar Mid-Cap Value Category Average.............. 8.41 9.36 10.54 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 3, 1999).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.05% Other Expenses............................. 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.07%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MIDCAP VALUE ACCOUNT $109 $340 $590 $1,306
34 Principal Variable Contracts Fund 1-800-247-4123 MONEY MARKET ACCOUNT The Account has an investment objective of as high a level of current income available from investments in short-term securities as is consistent with preservation of principal and maintenance of liquidity. MAIN STRATEGIES The Account invests its assets in a portfolio of high quality, short-term money market instruments. The investments are U.S. dollar denominated securities which the Sub-Advisor, Principal, believes present minimal credit risks. At the time the Account purchases each security, it is an "eligible security" as defined in the regulations issued under the Investment Company Act of 1940, as amended. The Account maintains a dollar weighted average portfolio maturity of 90 days or less. It intends to hold its investments until maturity. However, the Account may sell a security before it matures: . to take advantage of market variations; . to generate cash to cover sales of Account shares by its shareholders; or . upon revised credit opinions of the security's issuer. The sale of a security by the Account before maturity may not be in the best interest of the Account. The sale of portfolio securities is usually a taxable event. The Account does have an ability to borrow money to cover the redemption of Account shares. It is the policy of the Account to be as fully invested as possible to maximize current income. Securities in which the Account invests include: . securities issued or guaranteed by the U.S. government, including treasury bills, notes and bonds; . securities issued or guaranteed by agencies or instrumentalities of the U.S. government. These are backed either by the full faith and credit of the U.S. government or by the credit of the particular agency or instrumentality; . bank obligations including: . certificates of deposit which generally are negotiable certificates against funds deposited in a commercial bank; or . bankers acceptances which are time drafts drawn on a commercial bank, usually in connection with international commercial transactions. . commercial paper which is short-term promissory notes issued by U.S. or foreign corporations primarily to finance short-term credit needs; . corporate debt consisting of notes, bonds or debentures which at the time of purchase by the Account has 397 days or less remaining to maturity; . repurchase agreements under which securities are purchased with an agreement by the seller to repurchase the security at the same price plus interest at a specified rate. Generally these have a short maturity (less than a week) but may also have a longer maturity; and . taxable municipal obligations which are short-term obligations issued or guaranteed by state and municipal issuers which generate taxable income. Among the certificates of deposit typically held by the Account are Eurodollar and Yankee obligations which are issued in U.S. dollars by foreign banks and foreign branches of U.S. banks. Before the Sub-Advisor selects a Eurodollar or Yankee obligation, however, the foreign issuer undergoes the same credit-quality analysis and tests of financial strength as an issuer of domestic securities. MAIN RISKS As with all mutual funds, the value of the Account's assets may rise or fall. Although the Account seeks to preserve the value of an investment at $1.00 per share, it is possible to lose money by investing in the Account. An investment in the Account is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. As with any security, the securities in which the Account invests have associated risks. These include risks of: CREDIT RISK . Credit risk pertains to the issuer's ability to make scheduled principal or interest payments. This may reduce the Account's stream of income and decrease the Account's yield. Principal Variable Contracts Fund 35 www.principal.com INTEREST RATE RISK . The value of the Account's shares is directly impacted by trends in interest rates. If interest rates rise, the value of debt securities generally will fall. REPURCHASE AGREEMENTS . The Account may invest in repurchase agreements with commercial banks, brokers and dealers considered by the Sub-Advisor to be creditworthy. Default or insolvency of the other party is a potential risk to the Account. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in securities issued by government-sponsored enterprises. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. EURODOLLAR AND YANKEE OBLIGATIONS . Eurodollar and Yankee obligations have risks similar to U.S. money market instruments, such as income risk and credit risk. Other risks of Eurodollar and Yankee obligations include the possibilities that: a foreign government will not let U.S. dollar-denominated assets leave the country; the banks that issue Eurodollar obligations may not be subject to the same regulations as U.S. banks; and adverse political or economic developments will affect investments in a foreign country. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking monthly dividends without incurring much principal risk. 36 Principal Variable Contracts Fund 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"5.07 "1997"5.04 "1998"5.2 "1999"4.84 "2000"6.07 "2001"3.92 "2002"1.42 "2003"0.74 "2004"0.92 "2005"2.69 TO OBTAIN THE ACCOUNT'S CURRENT YIELD INFORMATION, PLEASE CALL 1-800-247-4123 LOGO The year-to-date return as of March 31, 2006 is 1.00%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* Money Market Account . 2.69 1.93 3.60 3.15 *Lifetime results are measured from the date the Account was first sold (March 18, 1983).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.49% Other Expenses................... 0.12 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.61%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MONEY MARKET ACCOUNT $62 $195 $340 $762
Principal Variable Contracts Fund 37 www.principal.com SHORT-TERM BOND ACCOUNT F/K/A LIMITED TERM BOND ACCOUNT The Account seeks to provide current income. MAIN STRATEGIES The Account invests primarily in short-term fixed-income securities. Under normal circumstances, the Account maintains a dollar-weighted effective maturity of not more than three years. In determining the average effective maturity of the Fund's assets, the maturity date of a callable security or prepayable securities may be adjusted to reflect the judgment of Principal, the Sub-Advisor, regarding the likelihood of the security being called or prepaid. The Account considers the term "bond" to mean any debt security. Under normal circumstances, it invests at least 80% of its assets in: . securities issued or guaranteed by the U.S. government or its agencies or instrumentalities; . debt securities of U.S. issuers rated in the three highest grades by Standard & Poor's Rating Service or Moody's Investors Service, Inc. or, if unrated, in the opinion of the Sub-Advisor, Principal, of comparable quality; and . mortgage-backed securities representing an interest in a pool of mortgage loans. The rest of the Account's assets may be invested in a variety of financial instruments, including securities in the fourth highest rating category or their equivalent. Securities in the fourth highest category are "investment grade." While they are considered to have adequate capacity to pay interest and repay principal, they do have speculative characteristics. Changes in economic and other conditions are more likely to affect the ability of the issuer to make principal and interest payments than is the case with issuers of higher rated securities. The Account may invest up to 15% of its assets in below-investment-grade fixed-income securities. Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (please see "High Yield Securities" in the section of the prospectus entitled "Certain Investment Strategies and Related Risks) The Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income. Under a reverse repurchase agreement, the Account sells securities and agrees to repurchase them at a specified date and price. The Account pays interest on this "secured financing" and attempts to make money on the difference between the financing rate and the interest it earns by investing the proceeds of the financing. While a reverse repurchase agreement is outstanding, the Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account may lend its portfolio securities to brokers, dealers and other financial institutions. In connection with such loans, the Account remains the owner of the loaned securities and continues to be entitled to payments in amounts equal to the interest, dividends or other distributions payable on the loaned securities. Loans of portfolio securities may not exceed 33 1/3% of the value of the Account's total assets (including the value of all assets received as collateral for loan). In connection with such loans the Account will receive collateral from the borrower equal to at least 100% of the value of the loaned securities. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates. When interest rates rise, the value of fixed-income securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of fixed-income securities. Some fixed-income investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. 38 Principal Variable Contracts Fund 1-800-247-4123 CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. PORTFOLIO DURATION. . The average portfolio duration of the Account normally is less than three years and is based on Principal's forecast for interest rates. Duration is a measure of the expected life of a fixed-income security that is used to determine the sensitivity of a security's price to changes in interest rates. For example, if the portfolio duration of the Account is three years, a change of 1% in the market's yield results in a change of approximately 3% in the value of the Account's securities. The longer a security's duration, the more sensitive it is to changes in interest rates. An Account with a longer average portfolio duration will be more sensitive to changes in interest rates than an Account with a shorter average portfolio duration. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates. This may increase the volatility of the Account. REVERSE REPURCHASE AGREEMENTS. . This strategy involves the risk that interest costs on money borrowed may exceed the return on securities purchased with the borrowed money. In addition, reverse repurchase agreements may increase the volatility of the Fund. LENDING OF SECURITIES . If the Account lends its portfolio securities and the borrower of the securities fail financially, the Account may experience delays in recovering the loaned securities or exercising its rights in the collateral. Loans are made only to borrowers that are deemed by the Sub-Advisor to be of good financial standing. HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.) DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. COMMODITY-LINKED DERIVATIVE INSTRUMENTS . The use of commodity-linked derivative instruments may subject the Account to greater volatility than investments in traditional securities. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-- Principal Variable Contracts Fund 39 www.principal.com Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking diversification by investing in a fixed-income mutual fund. 40 Principal Variable Contracts Fund 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2004"1.3 "2005"1.8 The Account's highest/lowest quarterly returns LOGO during this time period were: HIGHEST Q1 '04 1.50% LOWEST Q2 '04 -1.58% The year-to-date return as of March 31, 2006 is 0.28%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF ACCOUNT* SHORT-TERM BOND ACCOUNT .................... 1.80 1.46 Lehman Brothers Mutual Fund 1-5 Gov't/Credit Index ...................................... 1.44 1.87 Morningstar Short-Term Bond Category Average 1.43 1.64 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 2003).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees...................................... 0.50% Other Expenses....................................... 0.07 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.57%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SHORT-TERM BOND ACCOUNT $58 $183 $318 $714
Principal Variable Contracts Fund 41 www.principal.com SMALLCAP ACCOUNT The Account seeks long-term growth of capital by investing primarily in equity securities of companies with comparatively small market capitalizations. MAIN STRATEGIES The Account invests primarily in common stocks of small capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with small market capitalizations (those with market capitalizations similar to companies in the Russell 2000/(R)/ Index (as of March 31, 2006, this range was between approximately $23 million and $5.4 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. The Account may invest up to 25% of its assets in securities of foreign companies. In selecting securities for investment, the Sub-Advisor, Principal, looks at stocks with value and/or growth characteristics and constructs an investment portfolio that has a "blend" of stocks with these characteristics. In managing the assets of the Account, Principal does not have a policy of preferring one of these categories to the other. The value orientation emphasizes buying stocks at less than their investment value and avoiding stocks whose price has been artificially built up. The growth orientation emphasizes buying stocks of companies whose potential for growth of capital and earnings is expected to be above average. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. Principal may purchase securities issued as part of, or a short period after, companies' initial public offerings ("IPOs"), and may at times dispose of those shares shortly after their acquisition. MAIN RISKS The Account's share price may fluctuate more than that of funds primarily invested in stocks of mid-sized and large companies and may underperform as compared to the securities of larger companies. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. 42 Principal Variable Contracts Fund 1-800-247-4123 VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 125.8%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the potential for volatile fluctuations in the value of investments. Principal Variable Contracts Fund 43 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999 "43.58 "2000"-11.73 "2001 "2.55 "2002"-27.33 "2003 "36.82 "2004 "19.82 The Account's highest/lowest quarterly returns "2005 "7.04 during this time period were: HIGHESTQ2 '9926.75% LOWEST Q3 '01-25.61% LOGO The year-to-date return as of March 31, 2006 is 11.13%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* SMALLCAP ACCOUNT ............. 7.04 5.51 3.66 Russell 2000 Index ........... 4.55 8.22 5.77 Morningstar Small Blend Category Average.............. 6.62 9.89 8.23 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.85% Other Expenses............................. 0.03 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.88%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SMALLCAP ACCOUNT $90 $281 $488 $1,084
44 Principal Variable Contracts Fund 1-800-247-4123 SMALLCAP GROWTH ACCOUNT The Account seeks long-term growth of capital. The Manager has selected UBS Global AM and Emerald as Sub-Advisors to the Account. MAIN STRATEGIES The Account pursues its investment objective by investing primarily in equity securities. Under normal market conditions, the Account invests at least 80% of its assets in equity securities of companies with small market capitalizations (those with market capitalizations equal to or smaller than the greater of 1) $2.5 billion or 2) the highest market capitalization of the companies in the Russell 2000/(R)/ Growth Index at the time of purchase (as of March 31, 2005, this range was between approximately $23 million and $5.4 billion)). Market capitalization is defined as total current market value of a company's outstanding common stock. The Account may invest up to 25% of its assets in securities of foreign companies. UBS Global AM seeks to invest in companies that possess dominant market positions or franchises, a major technical edge, or a unique competitive advantage. To this end, UBS Global AM considers earnings revision trends, positive stock price momentum and strong fundamentals when selecting securities. The Account may also invest in securities of emerging growth companies which are companies that UBS Global AM expects to experience above average earnings or cash flow growth or meaningful changes in underlying asset values. Investments in equity securities may include common stock and preferred stock. Utilizing fundamental analysis, Emerald seeks to invest in the common stock of companies with distinct competitive advantages, strong management teams, leadership positions, high revenue and earnings growth rates versus peers, differentiated growth drivers and limited sell-side research. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. The Manager may, from time-to-time, reallocate Account assets among the Sub-Advisors. The decision to do so may be based on a variety of factors, including but not limited to: the investment capacity of each Sub-Advisor, portfolio diversification, volume of net cash flows, fund liquidity, investment performance, investment strategies, changes in each Sub-Advisor's firm or investment professionals, or changes in the number of Sub-Advisors. Ordinarily, reallocations of Account assets among Sub-Advisors will occur as a Sub-Advisor liquidates assets in the normal course of portfolio management and with net new cash flows; however, at times reallocations may occur by transferring assets in cash or in kind among Sub-Advisors. MAIN RISKS The Account's share price may fluctuate more than that of funds primarily invested in stocks of mid-sized and large companies and may underperform as compared to the securities of larger companies. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. Principal Variable Contracts Fund 45 www.principal.com SECTOR RISK . UBS Global AM may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As UBS Global AM allocates more of the Account's portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries . INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks that may have greater risks than stocks of companies with lower potential for earnings growth. 46 Principal Variable Contracts Fund 1-800-247-4123 UBS Global AM became the Sub-Advisor to the Account on October 1, 2002. On August 24, 2004, Emerald also became Sub-Advisor to the Account. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999 "95.69 "2000"-13.91 "2001"-32.01 "2002"-45.85 "2003 "45.64 The Account's highest/lowest quarterly returns "2004"11.24 during this time period were: HIGHESTQ4 '9959.52% LOWEST Q3 '01-37.66% LOGO The year-to-date return as of March 31, 2006 is 13.41%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* SMALLCAP GROWTH ACCOUNT ...... 6.67 -8.64 1.29 Russell 2000 Growth Index .... 4.15 2.28 1.46 Morningstar Small Growth Category Average.............. 5.74 2.17 6.26 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.00% Other Expenses............................. 0.05 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.05%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SMALLCAP GROWTH ACCOUNT $107 $334 $579 $1,283
Principal Variable Contracts Fund 47 www.principal.com CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS The Statement of Additional Information (SAI) contains additional information about investment strategies and their related risks. SECURITIES AND INVESTMENT PRACTICES MARKET VOLATILITY . Equity securities include common stocks, preferred stocks, convertible securities, depositary receipts, rights and warrants. Common stocks, the most familiar type, represent an equity (ownership) interest in a corporation. The value of a company's stock may fall as a result of factors directly relating to that company, such as decisions made by its management or lower demand for the company's products or services. A stock's value may also fall because of factors affecting not just the company, but also companies in the same industry or in a number of different industries, such as increases in production costs. The value of a company's stock may also be affected by changes in financial markets that are relatively unrelated to the company or its industry, such as changes in interest rates or currency exchange rates. In addition, a company's stock generally pays dividends only after the company invests in its own business and makes required payments to holders of its bonds and other debt. For this reason, the value of a company's stock will usually react more strongly than its bonds and other debt to actual or perceived changes in the company's financial condition or prospects. Stocks of smaller companies may be more vulnerable to adverse developments than those of larger companies. Fixed-income securities include bonds and other debt instruments that are used by issuers to borrow money from investors. The issuer generally pays the investor a fixed, variable or floating rate of interest. The amount borrowed must be repaid at maturity. Some debt securities, such as zero coupon bonds, do not pay current interest, but are sold at a discount from their face values. INTEREST RATE CHANGES . Fixed-income securities are sensitive to changes in interest rates. In general, fixed-income security prices rise when interest rates fall and fall when interest rates rise. Longer term bonds and zero coupon bonds are generally more sensitive to interest rate changes. CREDIT RISK . Fixed-income security prices are also affected by the credit quality of the issuer. Investment grade debt securities are medium and high quality securities. Some bonds, such as lower grade or "junk" bonds, may have speculative characteristics and may be particularly sensitive to economic conditions and the financial condition of the issuers. REPURCHASE AGREEMENTS AND LOANED SECURITIES Although not a principal investment strategy, each of the Accounts may invest a portion of its assets in repurchase agreements. Repurchase agreements typically involve the purchase of debt securities from a financial institution such as a bank, savings and loan association or broker-dealer. A repurchase agreement provides that the Account sells back to the seller and that the seller repurchases the underlying securities at a specified price on a specific date. Repurchase agreements may be viewed as loans by an Account collateralized by the underlying securities. This arrangement results in a fixed rate of return that is not subject to market fluctuation while the Account holds the security. In the event of a default or bankruptcy by a selling financial institution, the affected Account bears a risk of loss. To minimize such risks, the Account enters into repurchase agreements only with large, well-capitalized and well-established financial institutions. In addition, the value of the securities collateralizing the repurchase agreement is, and during the entire term of the repurchase agreement remains, at least equal to the repurchase price, including accrued interest. Each of the Accounts may lend its portfolio securities to unaffiliated broker-dealers and other unaffiliated qualified financial institutions. REVERSE REPURCHASE AGREEMENTS An Account may use reverse repurchase agreements to obtain cash to satisfy unusually heavy redemption requests or for other temporary or emergency purposes without the necessity of selling portfolio securities, or to earn additional income on portfolio securities, such as Treasury bills or notes. In a reverse repurchase agreement, an Account sells a portfolio security to another party, such as a bank or broker-dealer, in return for cash and agrees to repurchase the instrument at a particular price and time. While a reverse repurchase agreement is outstanding, an Account will 48 Principal Variable Contracts Fund 1-800-247-4123 maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account will enter into reverse repurchase agreements only with parties that the Sub-Advisor deems creditworthy. Using reverse repurchase agreements to earn additional income involves the risk that the interest earned on the invested proceeds is less than the expense of the reverse repurchase agreement transaction. This technique may also have a leveraging effect on the Account, although the Account's intent to segregate assets in the amount of the repurchase agreement minimizes this effect. CURRENCY CONTRACTS The Accounts may enter into currency contracts, currency futures contracts and options, and options on currencies for hedging and other purposes. A forward currency contract involves a privately negotiated obligation to purchase or sell a specific currency at a future date at a price set in the contract. An Account will not hedge currency exposure to an extent greater than the aggregate market value of the securities held or to be purchased by the Account (denominated or generally quoted or currently convertible into the currency). Hedging is a technique used in an attempt to reduce risk. If an Account's Sub-Advisor hedges market conditions incorrectly or employs a strategy that does not correlate well with the Account's investment, these techniques could result in a loss. These techniques may increase the volatility of an Account and may involve a small investment of cash relative to the magnitude of the risk assumed. In addition, these techniques could result in a loss if the other party to the transaction does not perform as promised. There is also a risk of government action through exchange controls that would restrict the ability of the Account to deliver or receive currency. FORWARD COMMITMENTS Although not a principal investment strategy, each of the Accounts may enter into forward commitment agreements. These agreements call for the Account to purchase or sell a security on a future date at a fixed price. Each of the Accounts may also enter into contracts to sell its investments either on demand or at a specific interval. WARRANTS Each of the Accounts may invest in warrants though none of the Accounts use such investments as a principal investment strategy. A warrant is a certificate granting its owner the right to purchase securities from the issuer at a specified price, normally higher than the current market price. HIGH YIELD SECURITIES The Bond, MidCap Value and Short-Term Bond may invest in debt securities rated lower than BBB by S&P or Baa by Moody's or, if not rated, determined to be of equivalent quality by the Manager or the Sub-Advisor. Such securities are sometimes referred to as high yield or "junk bonds" and are considered speculative. Investment in high yield bonds involves special risks in addition to the risks associated with investment in highly rated debt securities. High yield bonds may be regarded as predominantly speculative with respect to the issuer's continuing ability to meet principal and interest payments. Moreover, such securities may, under certain circumstances, be less liquid than higher rated debt securities. Analysis of the creditworthiness of issuers of high yield securities may be more complex than for issuers of higher quality debt securities. The ability of an Account to achieve its investment objective may, to the extent of its investment in high yield bonds, be more dependent on such credit analysis than would be the case if the Account were investing in higher quality bonds. High yield bonds may be more susceptible to real or perceived adverse economic and competitive industry conditions than higher-grade bonds. The prices of high yield bonds have been found to be less sensitive to interest rate changes than more highly rated investments, but more sensitive to adverse economic downturns or individual corporate developments. If the issuer of high yield bonds defaults, an Account may incur additional expenses to seek recovery. The secondary market on which high yield bonds are traded may be less liquid than the market for higher-grade bonds. Less liquidity in the secondary trading market could adversely affect the price at which an Account could sell a high yield bond and could adversely affect and cause large fluctuations in the daily price of the Account's shares. Adverse Principal Variable Contracts Fund 49 www.principal.com publicity and investor perceptions, whether or not based on fundamental analysis, may decrease the value and liquidity of high yield bonds, especially in a thinly traded market. The use of credit ratings for evaluating high yield bonds also involves certain risks. For example, credit ratings evaluate the safety of principal and interest payments, not the market value risk of high yield bonds. Also, credit rating agencies may fail to change credit ratings in a timely manner to reflect subsequent events. If a credit rating agency changes the rating of a portfolio security held by an Account, the Account may retain the security if the Manager or Sub-Advisor thinks it is in the best interest of shareholders. INITIAL PUBLIC OFFERINGS ("IPOS") Certain of the Accounts may invest in IPOs. An IPO is a company's first offering of stock to the public. IPO risk is that the market value of IPO shares will fluctuate considerably due to factors such as the absence of a prior public market, unseasoned trading, the small number of shares available for trading and limited information about the issuer. The purchase of IPO shares may involve high transaction costs. IPO shares are subject to market risk and liquidity risk. In addition, the market for IPO shares can be speculative and/or inactive for extended periods of time. The limited number of shares available for trading in some IPOs may make it more difficult for an Account to buy or sell significant amounts of shares without an unfavorable impact on prevailing prices. Investors in IPO shares can be affected by substantial dilution in the value of their shares by sales of additional shares and by concentration of control in existing management and principal shareholders. When an Account's asset base is small, a significant portion of the Account's performance could be attributable to investments in IPOs because such investments would have a magnified impact on the Account. As the Account's assets grow, the effect of the Account's investments in IPOs on the Account's performance probably will decline, which could reduce the Account's performance. Because of the price volatility of IPO shares, an Account may choose to hold IPO shares for a very short period of time. This may increase the turnover of the Account's portfolio and lead to increased expenses to the Account, such as commissions and transaction costs. By selling IPO shares, the Account may realize taxable gains it will subsequently distribute to shareholders. DERIVATIVES To the extent permitted by its investment objectives and policies, each of the Accounts (except Money Market) may invest in securities that are commonly referred to as derivative securities. Generally, a derivative is a financial arrangement, the value of which is derived from, or based on, a traditional security, asset, or market index. Certain derivative securities are described more accurately as index/structured securities. Index/structured securities are derivative securities whose value or performance is linked to other equity securities (such as depositary receipts), currencies, interest rates, indices or other financial indicators (reference indices). Some derivatives, such as mortgage-related and other asset-backed securities, are in many respects like any other investment, although they may be more volatile or less liquid than more traditional debt securities. There are many different types of derivatives and many different ways to use them. Futures and options are commonly used for traditional hedging purposes to attempt to protect an Account from exposure to changing interest rates, securities prices, or currency exchange rates and for cash management purposes as a low-cost method of gaining exposure to a particular securities market without investing directly in those securities. The Accounts may enter into put or call options, future contracts, options on futures contracts and over-the-counter swap contracts (e.g., interest rate swaps, total return swaps and credit default swaps) for both hedging and non-hedging purposes. Generally, no Account may invest in a derivative security unless the reference index or the instrument to which it relates is an eligible investment for the Account. The return on a derivative security may increase or decrease, depending upon changes in the reference index or instrument to which it relates. The risks associated with derivative investments include: . the risk that the underlying security, interest rate, market index or other financial asset will not move in the direction the Manager or Sub-Advisor anticipated; . the possibility that there may be no liquid secondary market which may make it difficult or impossible to close out a position when desired; 50 Principal Variable Contracts Fund 1-800-247-4123 . the risk that adverse price movements in an instrument can result in a loss substantially greater than an Account's initial investment; and . the counterparty may fail to perform its obligations. EXCHANGE TRADED FUNDS (ETFS) These are a type of index fund bought and sold on a securities exchange. An ETF trades like common stock and represents a fixed portfolio of securities designed to track a particular market index. The Accounts could purchase shares issued by an ETF to temporarily gain exposure to a portion of the U.S. or a foreign market while awaiting purchase of underlying securities. The risks of owning an ETF generally reflect the risks of owning the underlying securities they are designed to track, although ETFs have management fees that increase their costs. CONVERTIBLE SECURITIES Convertible securities are fixed-income securities that an Account has the right to exchange for equity securities at a specified conversion price. The option allows the Account to realize additional returns if the market price of the equity securities exceeds the conversion price. For example, the Account may hold fixed-income securities that are convertible into shares of common stock at a conversion price of $10 per share. If the market value of the shares of common stock reached $12, the Account could realize an additional $2 per share by converting its fixed-income securities. Convertible securities have lower yields than comparable fixed-income securities. In addition, at the time a convertible security is issued the conversion price exceeds the market value of the underlying equity securities. Thus, convertible securities may provide lower returns than non-convertible fixed-income securities or equity securities depending upon changes in the price of the underlying equity securities. However, convertible securities permit the Account to realize some of the potential appreciation of the underlying equity securities with less risk of losing its initial investment. The Accounts treat convertible securities as both fixed-income and equity securities for purposes of investment policies and limitations because of their unique characteristics. The Accounts may invest in convertible securities without regard to their ratings. FOREIGN INVESTING As a principal investment strategy, the Diversified International Account may invest Account assets in securities of foreign companies. The other Accounts (except Government & High Quality Bond) may invest in securities of foreign companies but not as a principal investment strategy. For the purpose of this restriction, foreign companies are: . companies with their principal place of business or principal office outside the U.S.; and . companies for which the principal securities trading market is outside the U.S. Foreign companies may not be subject to the same uniform accounting, auditing and financial reporting practices as are required of U.S. companies. In addition, there may be less publicly available information about a foreign company than about a U.S. company. Securities of many foreign companies are less liquid and more volatile than securities of comparable U.S. companies. Commissions on foreign securities exchanges may be generally higher than those on U.S. exchanges, although each Account seeks the most favorable net results on its portfolio transactions. Foreign markets also have different clearance and settlement procedures than those in U.S. markets. In certain markets there have been times when settlements have been unable to keep pace with the volume of securities transactions, making it difficult to conduct these transactions. Delays in settlement could result in temporary periods when a portion of Account assets is not invested and earning no return. If an Account is unable to make intended security purchases due to settlement problems, the Account may miss attractive investment opportunities. In addition, an Account may incur a loss as a result of a decline in the value of its portfolio if it is unable to sell a security. With respect to certain foreign countries, there is the possibility of expropriation or confiscatory taxation, political or social instability, or diplomatic developments that could affect an Account's investments in those countries. In addition, an Account may also suffer losses due to nationalization, expropriation or differing accounting practices and treatments. Investments in foreign securities are subject to laws of the foreign country that may limit the amount and types of foreign investments. Changes of governments or of economic or monetary policies, in the U.S. or abroad, changes in dealings between nations, currency convertibility or exchange rates could result in investment losses for an Principal Variable Contracts Fund 51 www.principal.com Account. Finally, even though certain currencies may be convertible into U.S. dollars, the conversion rates may be artificial relative to the actual market values and may be unfavorable to Account investors. Foreign securities are often traded with less frequency and volume, and therefore may have greater price volatility, than is the case with many U.S. securities. Brokerage commissions, custodial services, and other costs relating to investment in foreign countries are generally more expensive than in the U.S. Though the Accounts intend to acquire the securities of foreign issuers where there are public trading markets, economic or political turmoil in a country in which an Account has a significant portion of its assets or deterioration of the relationship between the U.S. and a foreign country may negatively impact the liquidity of an Account's portfolio. An Account may have difficulty meeting a large number of redemption requests. Furthermore, there may be difficulties in obtaining or enforcing judgments against foreign issuers. An Account may choose to invest in a foreign company by purchasing depositary receipts. Depositary receipts are certificates of ownership of shares in a foreign-based issuer held by a bank or other financial institution. They are alternatives to purchasing the underlying security but are subject to the foreign securities to which they relate. Investments in companies of developing countries may be subject to higher risks than investments in companies in more developed countries. These risks include: . increased social, political and economic instability; . a smaller market for these securities and low or nonexistent volume of trading that results in a lack of liquidity and in greater price volatility; . lack of publicly available information, including reports of payments of dividends or interest on outstanding securities; . foreign government policies that may restrict opportunities, including restrictions on investment in issuers or industries deemed sensitive to national interests; . relatively new capital market structure or market-oriented economy; . the possibility that recent favorable economic developments may be slowed or reversed by unanticipated political or social events in these countries; . restrictions that may make it difficult or impossible for the Account to vote proxies, exercise shareholder rights, pursue legal remedies, and obtain judgments in foreign courts; and . possible losses through the holding of securities in domestic and foreign custodial banks and depositories. In addition, many developing countries have experienced substantial, and in some periods, extremely high rates of inflation for many years. Inflation and rapid fluctuations in inflation rates have had and may continue to have negative effects on the economies and securities markets of those countries. Repatriation of investment income, capital and proceeds of sales by foreign investors may require governmental registration and/or approval in some developing countries. An Account could be adversely affected by delays in or a refusal to grant any required governmental registration or approval for repatriation. Further, the economies of developing countries generally are heavily dependent upon international trade and, accordingly, have been and may continue to be adversely affected by trade barriers, exchange controls, managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries with which they trade. SMALL AND MEDIUM CAPITALIZATION COMPANIES The Accounts (except Bond, Government & High Quality Bond, Money Market and Short-Term Bond) may invest in securities of companies with small- or mid-sized market capitalizations. The Capital Value, LargeCap Growth Equity and LargeCap Stock Index Accounts may hold securities of small and medium capitalization companies but not as a principal investment strategy. Market capitalization is defined as total current market value of a company's outstanding common stock. Investments in companies with smaller market capitalizations may involve greater risks and price volatility (wide, rapid fluctuations) than investments in larger, more mature companies. Small companies may be less significant within their industries and may be at a competitive disadvantage relative to their larger competitors. While smaller companies may be subject to these additional risks, they may also realize more substantial growth than larger or more established companies. 52 Principal Variable Contracts Fund 1-800-247-4123 Smaller companies may be less mature than larger companies. At this earlier stage of development, the companies may have limited product lines, reduced market liquidity for their shares, limited financial resources or less depth in management than larger or more established companies. Unseasoned issuers are companies with a record of less than three years continuous operation, including the operation of predecessors and parents. Unseasoned issuers by their nature have only a limited operating history that can be used for evaluating the company's growth prospects. As a result, investment decisions for these securities may place a greater emphasis on current or planned product lines and the reputation and experience of the company's management and less emphasis on fundamental valuation factors than would be the case for more mature growth companies. TEMPORARY DEFENSIVE MEASURES From time to time, as part of its investment strategy, each Account (other than the Money Market Account which may invest in high quality money market securities at any time) may invest without limit in cash and cash equivalents for temporary defensive purposes in response to adverse market, economic or political conditions. To the extent that the Account is in a defensive position, it may lose the benefit of upswings and limit its ability to meet its investment objective. For this purpose, cash equivalents include: bank notes, bank certificates of deposit, bankers' acceptances, repurchase agreements, commercial paper, and commercial paper master notes which are floating rate debt instruments without a fixed maturity. In addition, an Account may purchase U.S. government securities, preferred stocks and debt securities, whether or not convertible into or carrying rights for common stock. PORTFOLIO TURNOVER "Portfolio Turnover" is the term used in the industry for measuring the amount of trading that occurs in an Account's portfolio during the year. For example, a 100% turnover rate means that on average every security in the portfolio has been replaced once during the year. Accounts with high turnover rates (more than 100%) often have higher transaction costs (which are paid by the Account) and may have an adverse impact on the Account's performance. No turnover rate can be calculated for the Money Market Account because of the short maturities of the securities in which it invests. Turnover rates for each of the other Accounts may be found in the Account's Financial Highlights table. Please consider all the factors when you compare the turnover rates of different funds. A fund with consistently higher total returns and higher turnover rates than another fund may actually be achieving better performance precisely because the managers are active traders. You should also be aware that the "total return" line in the Financial Highlights section already includes portfolio turnover costs. PRICING OF ACCOUNT SHARES Each Account's shares are bought and sold at the current share price. The share price of each Account is calculated each day the New York Stock Exchange ("NYSE") is open (shares are not priced on the days on which the NYSE is closed for trading). The share price is determined at the close of business of the NYSE (normally 3:00 p.m. Central time). When an order to buy or sell shares is received, the share price used to fill the order is the next price calculated after the order is received. For all Accounts, except the Money Market Account, the share price is calculated by: . taking the current market value of the total assets of the Account . subtracting liabilities of the Account . dividing the remainder by the total number of shares owned by the Account. The securities of the Money Market Account are valued at amortized cost. The calculation procedure is described in the SAI. The Money Market Account reserves the right to determine a share price more than once each day. NOTES: . If current market values are not readily available for a security owned by an Account, its fair value is determined using a policy adopted by the Directors. Principal Variable Contracts Fund 53 www.principal.com . An Account's securities may be traded on foreign securities markets that generally complete trading at various times during the day prior to the close of the NYSE. Generally, the values of foreign securities used in computing a Fund's NAV are determined at the time the foreign market closes. Foreign securities and currencies are converted to U.S. dollars using the exchange rate in effect at the close of the London Exchange (generally 11:00 a.m. Eastern Time). Occasionally, events affecting the value of foreign securities occur when the foreign market is closed and the NYSE is open. The Account has adopted policies and procedures to "fair value" some or all securities held by an Account if significant events occur after the close of the market on which the foreign securities are traded but before the Account's NAV is calculated. Significant events can be specific to a single security or can include events that affect a particular foreign market or markets. A significant event can also include a general market movement in the U.S. securities markets. If the Manager believes that the market value of any or all of the foreign securities is materially affected by such an event, the securities will be valued, and the Account's NAV will be calculated, using the policy adopted by the Account. These fair valuation procedures are intended to discourage shareholders from investing in the Account for the purpose of engaging in market timing or arbitrage transactions. The trading of foreign securities generally or in a particular country or countries may not take place on all days the NYSE is open, or may trade on days the NYSE is closed. Thus, the value of the foreign securities held by the Account may change on days when shareholders are unable to purchase or redeem shares. . Certain securities issued by companies in emerging market countries may have more than one quoted valuation at any point in time. These may be referred to as local price and premium price. The premium price is often a negotiated price that may not consistently represent a price at which a specific transaction can be effected. The Fund has a policy to value such securities at a price at which the Sub-Advisor expects the securities may be sold. DIVIDENDS AND DISTRIBUTIONS The Accounts earn dividends, interest and other income from investments and distribute this income (less expenses) as dividends. The Accounts also realize capital gains from investments and distribute these gains (less any losses) as capital gain distributions. The Accounts normally make dividends and capital gain distributions at least annually, in February. Dividends and capital gain distributions are automatically reinvested in additional shares of the Account making the distribution. MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE THE MANAGER Principal Management Corporation serves as the manager for the Fund. In its handling of the business affairs of the Fund, the Manager provides clerical, recordkeeping and bookkeeping services, and keeps the required financial and accounting records. THE SUB-ADVISORS The Manager has signed a contract with a Sub-Advisor under which the Sub-Advisor agrees to assume the obligations of the Manager to provide investment advisory service for the Account. For these services, the Sub-Advisor is paid a fee by the Manager. Information regarding Sub-Advisors and individual portfolio managers is set forth below. The Statement of Additional Information provides additional information about each portfolio manager's compensation, other accounts managed by the portfolio manager and the portfolio manager's ownership of securities in the Account. MANAGER: The Manager is an indirect subsidiary of Principal Financial Services, Inc. and has managed mutual funds since 1969. As of December 31, 2005, the mutual funds it manages had assets of approximately $28.6 billion. The Manager's address is Principal Financial Group, Des Moines, Iowa 50392-2080. SUB-ADVISOR: Emerald Advisers, Inc. ("Emerald") is a wholly-owned subsidiary of Emerald Asset Management. Emerald provides professional investment advisory services to institutional investors, high net worth 54 Principal Variable Contracts Fund 1-800-247-4123 individuals and the general public. As of December 31, 2005, Emerald managed approximately $2.36 billion in assets. Emerald's offices are located at 1703 Oregon Pike Road, Suite 101, Lancaster, Pennsylvania 17601.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ SmallCap Growth Joseph W. Garner Kenneth G. Mertz Stacey L. Sears
The portfolio management and strategy team have long tenures at Emerald, with Ms. Sears joining Emerald in 1991, Mr. Mertz in 1992 and Mr. Garner in 1994. JOSEPH W. GARNER . Mr. Garner joined Emerald in 1994 and serves as Director of Emerald Research and Portfolio Manager. Prior to joining Emerald, Mr. Garner was the Program Manager of the Pennsylvania Economic Development Financing Authority (PEDFA); an Economic Development Analyst with the PA Department of Commerce's Office of Technology Development; and an Industry Research Analyst with the Pittsburgh High Technology Council. Mr. Garner earned an MBA from the Katz Graduate School of Business, University of Pittsburgh, and graduated magna cum laude with a BA in Economics from Millersville University. KENNETH G. MERTZ II, CFA. . Mr. Mertz joined Emerald in 1992 and serves as President of Emerald Advisers, Inc. Formerly he served as Past Trustee, Vice President of the Emerald Mutual Funds (1992-2005) and Chief Investment Officer of the Pennsylvania State Employees' Retirement System (1985-1992). He earned a BA in Economics from Millersville University. Mr. Mertz supervises the entire portfolio management and trading process. As Chief Investment Officer, he has full discretion over all portfolios. Mr. Mertz, Ms. Sears and Mr. Garner work as a team developing strategy. STACEY L. SEARS . Ms. Sears joined Emerald in 1991 and serves as Senior Vice President and Portfolio Manager of Emerald Advisers, Inc. She is co-manager of the Forward Emerald Growth Fund and a member of the Portfolio Management team. Additionally, Ms. Sears maintains research coverage of retail, apparel, consumer goods and consumer technology companies. Ms. Sears earned a BS in Business Administration from Millersville University and an MBA from Villanova University. SUB-ADVISOR: Grantham, Mayo, Van Otterloo & Co. LLC ("GMO") is a privately held global investment management firm servicing clients in the corporate, public, endowment and foundation marketplace located at 40 Rowes Wharf, Boston, MA 02110. As of December 31, 2005, GMO managed $111 billion in client assets.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ LargeCap Growth Equity Sam Wilderman
Day-to-day management of the LargeCap Growth Equity Account is the responsibility of GMO's U.S. Quantitative Division. The Division's members work collaboratively to manage the Account's portfolio, and no one person is primarily responsible for day-to-day management. The individual responsible for managing the implementation and monitoring of the overall portfolio management of the Account is Sam Wilderman. Mr. Wilderman allocates responsibility for portions of the Account's portfolio to various members of the Division, oversees the implementation of trades, reviews the overall composition of the Account's portfolio, including compliance with stated investment objectives and strategies and monitors cash flows. Principal Variable Contracts Fund 55 www.principal.com Mr. Wilderman is a member (partner) of GMO and is Director of GMO's U.S. Quantitative Division. Mr. Wilderman served as co-director of U.S. equity management in 2005. Prior to this position, he was responsible for research and portfolio management for the GMO Emerging Markets Fund, the GMO Emerging Countries Fund and the GMO Emerging Markets Quality Fund. He joined GMO in 1996 following the completion of his B.A. in Economics from Yale University. The SAI contains other information about how GMO determines the compensation of the Division's senior member, other accounts managed by the team's senior member, and ownership of shares of the Account by the Division's senior member. SUB-ADVISOR: Mellon Equity Associates, LLP ("Mellon Equity"), 500 Grant Street, Suite 4200, Pittsburgh, PA 15258. Mellon Equity is a wholly owned subsidiary of Mellon Financial Corporation ("Mellon"). Mellon has approximately $4.7 trillion in assets under management, administration or custody, including $781 billion under management. As of December 31, 2005, Mellon Equity managed approximately $21.3 billion in assets.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ MidCap Growth Adam T. Logan John O'Toole
ADAM T. LOGAN, CFA . Joining the company in 1998, Mr. Logan is a portfolio manager and Vice President of Mellon Equity. Previously, he performed duties as a financial analyst in Mellon Financial Corporation's corporate finance department. He is currently responsible for the management of client portfolios with a specific focus on mid and small capitalization securities. He earned a BA in Finance from Westminster College and an MBA from the Katz Graduate School of Business at the University of Pittsburgh. He has earned the right to use the Chartered Financial Analyst designation. JOHN O'TOOLE, CFA . Senior Vice President of Mellon Equity since 1990. Mr. O'Toole holds an MBA in Finance from the University of Chicago and a BA in Economics from the University of Pennsylvania. He is a member of the Association for Investment Management and Research, and the Pittsburgh Society of Financial Analysts. He is a Chartered Financial Analyst. SUB-ADVISOR: Neuberger Berman Management, Inc. ("Neuberger Berman") is an affiliate of Neuberger Berman, LLC. Neuberger Berman, LLC is located at 605 Third Avenue, 2nd Floor, New York, NY 10158-0180. Together with Neuberger Berman, the firms manage more than $105.9 billion in total assets (as of December 31, 2005) and continue an asset management history that began in 1939. Neuberger Berman Management, Inc. is an indirect, wholly owned subsidiary of Lehman Brothers Holdings, Inc. Lehman Brothers is located at 745 Seventh Avenue, New York, NY 10019.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ MidCap Value S. Basu Mullick
S. BASU MULLICK . Mr. Mullick, Managing Director, Portfolio Manager, joined Neuberger Berman in 1998. He is manager of mid- to large-cap value Partners Fund and mid-cap value strategy totaling $5.4 billion in assets. Prior to joining the company, Mr. Mullick was a portfolio manager at Ark Asset Management. He earned a BA in Economics from the Presidency College, India. He also earned a MA in Economics and a Ph.D., ABD Finance from Rutgers University. 56 Principal Variable Contracts Fund 1-800-247-4123 SUB-ADVISOR: Principal Global Investors, LLC ("Principal") is an indirectly wholly-owned subsidiary of Principal Life Insurance Company and an affiliate of the Manager. Principal manages equity, fixed-income and real estate investments primarily for institutional investors, including Principal Life. As of December 31, 2005, Principal, together with its affiliated asset management companies, had approximately $159 billion in asset under management. Principal Global Investor's headquarters address is 801 Grand Avenue, Des Moines, Iowa 50392 and has other primary asset management offices in New York, London, Sydney and Singapore.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Bond William C. Armstrong Timothy R. Warrick Capital Value John Pihlblad Diversified International Paul H. Blankenhagen Juliet Cohn Christopher Ibach Government & High Quality Bond Brad Fredericks Lisa Stange LargeCap Stock Index Dirk Laschanzky Mariateresa Monaco MidCap K. William Nolin Money Market Tracy Reeg Alice Robertson Short-Term Bond Zeid Ayer Craig Dawson Martin J. Schafer SmallCap Thomas Morabito
WILLIAM C. ARMSTRONG, CFA . Mr. Armstrong is a portfolio manager for Principal. He manages multi-sector portfolios that invest in corporate bonds, mortgage-backed securities, commercial mortgage-backed securities, asset-backed securities, sovereigns, and agencies. He jointed the firm in 1992. Previously he served as a commissioned bank examiner at Federal Deposit Insurance Commission. He earned a Master's degree from the University of Iowa and a Bachelor's degree from Kearney State College. He has earned the right to use the Chartered Financial Analyst designation. ZEID AYER, PH.D., CFA . Mr. Ayer is a portfolio manager at Principal. he is a co-manager of the ultra short and short-term bond portfolios. He is also head of the Structured Debt group that covers asset-backed securities (ABS) and non-agency mortgage-backed securities (MBS). He joined Principal in 2001 and is the primary analyst responsible for mortgage-related ABS and non-agency MBS investments. Previously, Mr. Ayer was an assistant vice president at PNC Financial Services Group. He earned a doctorate in Physics from the University of Notre Dame, a master's in Computational Finance from Carnegie Mellon University and a Bachelor's degree in Physics from St. Xavier's College, Bombay University. He has earned the right to use the Chartered Financial Analyst designation. PAUL H. BLANKENHAGEN, CFA . Mr. Blankenhagen joined the firm in 1992 and was named a portfolio manager in 2000. He is responsible for developing portfolio strategy and the ongoing management of core international equity portfolios. He earned a Master's degree from Drake University and a Bachelor's degree in Finance from Iowa State University. He has earned the right to use the Chartered Financial Analyst designation, and is a member of the Association for Investment Management and Research (AIMR) and the Iowa Society of Financial Analysts. Principal Variable Contracts Fund 57 www.principal.com JULIET COHN . Ms. Cohn is a portfolio manager at Principal. She co-manages the core international equity portfolios, with an emphasis on Europe and on the health care sector. Prior to joining the firm in 2003, she served as a director and senior portfolio manager at Allianz Dresdner Asset Management, managing both retail and institutional European accounts. Prior to that, she was a fund manager at London firms Capel Cure Myers and Robert Fleming. She earned a bachelor's degree in Mathematics from Trinity College, Cambridge England. CRAIG DAWSON, CFA . Mr. Dawson is a portfolio manager at Principal. He is co-manager of the ultra short and short term bond portfolios. He joined the firm in 1998 as a research associate, then moved into a portfolio analyst role before moving into a portfoio manager position in 2002. He earned an MBA and a Bachelor's degree in Finance from the University of Iowa. Mr. Dawson has earned the right to use the Chartered Financial Analyst designation. BRAD FREDERICKS. . Mr. Fredericks is a portfolio manager at Principal. He is responsible for co-managing the government securities accounts. His responsibilities include general portfolio overview and security analysis. He joined the firm in 1998 as a financial accountant and was named a portfolio manager in 2002. Previously, Mr. Fredericks was an assistant trader at Norwest Mortgage. He earned a Bachelor's degree in Finance from Iowa State University. Mr. Fredericks is a Fellow of the Life Management Institute (FLMI). CHRISTOPHER IBACH, CFA . Mr. Ibach is an associate portfolio manager and equity research analyst at Principal. He specializes primarily in the analysis of international technology companies, with a particular emphasis on semi-conductor research. Prior to joining Principal in 2000, he gained six years of related industry experience with Motorola, Inc. Mr. Ibach earned an MBA in Finance and a Bachelor's degree in Electrical Engineering from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. DIRK LASCHANZKY, CFA . Mr. Laschanzky is a portfolio manager for Principal, responsible for portfolio implementation strategies, asset allocation and managing the midcap value and index portfolios. Prior to joining Principal in 1997, he was a portfolio manager and analyst for over seven years at AMR Investment Services. He earned an MBA and BA, both in Finance, from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. MARIATERESA MONACO . Ms. Monaco is an portfolio manager at Principal. She serves as portfolio manager for the firm's small-cap growth and index portfiols and as a member of the firm's asset allocation policy group. Prior to joining Principal in 2005, she was a quantitative equity analyst at Fidelity Management and Research supporting a family of institutional equity funds. Ms. Monaco earned an MBA from the Sloan School of Management at the Massachusetts Institute of Technology and a Master's degree in Electrical Engineering from Northeastern University. She also earned a Master's degree in Electrical Engineering from Politecnico di Torino, Italy, and a diploma in Piano from the Conservatorio di Torino, Italy. THOMAS MORABITO, CFA . Mr. Morabito leads the small-cap portfolio management team for Principal and is the portfolio manager on the small-cap value portfolios. Prior to joining Principal in 2000, he managed the Structured Small Cap Fund for Invesco Management & Research. He earned an MBA in Finance from Northeastern University and his BA in Economics from State University of New York. He has earned the right to use the Chartered Financial Analyst designation. K. WILLIAM NOLIN, CFA . Mr. Nolin is a portfolio manager for Principal. He serves as the portfolio manager for the firm's international small-cap equity portfolios. He joined the firm in 1994. He earned an MBA from the Yale School of Management and a Bachelor's degree in Finance from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. JOHN PIHLBLAD, CFA . Mr. Pihlblad is a portfolio manager at Principal. He joined the firm in 2000 and led the development of Principal Global Investors' Global Research Platform. He has over 25 years experience in creating and managing quantitative investment systems. Prior to joining Principal, Mr. Pihlblad was a partner and co-founder of GlobeFlex Capital in San Diego where he was responsible for the development and implementation of the investment process for both domestic and international products. He earned a BA from Westminster College. He has earned the right to use the Chartered Financial Analyst designation. 58 Principal Variable Contracts Fund 1-800-247-4123 TRACY REEG. . Ms. Reeg is a portfolio manager at Principal. She is involved in the portfolio management of money market portfolios. She joined the firm in 1993 and began trading and portfolio management duties in 2000. Ms. Reeg earned a Bachelor's degree in Finance from the University of Northern Iowa. She is a member of the Life Office Management Association (LOMA) and is a Fellow of the Life Management Institute (FLMI). ALICE ROBERTSON . Ms. Robertson is a trader for Principal on the corporate fixed-income trading desk. She joined the Principal Financial Group in 1990 as a credit analyst and moved to her current position in 1993. Previously, Ms. Robertson was an assistant vice president/commercial paper analyst with Duff & Phelps Credit Company. Ms. Robertson earned her Master's degree in Finance and Marketing from DePaul University and her Bachelor's degree in Economics from Northwestern University. MARTIN J. SCHAFER . Mr. Schafer is a portfolio manager for Principal. He specializes in short-term and long duration portfolios, as well as the Inflation Protection Fund and stable value mandates. He also has experience in managing mortgage-backed securities. Mr. Schafer joined the firm in 1977 and in the early 1980s he developed the firm's secondary mortgage marketing operation. In 1984, he assumed portfolio management responsibility for its residential mortgage portfolio. He began managing mutual fund assets in 1985, institutional portfolios in 1992 and stable value portfolios in 2000. He has earned a Bachelor's degree in Accounting and Finance from the University of Iowa. LISA A. STANGE, CFA . Ms. Stange is a portfolio manager and strategist for Principal. She is responsible for managing the government securities portfolios and the mortgage-backed securities (MBS) within the multi-sector portfolios. As a strategies, Ms. Stange is involved in the formulation of broad investment strategy, quantitative research and product development. Previously, she was co-portfolio manager for U.S. multi-sector portfolios. She joined the firm in 1989. Ms. Stange earned an MBA and a Bachelor's degree from the University of Iowa. She has earned the right to use the Chartered Financial Analyst designation. TIMOTHY R. WARRICK, CFA . Mr. Warrick is a portfolio manager at Principal with responsibility for the corporate and U.S. multi-sector portfolios. He also serves as portfolio management team leader with responsibility for overseeing portfolio management function for all total return fixed income products. Prior to his portfolio management responsibilities with the firm, Mr. Warrick was a fixed income credit analyst and extensively involved in product development He joined the firm in 1990. He received an MBA in Finance from Drake University and a Bachelor's degree in Accounting and Economics from Simpson College. He has earned the right to use the Chartered Financial Analyst designation. SUB-ADVISOR: UBS Global Asset Management (Americas) Inc., a Delaware corporation located at One North Wacker, Chicago, IL 60606 ("UBS Global AM"), is a registered investment advisor. UBS Global AM, a subsidiary of UBS AG, is a member of the UBS Global Asset Management business group (the "Group") of UBS AG. As of December 31, 2005, UBS Global AM managed approximately $66.12 billion in assets and the Group managed approximately $581.49 billion in assets.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ SmallCap Growth Paul A. Graham, Jr. David N. Wabnik
PAUL A. GRAHAM, JR., CFA . Mr. Graham joined UBS Global AM in 1994 and has had portfolio management responsibilities since 1994. Mr. Graham is Managing Director, Head of Growth Investors and Co-Head of U.S. Small Cap Growth Equity. For eight years prior to joining the firm, he served as a small cap portfolio manager and research analyst at Value Line Asset Management. Mr. Graham received his BA from Dartmouth College. He has earned the right to use the Chartered Financial Analyst designation and is a member of the New York Society of Security Analysts. DAVID N. WABNIK . Mr. Wabnik joined UBS Global AM in 1995 and has been a portfolio manager since 1995. Mr. Wabnik is Executive Director, Co-Head of U.S. SmallCap Growth Equity. For four years prior to joining the firm, he served as a small cap portfolio manager/senior research analyst at Value Line Asset Management. Mr. Wabnik Principal Variable Contracts Fund 59 www.principal.com received his BS from Binghamton University and his MBA from Columbia Business School. He has completed the Certified Financial Analyst Level I exam. THE SUB-SUB-ADVISORS Principal Global Investors, LLC ("Principal") has entered into sub-sub-advisory agreements for various Accounts. Under these agreements, each sub-sub-advisor has agreed to assume the obligations of Principal for a certain portion of the Account's assets. The sub-sub-advisor is paid a fee by Principal. Principal is the sub-advisor for the Bond Account. Day-to-day management decisions concerning a portion of the Bond Account's portfolio are made by Spectrum Asset Management, Inc. ("Spectrum"), and Post Advisory Group, LLC ("Post") each of which serves as sub-sub-advisor. SUB-ADVISOR: Post Advisory Group, LLC ("Post") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. Post was founded in April 1992. Its address is 11755 Wilshire Boulevard, Los Angeles, CA 90025. As of December 31, 2005, Post had $8.1 billion in asset under management. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account. LAWRENCE A. POST . Mr. Post is a chief executive office and chief investment officer for Post, an affiliate of Principal. He has over 35 years experience in the investment business, including 25 years in the high yield bond market. Prior to founding Post Advisory Group in 1992, he founded the high yield bond department at Smith Barney, and subsequently served as director of high yield research at Salomon Brothers and co-director of research and senior trader at Drexel Burnham Lambert. He earned an MBA in business administration from the University of Pennsylvania's Wharton School of Business and a Bachelor's degree from Lehigh University. ALLAN SCHWEITZER . Mr. Schweitzer is a Managing Director at Post. Prior to joining Post in 2000, he was a senior high yield analyst at Trust Company of the West ("TCW"). Prior to TCW, he was a high yield research analyst at Putnam Investments. Mr. Schweitzer earned a Bachelor's degree in Business Administration from Washington University at St. Louis and a Master's in Business Administration from the University of Chicago with a concentration in analytical finance and international economics. SUB-ADVISOR: Spectrum Asset Management, Inc. ("Spectrum") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. Spectrum was founded in 1987. Its address is 4 High Ridge Park, Stamford, CT 06905. As of December 31, 2005, Spectrum, together with its affiliated asset management companies, had approximately $13.2 billion in asset under management. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account. L. PHILLIP JACOBY. . Mr. Jacoby is Sr. Vice President and Portfolio Manager for Spectrum and chairman of Spectrum's Investment Committee. Prior to joining Spectrum in 1995, he was a senior investment officer as USL Capital Corporation, a subsidiary of Ford Motor Corporate, and co-managed a $600 million preferred stock portfolio. He earned a earned a his BS in Finance from Boston University. 60 Principal Variable Contracts Fund 1-800-247-4123 BERNARD M. SUSSMAN. . Mr. Sussman is Chief Investment Officer of Spectrum and Chair of its Investment Committee. Prior to joining Spectrum in 1995, Mr. Sussman was a general partner and heard of the Preferred Stock area of Goldman Sachs & Co. He was responsible for sales, trading and underwriting for all preferred products and was instrumental in the development of the hybrid (MIPS) market. He earned both an MBA in Finance and a Bachelor's degree in Industrial Relations from Cornell University. DUTIES OF THE MANAGER AND SUB-ADVISOR The Manager or Sub-Advisor provides the Directors of the Fund with a recommended investment program. The program must be consistent with the Account's investment objective and policies. Within the scope of the approved investment program, the Sub-Advisor advises the Account on its investment policy and determines which securities are bought or sold, and in what amounts. FEES PAID TO THE MANAGER The Manager is paid a fee by each Account for its services, which includes any fee paid to the Sub-Advisor. The fee paid by each Account (as a percentage of the average daily net assets) for the fiscal year ended December 31, 2005 was:
Bond 0.45% MidCap Growth 0.90% Capital Value 0.60% MidCap Value 1.05% Diversified International 0.85% Money Market 0.49% Government & High Quality Short-Term Bond Bond 0.44% 0.50% LargeCap Growth Equity 1.00% SmallCap 0.85% LargeCap Stock Index 0.35% SmallCap Growth 1.00% MidCap 0.57%
FEES PAID TO THE SUB-ADVISOR The Sub-Advisor fee paid by each Account (as a percentage of the average daily net assets) for the fiscal year ended December 31, 2005 was:
Bond 0.10% MidCap Growth 0.36% Capital Value 0.14% MidCap Value 0.46% Diversified International 0.10% Money Market 0.07% Government & High Quality Short-Term Bond Bond 0.10% 0.10% LargeCap Growth Equity 0.38% SmallCap 0.19% LargeCap Stock Index 0.01% SmallCap Growth 0.54% MidCap 0.14%
The Fund and the Manager, under an order received from the SEC, may enter into and materially amend agreements with Sub-Advisors, other than those affiliated with the Manager, without obtaining shareholder approval. For any Account that is relying on that order, the Manager may: . hire one or more Sub-Advisors; . change Sub-Advisors; and . reallocate management fees between itself and Sub-Advisors. The Manager will continue to have the ultimate responsibility for the investment performance of these Accounts due to its responsibility to oversee Sub-Advisors and recommend their hiring, termination and replacement. No Account will rely on the order until it receives approval from its shareholders or, in the case of a new Account, the Account's sole initial shareholder before the Account is available to the other purchasers, and the Account states in its prospectus that it intends to rely on the order. Principal Variable Contracts Fund 61 www.principal.com The LargeCap Growth Equity, MidCap Growth, MidCap Value and SmallCap Growth Accounts have received the necessary shareholder approval and intend to rely on the order. 62 Principal Variable Contracts Fund 1-800-247-4123 GENERAL INFORMATION ABOUT AN ACCOUNT FREQUENT TRADING AND MARKET-TIMING (ABUSIVE TRADING PRACTICES) The Accounts of the Principal Variable Contracts Fund are not designed for frequent trading or market timing activity. The Fund has adopted fair valuation procedures to be used in the case of significant events, including broad market movements, occurring after the close of a foreign market in which securities are traded. The procedures will be followed if the Manager believes the events will impact the value of the foreign securities. These procedures are intended to discourage market timing transactions in shares of the Accounts. The Accounts do not knowingly accommodate frequent purchases and redemptions ("excessive trading") of Fund shares by investors. If you intend to trade frequently and/or use market timing investment strategies, do not purchase these Accounts. The Fund does not knowingly accommodate excessive trading. The Principal Variable Contracts Fund considers frequent trading and market timing activities to be abusive trading practices because they may: . Disrupt the management of the Accounts by; . forcing the Account to hold short-term (liquid) assets rather than investing for long term growth, which results in lost investment opportunities for the Account; and . causing unplanned portfolio turnover; . Hurt the portfolio performance of the Account; and . Increase expenses of the Account due to; . increased broker-dealer commissions; and . increased recordkeeping and related costs. If we are not able to identify such excessive trading practices, The Accounts may be negatively impacted and may cause investors to suffer the harms described. Certain Accounts may be at greater risk for abusive trading practices. For example, those Accounts that invest in foreign securities may appeal to investors attempting to take advantage of time-zone arbitrage. This risk is particularly relevant to the Diversified International, International Emerging Markets and International SmallCap Accounts but does apply to the purchase of foreign securities by any Account. As the Accounts of the Principal Variable Contracts Fund are only available through variable annuity or variable life contracts, the Principal Variable Contracts Fund must rely on Principal Life (as sponsor of the variable contract) to monitor customer trading activity to identify and take action against excessive trading. There can be no certainty that Principal Life will identify and prevent excessive trading in all instances. When Principal Life identifies excessive trading, Principal Life will act to curtail such trading in a fair and uniform manner. If Principal Life, or the Principal Variable Contracts Fund, deem excessive trading practices to be occurring, Principal Life will take action that may include, but is not limited to: . Rejecting exchange instructions from shareholder or other person authorized by the shareholder to direct exchanges; . Restricting submission of exchange requests by, for example, allowing exchange requests to be submitted by 1st class U.S. mail only and disallowing requests made via the internet, by facsimile, by overnight courier or by telephone; . Limiting the dollar amount of an exchange and/or the number of exchanges during a year; . Requiring a holding period of a minimum of 30 days before permitting exchanges among the Accounts where there is evidence of at least one round-trip exchange (exchange or redemption of shares that were purchased within 30 days of the exchange/redemption); and . Taking such other action as directed by the Principal Variable Contracts Fund. The Principal Variable Contracts Fund has reserved the right to accept or reject, without prior written notice, any exchange requests. In some instances, an exchange may be completed prior to a determination of abusive trading. In those instances, Principal Life will reverse an exchange (within three business days of the exchange) and return the account holdings to the positions held prior to the exchange. Principal Life will give you notice in writing in this instance. Principal Variable Contracts Fund 63 www.principal.com ELIGIBLE PURCHASERS Only certain eligible purchasers may buy shares of the Accounts. Eligible purchasers are limited to 1) separate accounts of Principal Life or of other insurance companies, 2) Principal Life or any of its subsidiaries or affiliates, 3) trustees of other managers of any qualified profit sharing, incentive or bonus plan established by Principal Life or any of its subsidiaries or affiliates for employees of such company, subsidiary or affiliate. Such trustees or managers may buy Account shares only in their capacities as trustees or managers and not for their personal accounts. The Board of Directors of the Fund reserves the right to broaden or limit the designation of eligible purchaser. Each Account serves as the underlying investment vehicle for variable annuity contracts and variable life insurance policies that are funded through separate accounts established by Principal Life. It is possible that in the future, it may not be advantageous for variable life insurance separate accounts and variable annuity separate accounts to invest in the Accounts at the same time. Although neither Principal Life nor the Fund currently foresees any such disadvantage, the Fund's Board of Directors monitors events in order to identify any material conflicts between such policy owners and contract holders. Material conflict could result from, for example, 1) changes in state insurance laws, 2) changes in Federal income tax law, 3) changes in the investment management of an Account, or 4) differences in voting instructions between those given by policy owners and those given by contract holders. Should it be necessary, the Board would determine what action, if any, should be taken. Such action could include the sale of Account shares by one or more of the separate accounts which could have adverse consequences. SHAREHOLDER RIGHTS The following information applies to each Account of the Principal Variable Contracts Fund, Inc. Each Account share is eligible to vote, either in person or by proxy, at all shareholder meetings for that Account. This includes the right to vote on the election of directors, selection of independent auditors and other matters submitted to meetings of shareholders of the Account. Each share has equal rights with every other share of the Account as to dividends, earnings, voting, assets and redemption. Shares are fully paid, non-assessable and have no preemptive or conversion rights. Shares of an Account are issued as full or fractional shares. Each fractional share has proportionately the same rights including voting as are provided for a full share. Shareholders of the Fund may remove any director with or without cause by the vote of a majority of the votes entitled to be case at a meeting of all Account shareholders. The bylaws of the Fund provide that the Board of Directors of the Fund may increase or decrease the aggregate number of shares that the Fund has the authority to issue, without a shareholder vote. The bylaws of the Fund also provide that the Fund does not need to hold an annual meeting of shareholders unless one of the following is required to be acted upon by shareholders under the Investment Company Act of 1940: election of directors; approval of an investment advisory agreement; ratification of the selection of independent auditors; and approval of the distribution agreement. The Fund intends to hold shareholder meetings only when required by law and at such other times when the Board of Directors deems it to be appropriate. Shareholder inquiries should be directed to: Principal Variable Contracts Fund, Inc., Principal Financial Group, Des Moines, Iowa 50392-2080. NON-CUMULATIVE VOTING The Fund's shares have non-cumulative voting rights. This means that the holders of more than 50% of the shares voting for the election of directors of the Fund can elect 100% of the directors if they choose to do so. In such event, the holders of the remaining shares voting for the election of directors will not be able to elect any directors. Principal Life votes each Account's shares allocated to each of its separate accounts registered under the Investment Company Act of 1940 and attributable to variable annuity contracts or variable life insurance policies participating in the separate accounts. The shares are voted in accordance with instructions received from contract holders, policy owners, participants and annuitants. Other shares of each Account held by each separate account, including shares for which no timely voting instructions are received, are voted in proportion to the instructions that are received with respect to contracts or policies participating that separate account. Shares of each of the Accounts held in the general account of Principal Life or in the unregistered separate accounts are voted in proportion to the instructions that are received with respect to contracts and policies participating in its registered and unregistered separate accounts. If Principal Life determines, under applicable law, that an Account's shares held in one or more separate accounts or in 64 Principal Variable Contracts Fund 1-800-247-4123 its general account need not be voted according to the instructions that are received, it may vote those Account shares in its own right. PURCHASE OF ACCOUNT SHARES Shares are purchased from Princor Financial Services Corporation, the Fund's principal underwriter. There are no sales charges on shares of the Accounts, however, your variable contract may impose a charge. There are no restrictions on amounts to be invested in shares of the Accounts. Shareholder accounts for each Account are maintained under an open account system. Under this system, an account is opened and maintained for each investor. Each investment is confirmed by sending the investor a statement of account showing the current purchase and the total number of shares owned. The statement of account is treated by each Account as evidence of ownership of Account shares. Share certificates are not issued. SALE OF ACCOUNT SHARES This section applies to eligible purchasers other than the separate accounts of Principal Life and its subsidiaries. Each Account sells its shares upon request. There is no charge for the sale. A shareholder sends a written request to the Account requesting the sale of any part or all of the shares. The letter must be signed exactly as the account is registered. If payment is to be made to the registered shareholder or joint shareholder, the Account does not require a signature guarantee. If payment is to be made to another party, the shareholder's signature(s) must be guaranteed by a commercial bank, trust company, credit union, savings and loan association, national securities exchange member or brokerage firm. Shares are redeemed at the net asset value per share next computed after the request is received by the Account in proper and complete form. Sales proceeds are generally sent within three business days after the request is received in proper form. However, the right to sell shares may be suspended during any period when 1) trading on the NYSE is restricted as determined by the SEC or when the NYSE is closed for other than weekends and holidays, or 2) an emergency exists, as determined by the SEC, as a result of which a) disposal by a fund of securities owned by it is not reasonably practicable, b) it is not reasonably practicable for a fund to fairly determine the value of its net assets, or c) the SEC permits suspension for the protection of security holders. If payments are delayed and the instruction is not canceled by the shareholder's written instruction, the amount of the transaction is determined as of the first valuation date following the expiration of the permitted delay. The transaction occurs within five days thereafter. In addition, payments on surrenders attributable to a premium payment made by check may be delayed up to 15 days. This permits payment to be collected on the check. RESTRICTED TRANSFERS Shares of each of the Accounts may be transferred to an eligible purchaser. However, if an Account is requested to transfer shares to other than an eligible purchaser, the Account has the right, at its election, to purchase the shares at the net asset value next calculated after the receipt of the transfer request. However, the Account must give written notification to the transferee(s) of the shares of the election to buy the shares within seven days of the request. Settlement for the shares shall be made within the seven-day period. FINANCIAL STATEMENTS You will receive an annual financial statement for the Fund, audited by the Fund's independent registered public accounting firm, Ernst & Young LLP. That report is a part of this prospectus. You will also receive a semiannual financial statement that is unaudited. FINANCIAL HIGHLIGHTS The following financial highlights tables are intended to help you understand the Fund's financial performance for the periods shown. Certain information reflects results for a single Fund share. The total returns in each table represent the Principal Variable Contracts Fund 65 www.principal.com rate that an investor would have earned or lost each period on an investment in the Fund (assuming reinvestment of all distributions). The financial statements for the Fund were audited by Ernst & Young LLP, whose report, along with the financial statements, is included in the most recent annual report for the Fund. To receive a copy of the latest annual or semiannual report for the Fund, you may telephone 1-800-247-4123. FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- BOND ACCOUNT ------------ Net Asset Value, Beginning of Period.. $12.31 $12.31 $12.32 $11.84 $11.78 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.50 0.51 0.52 0.51 0.56/(c)/ Net Realized and Unrealized Gain (Loss) on Investments......... (0.20) 0.08 0.02 0.54 0.35/(c)/ ----- ---- ---- ---- ---- Total From Investment Operations 0.30 0.59 0.54 1.05 0.91 Less Dividends and Distributions: Dividends from Net Investment Income... (0.57) (0.59) (0.55) (0.57) (0.85) ----- ----- ----- ----- ----- Total Dividends and Distributions (0.57) (0.59) (0.55) (0.57) (0.85) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $12.04 $12.31 $12.31 $12.32 $11.84 ====== ====== ====== ====== ====== Total Return /(a)/ ... 2.50% 4.98% 4.59% 9.26% 8.12% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $338,044 $286,684 $263,435 $232,839 $166,658 Ratio of Expenses to Average Net Assets.. 0.47% 0.47% 0.47% 0.49% 0.50% Ratio of Net Investment Income to Average Net Assets.. 4.21% 4.23% 4.32% 5.02% 5.73%/(c)/ Portfolio Turnover Rate................ 176.2% 143.6% 82.1% 63.3% 146.1% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- CAPITAL VALUE ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $32.39 $29.23 $23.60 $27.78 $30.72 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.54 0.44 0.38 0.39 0.34 Net Realized and Unrealized Gain (Loss) on Investments......... 1.66 3.17 5.63 (4.18) (2.80) ---- ---- ---- ----- ----- Total From Investment Operations 2.20 3.61 6.01 (3.79) (2.46) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.45) (0.38) (0.39) (0.34) Distributions from Realized Gains...... -- -- -- -- (0.14) ----- ----- Total Dividends and Distributions -- (0.45) (0.38) (0.39) (0.48) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $34.59 $32.39 $29.23 $23.60 $27.78 ====== ====== ====== ====== ====== Total Return /(a)/ ... 6.80% 12.36% 25.49% (13.66)% (8.05)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $258,490 $265,580 $248,253 $206,541 $254,484 Ratio of Expenses to Average Net Assets.. 0.61% 0.60% 0.61% 0.61% 0.61% Ratio of Gross Expenses to Average Net Assets.......... -- 0.60%/(b)/ 0.61%/(b)/ 0.61%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.62% 1.47% 1.47% 1.45% 1.20% Portfolio Turnover Rate................ 120.9% 183.3% 125.7% 142.6% 91.7%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. /(c) /Effective January 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies. The effect of this change for the year ended December 31, 2001 was to decrease net investment income per share by $.01, increase net realized and unrealized gains/losses per share by $.01, and decrease the ratio of net investment income to average net assets by .08%. Financial highlights for prior periods have not been restated to reflect this change in presentation. 68 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- DIVERSIFIED INTERNATIONAL ACCOUNT --------------------------------- Net Asset Value, Beginning of Period /(a)/ ............... $13.75 $11.48 $8.78 $10.51 $13.90 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.18 0.17 0.13 0.10 0.09 Net Realized and Unrealized Gain (Loss) on Investments......... 3.05 2.22 2.67 (1.78) (3.46) ---- ---- ---- ----- ----- Total From Investment Operations 3.23 2.39 2.80 (1.68) (3.37) Less Dividends and Distributions: Dividends from Net Investment Income... (0.15) (0.12) (0.10) (0.05) (0.02) ----- ----- ----- ----- ----- Total Dividends and Distributions (0.15) (0.12) (0.10) (0.05) (0.02) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $16.83 $13.75 $11.48 $8.78 $10.51 ====== ====== ====== ===== ====== Total Return /(c)/ ... 23.79% 21.03% 32.33% (16.07)% (24.27)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $293,647 $226,753 $167,726 $119,222 $145,848 Ratio of Expenses to Average Net Assets.. 0.97% 0.96% 0.92% 0.92% 0.92% Ratio of Gross Expenses to Average Net Assets.......... 0.97%/(d)/ 0.97%/(e)/ 0.93%/(e)/ 0.93%/(e)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.27% 1.39% 1.33% 1.03% 0.78% Portfolio Turnover Rate................ 121.2% 170.1% 111.5% 82.2% 84.3% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- GOVERNMENT & HIGH QUALITY BOND ACCOUNT /(B)/ -------------------------------------- Net Asset Value, Beginning of Period.. $11.64 $11.77 $12.00 $11.58 $11.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.44 0.44 0.45 0.43 0.51 Net Realized and Unrealized Gain (Loss) on Investments......... (0.21) (0.04) (0.24) 0.55 0.32 ---- ----- ----- ---- ---- Total From Investment Operations 0.23 0.40 0.21 0.98 0.83 Less Dividends and Distributions: Dividends from Net Investment Income... (0.51) (0.53) (0.44) (0.52) (0.68) Distributions from Realized Gains...... -- -- -- (0.04) -- ---- ----- Total Dividends and Distributions (0.51) (0.53) (0.44) (0.56) (0.68) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $11.36 $11.64 $11.77 $12.00 $11.58 ====== ====== ====== ====== ====== Total Return /(c)/ ... 2.01% 3.56% 1.84% 8.80% 7.61% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $316,047 $334,034 $368,564 $342,001 $193,254 Ratio of Expenses to Average Net Assets.. 0.46% 0.44% 0.44% 0.47% 0.49% Ratio of Net Investment Income to Average Net Assets.. 3.88% 3.82% 3.83% 4.87% 5.63% Portfolio Turnover Rate................ 262.1% 67.2% 110.4% 33.8% 45.9%
/(a) /Effective May 1, 2005, International Account changed its name to Diversified International Account. /(b) /Effective November 19, 2005, Government Securities Account changed its name to Government & High Quality Bond Account. /(c) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(d) /Expense ratio without custodian credits. /(e) /Expense ratio without commission rebates and custodian credits. 69 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- LARGECAP GROWTH EQUITY ACCOUNT ------------------------------ Net Asset Value, Beginning of Period.. $4.60 $4.47 $3.63 $5.44 $7.78 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.01 0.01 -- (0.02) (0.03) Net Realized and Unrealized Gain (Loss) on Investments......... 0.16 0.13 0.84 (1.79) (2.31) ---- ---- ---- ----- ----- Total From Investment Operations 0.17 0.14 0.84 (1.81) (2.34) Less Dividends and Distributions: Dividends from Net Investment Income... (0.01) (0.01) -- -- -- ----- ----- ----- Total Dividends and Distributions (0.01) (0.01) -- -- -- ----- ----- ----- Net Asset Value, End of Period............ $4.76 $4.60 $4.47 $3.63 $5.44 ===== ===== ===== ===== ===== Total Return /(a)/ ... 3.63% 3.16% 23.14% (33.27)% (30.08)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $36,912 $31,179 $24,677 $5,572 $5,172 Ratio of Expenses to Average Net Assets.. 1.09% 1.04% 1.16% 1.05% 1.10% Ratio of Gross Expenses to Average Net Assets /(b)/ ... -- 1.05%/(d)/ 1.19%/(d)/ 1.09%/(d)/ 1.11% Ratio of Net Investment Income to Average Net Assets.. 0.18% 0.28% (0.13)% (0.49)% (0.62)% Portfolio Turnover Rate................ 91.2% 141.8% 51.1% 183.8% 121.2% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- LARGECAP STOCK INDEX ACCOUNT ---------------------------- Net Asset Value, Beginning of Period.. $8.77 $8.06 $6.35 $8.29 $9.52 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.13 0.14 0.10 0.08 0.08 Net Realized and Unrealized Gain (Loss) on Investments......... 0.26 0.70 1.70 (1.94) (1.23) ---- ---- ---- ----- ----- Total From Investment Operations 0.39 0.84 1.80 (1.86) (1.15) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.13) (0.09) (0.08) (0.08) ----- Total Dividends and Distributions -- (0.13) (0.09) (0.08) (0.08) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $9.16 $8.77 $8.06 $6.35 $8.29 ===== ===== ===== ===== ===== Total Return /(a)/ ... 4.47% 10.39% 28.32% (22.44)% (12.10)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $179,143 $158,237 $118,638 $72,949 $73,881 Ratio of Expenses to Average Net Assets.. 0.38% 0.37% 0.39% 0.39% 0.40% Ratio of Gross Expenses to Average Net Assets /(c)/ ... 0.38% 0.37% 0.39% 0.39% 0.41% Ratio of Net Investment Income to Average Net Assets.. 1.52% 1.64% 1.42% 1.22% 1.05% Portfolio Turnover Rate................ 13.1% 20.5% 15.7% 15.1% 10.8%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on May 1, 2002. /(c) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on April 29, 2005. /(d) /Expense ratio without commission rebates. . 73 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MIDCAP ACCOUNT -------------- Net Asset Value, Beginning of Period.. $39.63 $37.56 $28.54 $32.09 $34.47 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.45 0.39 0.35 0.30 0.24 Net Realized and Unrealized Gain (Loss) on Investments......... 3.12 6.05 9.01 (3.08) (1.50) ---- ---- ---- ----- ----- Total From Investment Operations 3.57 6.44 9.36 (2.78) (1.26) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.39) (0.34) (0.30) (0.24) Distributions from Realized Gains...... (0.66) (3.98) -- (0.47) (0.88) ---- ----- ----- ----- ----- Total Dividends and Distributions (0.66) (4.37) (0.34) (0.77) (1.12) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $42.54 $39.63 $37.56 $28.54 $32.09 ====== ====== ====== ====== ====== Total Return /(a)/ ... 9.21% 17.76% 32.81% (8.75)% (3.71)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $420,812 $395,304 $334,204 $248,986 $278,707 Ratio of Expenses to Average Net Assets.. 0.58% 0.59% 0.61% 0.62% 0.62% Ratio of Gross Expenses to Average Net Assets.......... -- 0.59%/(b)/ 0.61%/(b)/ 0.62%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.13% 1.02% 1.09% 0.98% 0.77% Portfolio Turnover Rate................ 49.9% 38.9% 44.9% 67.9% 73.6% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MIDCAP GROWTH ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $9.84 $8.80 $6.26 $8.49 $10.46 Income from Investment Operations: Net Investment Income (Operating Loss).... (0.02) (0.03) (0.03) (0.04) (0.05) Net Realized and Unrealized Gain (Loss) on Investments......... 1.37 1.07 2.57 (2.19) (1.68) ---- ---- ---- ----- ----- Total From Investment Operations 1.35 1.04 2.54 (2.23) (1.73) Less Dividends and Distributions: Distributions from Realized Gains...... -- -- -- -- (0.24) ---- ----- Total Dividends and Distributions -- -- -- -- (0.24) ---- ----- Net Asset Value, End of Period............ $11.19 $9.84 $8.80 $6.26 $8.49 ====== ===== ===== ===== ===== Total Return /(a)/ ... 13.72% 11.82% 40.58% (26.27)% (16.92)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $68,471 $59,674 $54,288 $21,934 $27,838 Ratio of Expenses to Average Net Assets.. 0.92% 0.86% 0.91% 0.91% 0.97% Ratio of Gross Expenses to Average Net Assets.......... -- 0.92%/(b)/ 0.94%/(b)/ 0.92%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. (0.15)% (0.30)% (0.39)% (0.55)% (0.66)% Portfolio Turnover Rate................ 97.0% 47.7% 67.5% 43.1% 55.2%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. 75 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MIDCAP VALUE ACCOUNT -------------------- Net Asset Value, Beginning of Period.. $15.38 $14.13 $10.48 $11.68 $12.57 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.05 0.02 0.01 -- 0.01 Net Realized and Unrealized Gain (Loss) on Investments......... 1.53 3.10 3.81 (1.16) (0.35) ---- ---- ---- ----- ----- Total From Investment Operations 1.58 3.12 3.82 (1.16) (0.34) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.01) (0.01) -- (0.01) Distributions from Realized Gains...... (0.39) (1.86) (0.16) (0.04) (0.54) ----- ----- ----- ----- ----- Total Dividends and Distributions (0.39) (1.87) (0.17) (0.04) (0.55) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $16.57 $15.38 $14.13 $10.48 $11.68 ====== ====== ====== ====== ====== Total Return /(a)/ ... 10.55% 22.67% 36.49% (9.96)% (2.58)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $112,437 $78,166 $52,054 $24,766 $11,778 Ratio of Expenses to Average Net Assets.. 1.07% 1.05% 1.05% 1.04% 1.36% Ratio of Gross Expenses to Average Net Assets.......... -- 1.08%/(b)/ 1.08%/(b)/ 1.10%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.32% 0.11% 0.11% 0.03% 0.12% Portfolio Turnover Rate................ 90.6% 59.2% 55.5% 75.3% 208.8% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MONEY MARKET ACCOUNT -------------------- Net Asset Value, Beginning of Period.. $1.000 $1.000 $1.000 $1.000 $1.000 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.027 0.009 0.007 0.014 0.039 ----- ----- ----- ----- ----- Total From Investment Operations 0.027 0.009 0.007 0.014 0.039 Less Dividends and Distributions: Dividends from Net Investment Income... (0.027) (0.009) (0.007) (0.014) (0.039) ------ ------ ------ ------ ------ Total Dividends and Distributions (0.027) (0.009) (0.007) (0.014) (0.039) ------ ------ ------ ------ ------ Net Asset Value, End of Period............ $1.000 $1.000 $1.000 $1.000 $1.000 ====== ====== ====== ====== ====== Total Return /(a)/ ... 2.69% 0.92% 0.74% 1.42% 3.92% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $150,653 $140,553 $151,545 $201,455 $180,923 Ratio of Expenses to Average Net Assets.. 0.61% 0.49% 0.49% 0.49% 0.50% Ratio of Net Investment Income to Average Net Assets.. 2.66% 0.91% 0.74% 1.40% 3.70%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. 76 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003/(D)/ ---- ---- ---- SHORT-TERM BOND ACCOUNT ----------------------- Net Asset Value, Beginning of Period /(c)/ ............... $10.12 $9.99 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.33 0.25 0.13 Net Realized and Unrealized Gain (Loss) on Investments......... (0.15) (0.12) (0.05) ----- ----- ----- Total From Investment Operations 0.18 0.13 0.08 Less Dividends and Distributions: Dividends from Net Investment Income... (0.19) -- (0.09) ---- ----- ----- Total Dividends and Distributions (0.19) -- (0.09) ---- ----- ----- Net Asset Value, End of Period............ $10.11 $10.12 $9.99 ====== ====== ===== Total Return /(a)/ ... 1.80% 1.30% 0.78%/(e)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $83,822 $56,241 $20,552 Ratio of Expenses to Average Net Assets.. 0.57% 0.53% 0.57%/(f)/ Ratio of Gross Expenses to Average Net Assets/(b)/..... -- -- 0.57%/(f)/ Ratio of Net Investment Income to Average Net Assets.. 3.26% 2.53% 2.15%/(f)/ Portfolio Turnover Rate................ 74.3% 34.8% 5.0%/(f)/ 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- SMALLCAP ACCOUNT ---------------- Net Asset Value, Beginning of Period.. $9.55 $7.97 $5.83 $8.03 $7.83 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.02 -- 0.01 0.01 -- Net Realized and Unrealized Gain (Loss) on Investments......... 0.65 1.58 2.14 (2.20) 0.20 ---- ---- ---- ----- ---- Total From Investment Operations 0.67 1.58 2.15 (2.19) 0.20 Less Dividends and Distributions: Dividends from Net Investment Income... -- -- (0.01) (0.01) -- ---- ----- ----- Total Dividends and Distributions -- -- (0.01) (0.01) -- ---- ----- ----- Net Asset Value, End of Period............ $10.22 $9.55 $7.97 $5.83 $8.03 ====== ===== ===== ===== ===== Total Return /(a)/ ... 7.04% 19.82% 36.82% (27.33)% 2.55% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $94,476 $85,115 $65,285 $32,201 $36,493 Ratio of Expenses to Average Net Assets.. 0.88% 0.86% 0.95% 0.97% 1.00% Ratio of Gross Expenses to Average Net Assets.......... -- 0.86%/(g)/ 0.95%/(g)/ 0.97%/(g)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.17% 0.03% 0.09% 0.12% (0.06)% Portfolio Turnover Rate................ 125.8% 188.7% 162.9% 215.5% 154.5%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on May 1, 2004. /(c) /Effective November 19, 2005, Limited Term Bond Account changed its name to Short-Term Bond Account. /(d) /Period from May 1, 2003, date operations commenced, through December 31, 2003. /(e) /Total return amounts have not been annualized. /(f) /Computed on an annualized basis. /(g) /Expense ratio without commission rebates. 80 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- SMALLCAP GROWTH ACCOUNT ----------------------- Net Asset Value, Beginning of Period.. $9.30 $8.36 $5.74 $10.60 $15.59 Income from Investment Operations: Net Investment Income (Operating Loss).... (0.07) (0.06) (0.04) (0.05) (0.10) Net Realized and Unrealized Gain (Loss) on Investments......... 0.69 1.00 2.66 (4.81) (4.89) ---- ---- ---- ----- ----- Total From Investment Operations 0.62 0.94 2.62 (4.86) (4.99) ---- ---- ---- ----- ----- Net Asset Value, End of Period............ $9.92 $9.30 $8.36 $5.74 $10.60 ===== ===== ===== ===== ====== Total Return /(a)/ ... 6.67% 11.24% 45.64% (45.85)% (32.01)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $66,656 $63,453 $55,628 $32,754 $55,966 Ratio of Expenses to Average Net Assets.. 1.05% 0.99% 0.99% 0.95% 1.05% Ratio of Gross Expenses to Average Net Assets ......... -- 1.01%/(b)/ 1.02%/(b)/ 1.06%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. (0.77)% (0.70)% (0.64)% (0.68)% (0.92)% Portfolio Turnover Rate................ 68.2% 43.3% 54.1% 287.9% 152.2%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. / / 81 ADDITIONAL INFORMATION Additional information about the Fund (including the Fund's policy regarding the disclosure of portfolio securities) is available in the Statement of Additional Information dated May 1, 2006 which is incorporated by reference into this prospectus. Additional information about the Funds' investments is available in the Fund's annual and semiannual reports to shareholders. In the Funds' annual report, you will find a discussion of the market conditions and investment strategies that significantly affected the Funds' performance during the last fiscal year. The Statement of Additional Information and the Fund's annual and semi-annual reports can be obtained free of charge by writing or telephoning Princor Financial Services Corporation, P.O. Box 10423, Des Moines, IA 50306. In addition, the Fund makes its Statement of Additional Information and annual and semi-annual reports available, free of charge, on http:// www.principal.com. To request this and other information about the Fund and to make shareholder inquiries, telephone 1-800-247-4123. Information about the Fund (including the Statement of Additional Information) can be reviewed and copied at the Commission's Public Reference Room in Washington, D.C. Information on the operation of the Public Reference Room may be obtained by calling the Commission at 1-202-942-8090. Reports and other information about the Fund are available on the EDGAR Database on the Commission's internet site at http://www.sec.gov. Copies of this information may be obtained, upon payment of a duplicating fee, by electronic request at the following E-mail address: publicinfo@sec.gov, or by writing the Commission's Public Reference Section, Washington, D.C. 20549-0102. The U.S. government does not insure or guarantee an investment in any of the Accounts. There can be no assurance that the Money Market Account will be able to maintain a stable share price of $1.00 per share. Shares of the Accounts are not deposits or obligations of, or guaranteed or endorsed by, any financial institution, nor are shares of the Accounts federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other agency. Principal Variable Contracts Fund, Inc. SEC File 811-01944 Principal Variable Contracts Fund 67 www.principal.com PRINCIPAL VARIABLE CONTRACTS FUND, INC.
ACCOUNTS OF THE FUND -------------------- BALANCED ACCOUNT GOVERNMENT & HIGH QUALITY BOND ACCOUNT BOND ACCOUNT (previously Government Securities Account) CAPITAL VALUE ACCOUNT GROWTH ACCOUNT DIVERSIFIED INTERNATIONAL MIDCAP ACCOUNT ACCOUNT MONEY MARKET ACCOUNT
This Prospectus describes a mutual fund organized by Principal Life Insurance Company/(R)/ ("Principal Life"). The Fund provides a choice of investment objectives through the Accounts listed above. The date of this Prospectus is May 1, 2006. As with all mutual funds, neither the Securities and Exchange Commission ("SEC") nor any State Securities Commission has approved or disapproved of these securities or determined if this prospectus is accurate or complete. It is a criminal offense to represent otherwise. TABLE OF CONTENTS ACCOUNT DESCRIPTIONS....................................................3 Balanced Account......................................................5 Bond Account..........................................................8 Capital Value Account.................................................12 Diversified International Account.....................................15 Government & High Quality Bond Account (f/k/a Government Securities Account)..................................18 Growth Account........................................................21 MidCap Account........................................................23 Money Market Account..................................................26 CERTAIN INVESTMENT STRATEGIES...........................................29 PRICING OF ACCOUNT SHARES...............................................34 DIVIDENDS AND DISTRIBUTIONS.............................................35 MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE..........................35 The Manager...........................................................35 The Sub-Advisors......................................................35 Duties of the Manager and Sub-Advisors................................39 Fees Paid to the Manager..............................................39 Fees Paid to the Sub-Advisor..........................................39 GENERAL INFORMATION ABOUT AN ACCOUNT....................................40 Frequent Trading and Market-Timing (Abusive Trading Practices)........40 Eligible Purchasers...................................................41 Shareholder Rights....................................................41 Non-Cumulative Voting.................................................41 Purchase of Account Shares............................................42 Sale of Account Shares................................................42 Restricted Transfers..................................................42 Financial Statements..................................................42 FINANCIAL HIGHLIGHTS....................................................42 ADDITIONAL INFORMATION..................................................47 2 Principal Variable Contracts Fund 1-800-247-4123 ACCOUNT DESCRIPTIONS The Principal Variable Contracts Fund (the "Fund") is made up of Accounts. Each Account has its own investment objective. Principal Management Corporation*, the "Manager" of the Fund, has selected a Sub-Advisor for the Accounts based on the Sub-Advisor's experience with the investment strategy for which it was selected. The Manager seeks to provide a wide range of investment approaches through the Fund. The Sub-Advisors are: . Columbus Circle Investors ("CCI") . Principal Global Investors, LLC ("Principal")* * CCI, Principal Management Corporation and Princor Financial Services Corporation ("Princor") are affiliates of Principal Life Insurance Company and with it are subsidiaries of Principal Financial Group, Inc. and members of the Principal Financial Group/(R)/. In the description for each Account, there is important information about the Account's: MAIN STRATEGIES AND RISKS These sections describe each Account's investment objective and summarize how each Account intends to achieve its investment objective. The Board of Directors may change an Account's objective or the investment strategies without a shareholder vote if it determines such a change is in the best interests of the Account. If there is a material change to the Account's investment objective or investment strategies, you should consider whether the Account remains an appropriate investment for you. There is no guarantee that an Account will meet its objective. The sections also describe each Account's primary investment strategies (including the type or types of securities in which the Account invests), any policy of the Account to concentrate in securities of issuers in a particular industry or group of industries and the main risks associated with an investment in the Account. A fuller discussion of risks appears later in the Prospectus under the caption "Certain Investment Strategies and Related Risks." Each Account may invest up to 100% of its assets in cash and cash equivalents for temporary defensive purposes in response to adverse market, economic or political condition as more fully described under the caption "Certain Investment Strategies and Related Risks-Temporary Defensive Measures." Each Account is designed to be a portion of an investor's portfolio. None of the Accounts is intended to be a complete investment program. You should consider the risks of each Account before making an investment and be prepared to maintain the investment during periods of adverse market conditions. INVESTMENT RESULTS A bar chart and a table are included with each Account that has annual returns for a full calendar year. They show the Account's annual returns and its long-term performance. The chart shows how the Account's performance has varied from year-to-year. The table compares the Account's performance over time to that of: . a broad-based securities market index (An index measures the market price of a specific group of securities in a particular market or securities in a market sector. You cannot invest directly in an index. An index does not have an investment advisor and does not pay any commissions or expenses. If an index had expenses, its performance would be lower.); and . an average of mutual funds with a similar investment objective and management style. The averages used are prepared by independent statistical services. An Account's past performance is not necessarily an indication of how the Account will perform in the future. Call the Principal Variable Contracts Funds at 1-800-247-4123 to get the current 7-day yield for the Money Market Account. FEES AND EXPENSES The annual operating expenses for each Account are deducted from that Account's assets. Each Account's operating expenses are shown with the description of the Account and are stated as a percentage of Account assets. A Principal Variable Contracts Fund 3 www.principal.com discussion of fees and expenses appears later in the Prospectus under the caption "The Costs of Investing." The fees and expenses shown do not include the effect of any separate account expenses or other contract level expenses. If such charges were included, overall expenses would be higher and would lower performance. The description of each Account includes examples of the costs associated with investing in the Account. The examples are intended to help you compare the cost of investing in a particular Account with the cost of investing in other mutual funds. The examples assume you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The examples also assume that your investment has a 5% total return each year and that the Account's operating expenses remain the same. Your actual costs of investing in a particular Account may be higher or lower than the costs assumed for purposes of the examples. NOTES: . No salesperson, dealer or other person is authorized to give information or make representations about an Account other than those contained in this Prospectus. Information or representations not contained in this Prospectus may not be relied upon as having been made by the Principal Variable Contracts Funds, an Account, the Manager, any Sub-Advisor or Princor. . Investments in these Accounts are not deposits of a bank and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. 4 Principal Variable Contracts Fund 1-800-247-4123 BALANCED ACCOUNT The Account seeks to generate a total return consisting of current income and capital appreciation. MAIN STRATEGIES The Account seeks growth of capital and current income by investing primarily in common stocks and corporate bonds. It may also invest in other equity securities, government bonds and notes (obligations of the U.S. government or its agencies or instrumentalities) and cash. Though the percentages in each category are not fixed, common stocks generally represent 40% to 70% of the Account's assets. The remainder of the Account's assets is invested in bonds and cash. The Sub-Advisor, Principal, utilizes an asset allocation approach to the management and development of a diversified balanced account. The strategy incorporates a wide range of asset classes and investment styles with primary emphasis placed on equity versus fixed income allocation decisions. Secondary focus is then placed on growth versus value, large cap versus small cap, and domestic versus international equity exposure. Strategic or long-term asset class targets are determined with gradual adjustments to the mix to enhance risk-adjusted results over time. Any asset allocation adjustments fall within a predetermined range and do not deviate by more than 10% of the long-term asset class targets. All marginal shifts in the asset mix are based on a consistent three-dimensional analytical framework. First, securities are reviewed based on price, earnings, and yield measures relative to long-term historical norms. Next, fundamental economic and market conditions are analyzed to identify opportunities, and finally, market trends are used to compare relative price strength and investor sentiment. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. Because the Account invests in both stocks and bonds, the Account may underperform stock funds when stocks are in favor and underperform bond funds when bonds are in favor. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. Risks for this Account include: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade are commonly referred to as "junk bonds" or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.) FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some Principal Variable Contracts Fund 5 www.principal.com investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates. This may increase the volatility of the Account. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 115.3%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking current income as well as long-term growth of capital. 6 Principal Variable Contracts Fund 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"13.13 "1997"17.93 "1998"11.91 "1999"2.4 "2000"0.13 "2001"-6.96 "2002"-13.18 "2003"18.82 "2004"10.05 The Account's highest/lowest quarterly returns "2005"6.79 during this time period were: HIGHEST Q2 '03 9.82% LOWEST Q3 '02 -9.61% LOGO The year-to-date return as of March 31, 2006 is 3.69%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* BALANCED ACCOUNT ..... 6.79 2.44 5.61 8.43 60% S&P 500 Index/40% Lehman Brothers Aggregate Bond Index . 4.01 2.96 8.24 10.52 Morningstar Moderate Allocation Category Average .............. 5.29 2.93 7.35 9.52 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (December 18, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.59% Other Expenses................... 0.05 ---- TOTAL ACCOUNT OPERATING EXPENSES 0.64%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 BALANCED ACCOUNT $65 $205 $357 $798
Principal Variable Contracts Fund 7 www.principal.com BOND ACCOUNT The Account seeks to provide as high a level of income as is consistent with preservation of capital and prudent investment risk. MAIN STRATEGIES Under normal circumstances, the Account invests at least 80% of its assets in intermediate maturity fixed-income or debt securities rated BBB or higher by Standard & Poor's Rating Service ("S&P") or Baa or higher by Moody's Investors Service, Inc. ("Moody's"). The Account considers the term "bond" to mean any debt security. Under normal circumstances, the Account invests in: . securities issued or guaranteed by the U.S. government or its agencies or instrumentalities; . mortgage-backed securities representing an interest in a pool of mortgage loans; . debt securities and taxable municipal bonds rated, at the time of purchase, in one of the top four categories by S&P or Moody's or, if not rated, in the opinion of the Sub-Advisor, Principal, of comparable quality; and . securities issued or guaranteed by the governments of Canada (provincial or federal government) or the United Kingdom payable in U.S. dollars. The rest of the Account's assets may be invested in: . preferred and common stock that may be convertible (may be exchanged for a fixed number of shares of common stock of the same issuer) or may be non-convertible; or . securities rated less than the four highest grades of S&P or Moody's (i.e. less than investment grade (commonly known as "junk bonds")) but not lower than CCC- (S&P) or Caa (Moody's). The Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income. Under a reverse repurchase agreement, the Account sells securities and agrees to repurchase them at a specified date and price. The Account pays interest on this "secured financing" and attempts to make money on the difference between the financing rate and the interest it earns by investing the proceeds of the financing. While a reverse repurchase agreement is outstanding, the Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account may lend its portfolio securities to brokers, dealers and other financial institutions. In connection with such loans, the Account remains the owner of the loaned securities and continues to be entitled to payments in amounts equal to the interest, dividends or other distributions payable on the loaned securities. Loans of portfolio securities may not exceed 33 1/3% of the value of the Account's total assets (including the value of all assets received as collateral for loan). In connection with such loans the Account will receive collateral from the borrower equal to at least 100% of the value of the loaned securities. The Account may actively trade securities in an attempt to achieve its investment objective. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: MUNICIPAL SECURITIES . Principal and interest payments of municipal securities may not be guaranteed by the issuing body and may be payable only from monies derived from a particular source. If the source does not perform as expected, principal and income payments may not be made on time or at all. In addition, the market for municipal securities is often thin and may be temporarily affected by large purchases and sales, including those of the Account. General conditions in the financial markets and the size of a particular offering may also negatively affect the returns of a municipal security. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining 8 Principal Variable Contracts Fund 1-800-247-4123 interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates. This may increase the volatility of the Account. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation maybe chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. REVERSE REPURCHASE AGREEMENTS. . This strategy involves the risk that interest costs on money borrowed may exceed the return on securities purchased with the borrowed money. In addition, reverse repurchase agreements may increase the volatility of the Fund. LENDING OF SECURITIES . If the Account lends its portfolio securities and the borrower of the securities fail financially, the Account may experience delays in recovering the loaned securities or exercising its rights in the collateral. Loans are made only to borrowers that are deemed by the Sub-Advisor to be of good financial standing. PORTFOLIO DURATION . The average portfolio duration of the Account normally varies within a three- to six-year time frame based on Sub-Advisor's forecast for interest rates. Duration is a measure of the expected life of a fixed-income security that is used to determine the sensitivity of a security's price to changes in interest rates. For example, if the portfolio duration of the Account is three years, a change of 1% in the market's yield results in a change of approximately 3% in the value of the Account's securities. The longer a security's duration, the more sensitive it is to changes in interest rates. An Account with a longer average portfolio duration will be more sensitive to changes in interest rates than an Account with a shorter average portfolio duration. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates. When interest rates rise, the value of fixed-income securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of fixed-income securities. Some fixed-income investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.) DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. COMMODITY-LINKED DERIVATIVE INSTRUMENTS . The use of commodity-linked derivative instruments may subject the Account to greater volatility than investments in traditional securities. The value of commodity-linked derivative Principal Variable Contracts Fund 9 www.principal.com instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 176.2%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking diversification by investing in a fixed-income mutual fund. 10 Principal Variable Contracts Fund 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"2.36 "1997"10.6 "1998"7.69 "1999"-2.59 "2000"8.17 "2001"8.12 "2002"9.26 "2003"4.59 "2004"4.98 The Account's highest/lowest quarterly returns "2005"2.5 during this time period were: HIGHEST Q3 '97 4.37% LOWEST Q1 '96-3.24% LOGO The year-to-date return as of March 31, 2006 is -0.55%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* BOND ACCOUNT ......... 2.50 5.86 5.50 7.69 Lehman Brothers Aggregate Bond Index . 2.43 5.87 6.17 7.78 Morningstar Intermediate-Term Bond Category Average...... 1.79 5.32 5.38 7.11 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (December 18, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.45% Other Expenses................... 0.02% ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.47%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 BOND ACCOUNT $48 $151 $263 $591
Principal Variable Contracts Fund 11 www.principal.com CAPITAL VALUE ACCOUNT The Account seeks to provide long-term capital appreciation and secondarily growth of investment income. MAIN STRATEGIES The Account invests primarily in common stock and other equity securities of large capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with large market capitalizations (those with market capitalizations similar to companies in the Russell 1000/(R)// /Value Index (as of March 31, 2006 this range was between approximately $688 million and $387.4 billion) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Up to 25% of Account assets may be invested in foreign securities. The Account invests in stocks that, in the opinion of the Sub-Advisor, Principal, are undervalued in the marketplace at the time of purchase. Value stocks are often characterized by below average price/earnings ratios (P/E) and above average dividend yields relative to the overall market. Securities for the Account are selected by consideration of the quality and price of individual issuers rather than forecasting stock market trends. The selection process focuses on four key elements: . determination that a stock is selling below its fair market value; . early recognition of changes in a company's underlying fundamentals; . evaluation of the sustainability of fundamental changes; and . by monitoring a stock's behavior in the market, evaluation of the timeliness of the investment. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization value stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. 12 Principal Variable Contracts Fund 1-800-247-4123 ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 120.9%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks, but who prefer investing in companies that appear to be considered undervalued relative to similar companies. Principal Variable Contracts Fund 13 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"23.5 "1997"28.53 "1998"13.58 "1999"-4.29 "2000"2.16 "2001"-8.05 "2002"-13.66 "2003"25.49 "2004"12.36 The Account's highest/lowest quarterly returns "2005"6.8 during this time period were: HIGHEST Q2 '03 15.52% LOWEST Q3 '02 -15.10% LOGO The year-to-date return as of March 31, 2006 is 6.07%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT CAPITAL VALUE ACCOUNT 6.80 3.64 7.74 11.92* Russell 1000 Value Index................. 7.05 5.28 10.94 14.32** Morningstar Large Value Category Average 5.88 3.96 8.85 13.21** Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 13, 1970). ** Lifetime results are measured from December 31, 1978 (earliest date for which information is available).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.60% Other Expenses................... 0.01% ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.61%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 CAPITAL VALUE ACCOUNT $62 $195 $340 $762
14 Principal Variable Contracts Fund 1-800-247-4123 DIVERSIFIED INTERNATIONAL ACCOUNT The Account seeks long-term growth of capital by investing in a portfolio of equity securities of companies established outside of the U.S. MAIN STRATEGIES The Account invests in a portfolio of equity securities of companies domiciled in any of the nations of the world. The Account invests in securities of: . companies with their principal place of business or principal office outside the U.S.; . companies for which the principal securities trading market is outside the U.S.; and . companies, regardless of where their securities are traded, that derive 50% or more of their total revenue from goods or services produced or sales made outside the U.S. The Account has no limitation on the percentage of assets that are invested in any one country or denominated in any one currency. However, under normal market conditions, the Account intends to have at least 80% of its assets invested in companies in at least three different countries. One of those countries may be the U.S. though currently the Account does not intend to invest in equity securities of U.S. companies. Investments may be made anywhere in the world. Primary consideration is given to securities of corporations of Western Europe, North America and Australasia (Australia, Japan and Far East Asia). Changes in investments are made as prospects change for particular countries, industries or companies. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. The Account may actively trade securities in an attempt to achieve its investment objective. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as companies in more developed countries. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more Principal Variable Contracts Fund 15 www.principal.com volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 121.2%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital in markets outside of the U.S. who are able to assume the increased risks of higher price volatility and currency fluctuations associated with investments in international stocks which trade in non-U.S. currencies. 16 Principal Variable Contracts Fund 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"25.09 "1997"12.24 "1998"9.98 "1999"25.93 "2000"-8.34 "2001"-24.27 "2002"-16.07 "2003"32.33 "2004"21.03 The Account's highest/lowest quarterly returns "2005"23.79 during this time period were: HIGHEST Q2 '03 17.25% LOWEST Q3 '02 -18.68% LOGO The year-to-date return as of March 31, 2006 is 11.97%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS DIVERSIFIED INTERNATIONAL ACCOUNT. 23.79 4.73 8.43 Citigroup BMI Global ex-US Index/(1)/...... 19.59 8.09 7.79 MSCI EAFE (Europe, Australia, Far East) Index - ND ........... 13.54 4.56 5.84 Morningstar Foreign Large Blend Category Average .............. 14.55 2.93 6.47 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 2, 1994). ** Lifetime results are measured from the Index inception date (December 31, 1994). ///(1)/ This index is now the benchmark against which the Account measures its performance. The Manager and the portfolio manager believe it better represents the universe of investment choices open to the Account under its investment philosophy. The index formerly used is also shown. LIFE OF ACCOUNT* DIVERSIFIED 8.09 INTERNATIONAL ACCOUNT. Citigroup BMI Global 8.02** ex-US Index/(1)/...... MSCI EAFE (Europe, 5.94 Australia, Far East) Index - ND ........... Morningstar Foreign 6.27 Large Blend Category Average .............. Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured f the date the Account was first sold (May 2, 1994). ** Lifetime results are measured the Index inception date (December 31, 1994). ///(1)/ This index is now the benchmark against which the Account measures its performance. The Manager and the portfolio manager believe it better represents the universe of investment choices open to the Account under its investment philosophy. The index formerly used is also shown.
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES
Management Fees.................... 0.85% Other Expenses..................... 0.12 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.97%
(EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005 EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate Principal Variable Contracts Fund 17 www.principal.com account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES -------------------------------------------------------------------------------------------- 1 3 5 10 DIVERSIFIED INTERNATIONAL ACCOUNT $99 $309 $536 $1,190
18 Principal Variable Contracts Fund 1-800-247-4123 GOVERNMENT & HIGH QUALITY BOND ACCOUNT F/K/A GOVERNMENT SECURITIES ACCOUNT The Account seeks a high level of current income, liquidity and safety of principal. MAIN STRATEGIES The Account seeks to achieve its investment objective by investing primarily (at least 80% of its assets) in securities that are issued by the U.S. Government, its agencies or instrumentalities. The Account may invest in mortgage-backed securities representing an interest in a pool of mortgage loans. These securities are rated AAA by Standard & Poor's Corporation or Aaa by Moody's Investor Services, Inc. or, if unrated, determined by the Sub-Advisor, Principal, to be of equivalent quality. The Account relies on the professional judgment of Principal to make decisions about the Account's portfolio securities. The basic investment philosophy of Principal is to seek undervalued securities that represent good long-term investment opportunities. Securities may be sold when Principal believes they no longer represent good long-term value. The Account may also hold cash and cash equivalents. The size of the Account's cash position depends on various factors, including market conditions and purchases and redemptions of Account shares. A large cash position could impact the ability of the Account to achieve its objective but it also would reduce the Account's exposure in the event of a market downturn and provide liquidity to make additional investments or to meet redemptions. The Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income. Under a reverse repurchase agreement, the Account sells securities and agrees to repurchase them at a specified date and price. The Account pays interest on this "secured financing" and attempts to make money on the difference between the financing rate and the interest it earns by investing the proceeds of the financing. While a reverse repurchase agreement is outstanding, the Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account may lend its portfolio securities to brokers, dealers and other financial institutions. In connection with such loans, the Account remains the owner of the loaned securities and continues to be entitled to payments in amounts equal to the interest, dividends or other distributions payable on the loaned securities. Loans of portfolio securities may not exceed 33 1/3% of the value of the Account's total assets (including the value of all assets received as collateral for loan). In connection with such loans the Account will receive collateral from the borrower equal to at least 100% of the value of the loaned securities. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: U.S. GOVERNMENT SECURITIES . U.S. Government securities do not involve the degree of credit risk associated with investments in lower quality fixed-income securities. As a result, the yields available from U.S. Government securities are generally lower than the yields available from many other fixed-income securities. Like other fixed-income securities, the values of U.S. Government securities change as interest rates fluctuate. Fluctuations in the value of the Account's securities do not affect interest income on securities already held by the Account, but are reflected in the Account's price per share. Since the magnitude of these fluctuations generally is greater at times when the Account's average maturity is longer, under certain market conditions the Account may invest in short-term investments yielding lower current income rather than investing in higher yielding longer term securities. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates. When interest rates rise, the value of fixed-income securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of fixed-income securities. Some fixed-income investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. Principal Variable Contracts Fund 19 www.principal.com CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. U.S. GOVERNMENT SPONSORED SECURITIES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. Prepayments, unscheduled principal payments, may result from voluntary prepayment, refinancing or foreclosure of the underlying mortgage. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates and potentially increasing the volatility of the Account. In addition, prepayments may cause losses on securities purchased at a premium (dollar amount by which the price of the bond exceeds its face value). At times, mortgage-backed securities may have higher than market interest rates and are purchased at a premium. Unscheduled prepayments are made at par and cause the Account to experience a loss of some or all of the premium. DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. REVERSE REPURCHASE AGREEMENTS. . This strategy involves the risk that interest costs on money borrowed may exceed the return on securities purchased with the borrowed money. In addition, reverse repurchase agreements may increase the volatility of the Fund. LENDING OF SECURITIES . If the Account lends its portfolio securities and the borrower of the securities fail financially, the Account may experience delays in recovering the loaned securities or exercising its rights in the collateral. The Account lends its securities only to borrowers that the Sub-Advisor determines are creditworthy. PORTFOLIO DURATION . The average portfolio duration of the Account normally varies within a three- to six-year time frame based on Sub-Advisor's forecast for interest rates. Duration is a measure of the expected life of a fixed-income security that is used to determine the sensitivity of a security's price to changes in interest rates. For example, if the portfolio duration of the Account is three years, a change of 1% in the market's yield results in a change of approximately 3% in the value of the Account's securities. The longer a security's duration, the more sensitive it is to changes in interest rates. An Account with a longer average portfolio duration will be more sensitive to changes in interest rates than an Account with a shorter average portfolio duration. 20 Principal Variable Contracts Fund 1-800-247-4123 ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading cost which may have an adverse impact on the Account's performance. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 262.1%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking diversification by investing in a fixed-income mutual fund. Principal Variable Contracts Fund 21 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"3.35 "1997"10.39 "1998"8.27 "1999"-0.29 "2000"11.4 "2001"7.61 "2002"8.8 "2003"1.84 "2004"3.56 The Account's highest/lowest quarterly returns "2005"2.01 during this time period were: HIGHEST Q2 '97 4.52% LOWEST Q1 '96 -1.90% LOGO The year-to-date return as of March 31, 2006 is -0.45%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* GOVERNMENT & HIGH QUALITY BOND ACCOUNT . 2.01 4.72 5.62 7.30 Lehman Brothers Government/Mortgage Index................. 2.63 5.40 6.01 7.56 Morningstar Intermediate Government Category Average .............. 1.90 4.62 5.12 6.67 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (April 9, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.44% Other Expenses................... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.46%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 GOVERNMENT & HIGH QUALITY BOND ACCOUNT $47 $148 $258 $579
22 Principal Variable Contracts Fund 1-800-247-4123 GROWTH ACCOUNT The Account seeks long-term growth of capital through the purchase primarily of common stocks, but the Account may invest in other securities. MAIN STRATEGIES The Account invests primarily in common stocks and other equity securities of large capitalization companies with strong earnings growth potential. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with large market capitalizations (those with market capitalizations similar to companies in the Russell 1000/(R)/ Growth Index (as of March 31, 2006 this range was between approximately $952 million and $368.9 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. The Sub-Advisor, CCI, uses a bottom-up approach (focusing on individual stock selection rather than forecasting stock market trends) in its selection of individual securities that it believes have an above average potential for earnings growth. Selection is based on the premise that companies doing better than expected will have rising securities prices, while companies producing less than expected results will not. CCI refers to its discipline as positive momentum and positive surprise. Through in-depth analysis of company fundamentals in the context of the prevailing economic environment, CCI seeks to select companies that meet the criteria of positive momentum and positive surprise in reported results. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization growth-oriented stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks that may have greater risks than stocks of companies with lower potential for earnings growth. Principal Variable Contracts Fund 23 www.principal.com CCI became the Sub-Advisor to the Account on January 5, 2005. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"12.51 "1997"26.96 "1998"21.36 "1999"16.44 "2000"-10.15 "2001"-25.5 "2002"-29.07 "2003"26.46 "2004"9.38 The Account's highest/lowest quarterly returns "2005"12.09 during this time period were: HIGHESTQ4 '9821.35% LOWEST Q1 '01-23.55% LOGO The year-to-date return as of March 31, 2006 is 4.86%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* GROWTH ACCOUNT ....... 12.09 -3.91 4.04 5.97 Russell 1000 Growth Index................. 5.26 -3.58 6.73 9.27 Morningstar Large Growth Category Average .............. 6.46 -3.36 6.95 9.05 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (May 2, 1994).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.60% Other Expenses................... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.62%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 GROWTH ACCOUNT $63 $199 $346 $774
24 Principal Variable Contracts Fund 1-800-247-4123 MIDCAP ACCOUNT The Account seeks to achieve capital appreciation by investing primarily in securities of emerging and other growth-oriented companies. MAIN STRATEGIES The Account invests primarily in common stocks and other equity securities of medium capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with medium market capitalizations (those with market capitalizations similar to companies in the Russell MidCap/(R)/ Index (as of March 31, 2006, this range was between approximately $688 million and $22.1 billion) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Up to 25% of Account assets may be invested in foreign securities. In selecting securities for investment, the Sub-Advisor, Principal, looks at stocks with value and/or growth characteristics and constructs an investment portfolio that has a "blend" of stocks with these characteristics. In managing the assets of the Account, Principal does not have a policy of preferring one of these categories to the other. The value orientation emphasizes buying stocks at less than their inherent value and avoiding stocks whose price has been artificially built up. The growth orientation emphasizes buying stocks of companies whose potential for growth of capital and earnings is expected to be above average. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. MAIN RISKS The Account is subject to the risk that its principal market segment, medium capitalization stocks, may underperform compared to other market segments or to the equity markets as a whole. Because different types of stocks tend to shift in and out of favor depending on market and economic conditions, the Account's performance may sometimes be lower or higher than that of other types of funds. The value of the Account's equity securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. Principal Variable Contracts Fund 25 www.principal.com MEDIUM CAPITALIZATIONS . Companies with medium capitalizations may have a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the potential for short-term fluctuations in the value of investments. 26 Principal Variable Contracts Fund 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"21.11 "1997"22.75 "1998"3.69 "1999"13.04 "2000"14.59 "2001"-3.71 "2002"-8.75 "2003"32.81 "2004"17.76 The Account's highest/lowest quarterly returns "2005"9.21 during this time period were: HIGHESTQ4 '9923.31% LOWEST Q3 '98-20.01% LOGO The year-to-date return as of March 31, 2006 is 4.55%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* MIDCAP ACCOUNT ....... 9.21 8.46 11.60 14.11 Russell Midcap Index . 12.65 8.45 12.49 14.57 Morningstar Mid-Cap Blend Category Average 9.21 8.14 11.74 14.12 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (December 18, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.57% Other Expenses................... 0.01 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.58%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MIDCAP ACCOUNT $59 $186 $324 $726
Principal Variable Contracts Fund 27 www.principal.com MONEY MARKET ACCOUNT The Account has an investment objective of as high a level of current income available from investments in short-term securities as is consistent with preservation of principal and maintenance of liquidity. MAIN STRATEGIES The Account invests its assets in a portfolio of high quality, short-term money market instruments. The investments are U.S. dollar denominated securities which the Sub-Advisor, Principal, believes present minimal credit risks. At the time the Account purchases each security, it is an "eligible security" as defined in the regulations issued under the Investment Company Act of 1940, as amended. The Account maintains a dollar weighted average portfolio maturity of 90 days or less. It intends to hold its investments until maturity. However, the Account may sell a security before it matures: . to take advantage of market variations; . to generate cash to cover sales of Account shares by its shareholders; or . upon revised credit opinions of the security's issuer. The sale of a security by the Account before maturity may not be in the best interest of the Account. The sale of portfolio securities is usually a taxable event. The Account does have an ability to borrow money to cover the redemption of Account shares. It is the policy of the Account to be as fully invested as possible to maximize current income. Securities in which the Account invests include: . securities issued or guaranteed by the U.S. government, including treasury bills, notes and bonds; . securities issued or guaranteed by agencies or instrumentalities of the U.S. government. These are backed either by the full faith and credit of the U.S. government or by the credit of the particular agency or instrumentality; . bank obligations including: . certificates of deposit which generally are negotiable certificates against funds deposited in a commercial bank; or . bankers acceptances which are time drafts drawn on a commercial bank, usually in connection with international commercial transactions. . commercial paper which is short-term promissory notes issued by U.S. or foreign corporations primarily to finance short-term credit needs; . corporate debt consisting of notes, bonds or debentures which at the time of purchase by the Account has 397 days or less remaining to maturity; . repurchase agreements under which securities are purchased with an agreement by the seller to repurchase the security at the same price plus interest at a specified rate. Generally these have a short maturity (less than a week) but may also have a longer maturity; and . taxable municipal obligations which are short-term obligations issued or guaranteed by state and municipal issuers which generate taxable income. Among the certificates of deposit typically held by the Account are Eurodollar and Yankee obligations which are issued in U.S. dollars by foreign banks and foreign branches of U.S. banks. Before the Sub-Advisor selects a Eurodollar or Yankee obligation, however, the foreign issuer undergoes the same credit-quality analysis and tests of financial strength as an issuer of domestic securities. MAIN RISKS As with all mutual funds, the value of the Account's assets may rise or fall. Although the Account seeks to preserve the value of an investment at $1.00 per share, it is possible to lose money by investing in the Account. An investment in the Account is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. As with any security, the securities in which the Account invests have associated risks. These include risks of: CREDIT RISK . Credit risk pertains to the issuer's ability to make scheduled principal or interest payments. This may reduce the Account's stream of income and decrease the Account's yield. 28 Principal Variable Contracts Fund 1-800-247-4123 INTEREST RATE RISK . The value of the Account's shares is directly impacted by trends in interest rates. If interest rates rise, the value of debt securities generally will fall. REPURCHASE AGREEMENTS . The Account may invest in repurchase agreements with commercial banks, brokers and dealers considered by the Sub-Advisor to be creditworthy. Default or insolvency of the other party is a potential risk to the Account. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in securities issued by government-sponsored enterprises. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. EURODOLLAR AND YANKEE OBLIGATIONS . Eurodollar and Yankee obligations have risks similar to U.S. money market instruments, such as income risk and credit risk. Other risks of Eurodollar and Yankee obligations include the possibilities that: a foreign government will not let U.S. dollar-denominated assets leave the country; the banks that issue Eurodollar obligations may not be subject to the same regulations as U.S. banks; and adverse political or economic developments will affect investments in a foreign country. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking monthly dividends without incurring much principal risk. Principal Variable Contracts Fund 29 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"5.07 "1997"5.04 "1998"5.2 "1999"4.84 "2000"6.07 "2001"3.92 "2002"1.42 "2003"0.74 "2004"0.92 "2005"2.69 TO OBTAIN THE ACCOUNT'S CURRENT YIELD INFORMATION, PLEASE CALL 1-800-247-4123 LOGO The year-to-date return as of March 31, 2006 is 1.00%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* Money Market Account . 2.69 1.93 3.60 3.15 *Lifetime results are measured from the date the Account was first sold (March 18, 1983).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.49% Other Expenses................... 0.12 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.61%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MONEY MARKET ACCOUNT $62 $195 $340 $762
30 Principal Variable Contracts Fund 1-800-247-4123 CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS The Statement of Additional Information (SAI) contains additional information about investment strategies and their related risks. SECURITIES AND INVESTMENT PRACTICES MARKET VOLATILITY . Equity securities include common stocks, preferred stocks, convertible securities, depositary receipts, rights and warrants. Common stocks, the most familiar type, represent an equity (ownership) interest in a corporation. The value of a company's stock may fall as a result of factors directly relating to that company, such as decisions made by its management or lower demand for the company's products or services. A stock's value may also fall because of factors affecting not just the company, but also companies in the same industry or in a number of different industries, such as increases in production costs. The value of a company's stock may also be affected by changes in financial markets that are relatively unrelated to the company or its industry, such as changes in interest rates or currency exchange rates. In addition, a company's stock generally pays dividends only after the company invests in its own business and makes required payments to holders of its bonds and other debt. For this reason, the value of a company's stock will usually react more strongly than its bonds and other debt to actual or perceived changes in the company's financial condition or prospects. Stocks of smaller companies may be more vulnerable to adverse developments than those of larger companies. Fixed-income securities include bonds and other debt instruments that are used by issuers to borrow money from investors. The issuer generally pays the investor a fixed, variable or floating rate of interest. The amount borrowed must be repaid at maturity. Some debt securities, such as zero coupon bonds, do not pay current interest, but are sold at a discount from their face values. INTEREST RATE CHANGES . Fixed-income securities are sensitive to changes in interest rates. In general, fixed-income security prices rise when interest rates fall and fall when interest rates rise. Longer term bonds and zero coupon bonds are generally more sensitive to interest rate changes. CREDIT RISK . Fixed-income security prices are also affected by the credit quality of the issuer. Investment grade debt securities are medium and high quality securities. Some bonds, such as lower grade or "junk" bonds, may have speculative characteristics and may be particularly sensitive to economic conditions and the financial condition of the issuers. REPURCHASE AGREEMENTS AND LOANED SECURITIES Although not a principal investment strategy, each of the Accounts may invest a portion of its assets in repurchase agreements. Repurchase agreements typically involve the purchase of debt securities from a financial institution such as a bank, savings and loan association or broker-dealer. A repurchase agreement provides that the Account sells back to the seller and that the seller repurchases the underlying securities at a specified price on a specific date. Repurchase agreements may be viewed as loans by an Account collateralized by the underlying securities. This arrangement results in a fixed rate of return that is not subject to market fluctuation while the Account holds the security. In the event of a default or bankruptcy by a selling financial institution, the affected Account bears a risk of loss. To minimize such risks, the Account enters into repurchase agreements only with large, well-capitalized and well-established financial institutions. In addition, the value of the securities collateralizing the repurchase agreement is, and during the entire term of the repurchase agreement remains, at least equal to the repurchase price, including accrued interest. Each of the Accounts may lend its portfolio securities to unaffiliated broker-dealers and other unaffiliated qualified financial institutions. REVERSE REPURCHASE AGREEMENTS An Account may use reverse repurchase agreements to obtain cash to satisfy unusually heavy redemption requests or for other temporary or emergency purposes without the necessity of selling portfolio securities, or to earn additional income on portfolio securities, such as Treasury bills or notes. In a reverse repurchase agreement, an Account sells a portfolio security to another party, such as a bank or broker-dealer, in return for cash and agrees to repurchase the instrument at a particular price and time. While a reverse repurchase agreement is outstanding, an Account will Principal Variable Contracts Fund 31 www.principal.com maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account will enter into reverse repurchase agreements only with parties that the Sub-Advisor deems creditworthy. Using reverse repurchase agreements to earn additional income involves the risk that the interest earned on the invested proceeds is less than the expense of the reverse repurchase agreement transaction. This technique may also have a leveraging effect on the Account, although the Account's intent to segregate assets in the amount of the repurchase agreement minimizes this effect. CURRENCY CONTRACTS The Accounts may enter into currency contracts, currency futures contracts and options, and options on currencies for hedging and other purposes. A forward currency contract involves a privately negotiated obligation to purchase or sell a specific currency at a future date at a price set in the contract. An Account will not hedge currency exposure to an extent greater than the aggregate market value of the securities held or to be purchased by the Account (denominated or generally quoted or currently convertible into the currency). Hedging is a technique used in an attempt to reduce risk. If an Account's Sub-Advisor hedges market conditions incorrectly or employs a strategy that does not correlate well with the Account's investment, these techniques could result in a loss. These techniques may increase the volatility of an Account and may involve a small investment of cash relative to the magnitude of the risk assumed. In addition, these techniques could result in a loss if the other party to the transaction does not perform as promised. There is also a risk of government action through exchange controls that would restrict the ability of the Account to deliver or receive currency. FORWARD COMMITMENTS Although not a principal investment strategy, each of the Accounts may enter into forward commitment agreements. These agreements call for the Account to purchase or sell a security on a future date at a fixed price. Each of the Accounts may also enter into contracts to sell its investments either on demand or at a specific interval. WARRANTS Each of the Accounts may invest in warrants though none of the Accounts use such investments as a principal investment strategy. A warrant is a certificate granting its owner the right to purchase securities from the issuer at a specified price, normally higher than the current market price. HIGH YIELD SECURITIES The Balanced and Bond Accounts may invest in debt securities rated lower than BBB by S&P or Baa by Moody's or, if not rated, determined to be of equivalent quality by the Manager or the Sub-Advisor. Such securities are sometimes referred to as high yield or "junk bonds" and are considered speculative. Investment in high yield bonds involves special risks in addition to the risks associated with investment in highly rated debt securities. High yield bonds may be regarded as predominantly speculative with respect to the issuer's continuing ability to meet principal and interest payments. Moreover, such securities may, under certain circumstances, be less liquid than higher rated debt securities. Analysis of the creditworthiness of issuers of high yield securities may be more complex than for issuers of higher quality debt securities. The ability of an Account to achieve its investment objective may, to the extent of its investment in high yield bonds, be more dependent on such credit analysis than would be the case if the Account were investing in higher quality bonds. High yield bonds may be more susceptible to real or perceived adverse economic and competitive industry conditions than higher-grade bonds. The prices of high yield bonds have been found to be less sensitive to interest rate changes than more highly rated investments, but more sensitive to adverse economic downturns or individual corporate developments. If the issuer of high yield bonds defaults, an Account may incur additional expenses to seek recovery. The secondary market on which high yield bonds are traded may be less liquid than the market for higher-grade bonds. Less liquidity in the secondary trading market could adversely affect the price at which an Account could sell a high yield bond and could adversely affect and cause large fluctuations in the daily price of the Account's shares. Adverse 32 Principal Variable Contracts Fund 1-800-247-4123 publicity and investor perceptions, whether or not based on fundamental analysis, may decrease the value and liquidity of high yield bonds, especially in a thinly traded market. The use of credit ratings for evaluating high yield bonds also involves certain risks. For example, credit ratings evaluate the safety of principal and interest payments, not the market value risk of high yield bonds. Also, credit rating agencies may fail to change credit ratings in a timely manner to reflect subsequent events. If a credit rating agency changes the rating of a portfolio security held by an Account, the Account may retain the security if the Manager or Sub-Advisor thinks it is in the best interest of shareholders. INITIAL PUBLIC OFFERINGS ("IPOS") Certain of the Accounts may invest in IPOs. An IPO is a company's first offering of stock to the public. IPO risk is that the market value of IPO shares will fluctuate considerably due to factors such as the absence of a prior public market, unseasoned trading, the small number of shares available for trading and limited information about the issuer. The purchase of IPO shares may involve high transaction costs. IPO shares are subject to market risk and liquidity risk. In addition, the market for IPO shares can be speculative and/or inactive for extended periods of time. The limited number of shares available for trading in some IPOs may make it more difficult for an Account to buy or sell significant amounts of shares without an unfavorable impact on prevailing prices. Investors in IPO shares can be affected by substantial dilution in the value of their shares by sales of additional shares and by concentration of control in existing management and principal shareholders. When an Account's asset base is small, a significant portion of the Account's performance could be attributable to investments in IPOs because such investments would have a magnified impact on the Account. As the Account's assets grow, the effect of the Account's investments in IPOs on the Account's performance probably will decline, which could reduce the Account's performance. Because of the price volatility of IPO shares, an Account may choose to hold IPO shares for a very short period of time. This may increase the turnover of the Account's portfolio and lead to increased expenses to the Account, such as commissions and transaction costs. By selling IPO shares, the Account may realize taxable gains it will subsequently distribute to shareholders. DERIVATIVES To the extent permitted by its investment objectives and policies, each of the Accounts (except Money Market) may invest in securities that are commonly referred to as derivative securities. Generally, a derivative is a financial arrangement, the value of which is derived from, or based on, a traditional security, asset, or market index. Certain derivative securities are described more accurately as index/structured securities. Index/structured securities are derivative securities whose value or performance is linked to other equity securities (such as depositary receipts), currencies, interest rates, indices or other financial indicators (reference indices). Some derivatives, such as mortgage-related and other asset-backed securities, are in many respects like any other investment, although they may be more volatile or less liquid than more traditional debt securities. There are many different types of derivatives and many different ways to use them. Futures and options are commonly used for traditional hedging purposes to attempt to protect an Account from exposure to changing interest rates, securities prices, or currency exchange rates and for cash management purposes as a low-cost method of gaining exposure to a particular securities market without investing directly in those securities. The Accounts may enter into put or call options, future contracts, options on futures contracts and over-the-counter swap contracts (e.g., interest rate swaps, total return swaps and credit default swaps) for both hedging and non-hedging purposes. Generally, no Account may invest in a derivative security unless the reference index or the instrument to which it relates is an eligible investment for the Account. The return on a derivative security may increase or decrease, depending upon changes in the reference index or instrument to which it relates. The risks associated with derivative investments include: . the risk that the underlying security, interest rate, market index or other financial asset will not move in the direction the Manager or Sub-Advisor anticipated; . the possibility that there may be no liquid secondary market which may make it difficult or impossible to close out a position when desired; Principal Variable Contracts Fund 33 www.principal.com . the risk that adverse price movements in an instrument can result in a loss substantially greater than an Account's initial investment; and . the counterparty may fail to perform its obligations. EXCHANGE TRADED FUNDS (ETFS) These are a type of index fund bought and sold on a securities exchange. An ETF trades like common stock and represents a fixed portfolio of securities designed to track a particular market index. The Accounts could purchase shares issued by an ETF to temporarily gain exposure to a portion of the U.S. or a foreign market while awaiting purchase of underlying securities. The risks of owning an ETF generally reflect the risks of owning the underlying securities they are designed to track, although ETFs have management fees that increase their costs. CONVERTIBLE SECURITIES Convertible securities are fixed-income securities that an Account has the right to exchange for equity securities at a specified conversion price. The option allows the Account to realize additional returns if the market price of the equity securities exceeds the conversion price. For example, the Account may hold fixed-income securities that are convertible into shares of common stock at a conversion price of $10 per share. If the market value of the shares of common stock reached $12, the Account could realize an additional $2 per share by converting its fixed-income securities. Convertible securities have lower yields than comparable fixed-income securities. In addition, at the time a convertible security is issued the conversion price exceeds the market value of the underlying equity securities. Thus, convertible securities may provide lower returns than non-convertible fixed-income securities or equity securities depending upon changes in the price of the underlying equity securities. However, convertible securities permit the Account to realize some of the potential appreciation of the underlying equity securities with less risk of losing its initial investment. The Accounts treat convertible securities as both fixed-income and equity securities for purposes of investment policies and limitations because of their unique characteristics. The Accounts may invest in convertible securities without regard to their ratings. FOREIGN INVESTING As a principal investment strategy, the Diversified International Account may invest Account assets in securities of foreign companies. The other Accounts (except Government & High Quality Bond) may invest in securities of foreign companies but not as a principal investment strategy. For the purpose of this restriction, foreign companies are: . companies with their principal place of business or principal office outside the U.S.; and . companies for which the principal securities trading market is outside the U.S. Foreign companies may not be subject to the same uniform accounting, auditing and financial reporting practices as are required of U.S. companies. In addition, there may be less publicly available information about a foreign company than about a U.S. company. Securities of many foreign companies are less liquid and more volatile than securities of comparable U.S. companies. Commissions on foreign securities exchanges may be generally higher than those on U.S. exchanges, although each Account seeks the most favorable net results on its portfolio transactions. Foreign markets also have different clearance and settlement procedures than those in U.S. markets. In certain markets there have been times when settlements have been unable to keep pace with the volume of securities transactions, making it difficult to conduct these transactions. Delays in settlement could result in temporary periods when a portion of Account assets is not invested and earning no return. If an Account is unable to make intended security purchases due to settlement problems, the Account may miss attractive investment opportunities. In addition, an Account may incur a loss as a result of a decline in the value of its portfolio if it is unable to sell a security. With respect to certain foreign countries, there is the possibility of expropriation or confiscatory taxation, political or social instability, or diplomatic developments that could affect an Account's investments in those countries. In addition, an Account may also suffer losses due to nationalization, expropriation or differing accounting practices and treatments. Investments in foreign securities are subject to laws of the foreign country that may limit the amount and types of foreign investments. Changes of governments or of economic or monetary policies, in the U.S. or abroad, changes in dealings between nations, currency convertibility or exchange rates could result in investment losses for an 34 Principal Variable Contracts Fund 1-800-247-4123 Account. Finally, even though certain currencies may be convertible into U.S. dollars, the conversion rates may be artificial relative to the actual market values and may be unfavorable to Account investors. Foreign securities are often traded with less frequency and volume, and therefore may have greater price volatility, than is the case with many U.S. securities. Brokerage commissions, custodial services, and other costs relating to investment in foreign countries are generally more expensive than in the U.S. Though the Accounts intend to acquire the securities of foreign issuers where there are public trading markets, economic or political turmoil in a country in which an Account has a significant portion of its assets or deterioration of the relationship between the U.S. and a foreign country may negatively impact the liquidity of an Account's portfolio. An Account may have difficulty meeting a large number of redemption requests. Furthermore, there may be difficulties in obtaining or enforcing judgments against foreign issuers. An Account may choose to invest in a foreign company by purchasing depositary receipts. Depositary receipts are certificates of ownership of shares in a foreign-based issuer held by a bank or other financial institution. They are alternatives to purchasing the underlying security but are subject to the foreign securities to which they relate. Investments in companies of developing countries may be subject to higher risks than investments in companies in more developed countries. These risks include: . increased social, political and economic instability; . a smaller market for these securities and low or nonexistent volume of trading that results in a lack of liquidity and in greater price volatility; . lack of publicly available information, including reports of payments of dividends or interest on outstanding securities; . foreign government policies that may restrict opportunities, including restrictions on investment in issuers or industries deemed sensitive to national interests; . relatively new capital market structure or market-oriented economy; . the possibility that recent favorable economic developments may be slowed or reversed by unanticipated political or social events in these countries; . restrictions that may make it difficult or impossible for the Account to vote proxies, exercise shareholder rights, pursue legal remedies, and obtain judgments in foreign courts; and . possible losses through the holding of securities in domestic and foreign custodial banks and depositories. In addition, many developing countries have experienced substantial, and in some periods, extremely high rates of inflation for many years. Inflation and rapid fluctuations in inflation rates have had and may continue to have negative effects on the economies and securities markets of those countries. Repatriation of investment income, capital and proceeds of sales by foreign investors may require governmental registration and/or approval in some developing countries. An Account could be adversely affected by delays in or a refusal to grant any required governmental registration or approval for repatriation. Further, the economies of developing countries generally are heavily dependent upon international trade and, accordingly, have been and may continue to be adversely affected by trade barriers, exchange controls, managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries with which they trade. SMALL AND MEDIUM CAPITALIZATION COMPANIES The Accounts (except Bond, Government & High Quality Bond, and Money Market) may invest in securities of companies with small- or mid-sized market capitalizations. The Capital Value Account may hold securities of small and medium capitalization companies but not as a principal investment strategy. Market capitalization is defined as total current market value of a company's outstanding common stock. Investments in companies with smaller market capitalizations may involve greater risks and price volatility (wide, rapid fluctuations) than investments in larger, more mature companies. Small companies may be less significant within their industries and may be at a competitive disadvantage relative to their larger competitors. While smaller companies may be subject to these additional risks, they may also realize more substantial growth than larger or more established companies. Principal Variable Contracts Fund 35 www.principal.com Smaller companies may be less mature than larger companies. At this earlier stage of development, the companies may have limited product lines, reduced market liquidity for their shares, limited financial resources or less depth in management than larger or more established companies. Unseasoned issuers are companies with a record of less than three years continuous operation, including the operation of predecessors and parents. Unseasoned issuers by their nature have only a limited operating history that can be used for evaluating the company's growth prospects. As a result, investment decisions for these securities may place a greater emphasis on current or planned product lines and the reputation and experience of the company's management and less emphasis on fundamental valuation factors than would be the case for more mature growth companies. TEMPORARY DEFENSIVE MEASURES From time to time, as part of its investment strategy, each Account (other than the Money Market Account which may invest in high quality money market securities at any time) may invest without limit in cash and cash equivalents for temporary defensive purposes in response to adverse market, economic or political conditions. To the extent that the Account is in a defensive position, it may lose the benefit of upswings and limit its ability to meet its investment objective. For this purpose, cash equivalents include: bank notes, bank certificates of deposit, bankers' acceptances, repurchase agreements, commercial paper, and commercial paper master notes which are floating rate debt instruments without a fixed maturity. In addition, an Account may purchase U.S. government securities, preferred stocks and debt securities, whether or not convertible into or carrying rights for common stock. PORTFOLIO TURNOVER "Portfolio Turnover" is the term used in the industry for measuring the amount of trading that occurs in an Account's portfolio during the year. For example, a 100% turnover rate means that on average every security in the portfolio has been replaced once during the year. Accounts with high turnover rates (more than 100%) often have higher transaction costs (which are paid by the Account) and may have an adverse impact on the Account's performance. No turnover rate can be calculated for the Money Market Account because of the short maturities of the securities in which it invests. Turnover rates for each of the other Accounts may be found in the Account's Financial Highlights table. Please consider all the factors when you compare the turnover rates of different funds. A fund with consistently higher total returns and higher turnover rates than another fund may actually be achieving better performance precisely because the managers are active traders. You should also be aware that the "total return" line in the Financial Highlights section already includes portfolio turnover costs. PRICING OF ACCOUNT SHARES Each Account's shares are bought and sold at the current share price. The share price of each Account is calculated each day the New York Stock Exchange ("NYSE") is open (shares are not priced on the days on which the NYSE is closed for trading). The share price is determined at the close of business of the NYSE (normally 3:00 p.m. Central time). When an order to buy or sell shares is received, the share price used to fill the order is the next price calculated after the order is received. For all Accounts, except the Money Market Account, the share price is calculated by: . taking the current market value of the total assets of the Account . subtracting liabilities of the Account . dividing the remainder by the total number of shares owned by the Account. The securities of the Money Market Account are valued at amortized cost. The calculation procedure is described in the SAI. The Money Market Account reserves the right to determine a share price more than once each day. NOTES: . If current market values are not readily available for a security owned by an Account, its fair value is determined using a policy adopted by the Directors. 36 Principal Variable Contracts Fund 1-800-247-4123 . An Account's securities may be traded on foreign securities markets that generally complete trading at various times during the day prior to the close of the NYSE. Generally, the values of foreign securities used in computing a Fund's NAV are determined at the time the foreign market closes. Foreign securities and currencies are converted to U.S. dollars using the exchange rate in effect at the close of the London Exchange (generally 11:00 a.m. Eastern Time). Occasionally, events affecting the value of foreign securities occur when the foreign market is closed and the NYSE is open. The Account has adopted policies and procedures to "fair value" some or all securities held by an Account if significant events occur after the close of the market on which the foreign securities are traded but before the Account's NAV is calculated. Significant events can be specific to a single security or can include events that affect a particular foreign market or markets. A significant event can also include a general market movement in the U.S. securities markets. If the Manager believes that the market value of any or all of the foreign securities is materially affected by such an event, the securities will be valued, and the Account's NAV will be calculated, using the policy adopted by the Account. These fair valuation procedures are intended to discourage shareholders from investing in the Account for the purpose of engaging in market timing or arbitrage transactions. The trading of foreign securities generally or in a particular country or countries may not take place on all days the NYSE is open, or may trade on days the NYSE is closed. Thus, the value of the foreign securities held by the Account may change on days when shareholders are unable to purchase or redeem shares. . Certain securities issued by companies in emerging market countries may have more than one quoted valuation at any point in time. These may be referred to as local price and premium price. The premium price is often a negotiated price that may not consistently represent a price at which a specific transaction can be effected. The Fund has a policy to value such securities at a price at which the Sub-Advisor expects the securities may be sold. DIVIDENDS AND DISTRIBUTIONS The Accounts earn dividends, interest and other income from investments and distribute this income (less expenses) as dividends. The Accounts also realize capital gains from investments and distribute these gains (less any losses) as capital gain distributions. The Accounts normally make dividends and capital gain distributions at least annually, in February. Dividends and capital gain distributions are automatically reinvested in additional shares of the Account making the distribution. MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE THE MANAGER Principal Management Corporation serves as the manager for the Fund. In its handling of the business affairs of the Fund, the Manager provides clerical, recordkeeping and bookkeeping services, and keeps the required financial and accounting records. THE SUB-ADVISORS The Manager has signed a contract with a Sub-Advisor under which the Sub-Advisor agrees to assume the obligations of the Manager to provide investment advisory service for the Account. For these services, the Sub-Advisor is paid a fee by the Manager. Information regarding Sub-Advisors and individual portfolio managers is set forth below. The Statement of Additional Information provides additional information about each portfolio manager's compensation, other accounts managed by the portfolio manager and the portfolio manager's ownership of securities in the Account. MANAGER: The Manager is an indirect subsidiary of Principal Financial Services, Inc. and has managed mutual funds since 1969. As of December 31, 2005, the mutual funds it manages had assets of approximately $28.6 billion. The Manager's address is Principal Financial Group, Des Moines, Iowa 50392-2080. SUB-ADVISOR: Columbus Circle Investors ("CCI") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. CCI was founded in 1975. Its address is Metro Center, One Station Place, Principal Variable Contracts Fund 37 www.principal.com Stamford, CT 06902. As of December 31, 2005, CCI had approximately $5.9 billion in assets under management.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Growth Anthony Rizza
ANTHONY RIZZA, CFA . Mr. Rizza, portfolio manager, joined CCI in 1991. He received a BS in Business from the University of Connecticut. Mr. Rizza has earned the right to use the Chartered Financial Analyst designation and is a member of the Hartford Society of Security Analysts. SUB-ADVISOR: Principal Global Investors, LLC ("Principal") is an indirectly wholly-owned subsidiary of Principal Life Insurance Company and an affiliate of the Manager. Principal manages equity, fixed-income and real estate investments primarily for institutional investors, including Principal Life. As of December 31, 2005, Principal, together with its affiliated asset management companies, had approximately $159 billion in asset under management. Principal Global Investor's headquarters address is 801 Grand Avenue, Des Moines, Iowa 50392 and has other primary asset management offices in New York, London, Sydney and Singapore.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Balanced Dirk Laschanzky Bond William C. Armstrong Timothy R. Warrick Capital Value John Pihlblad Diversified International Paul H. Blankenhagen Juliet Cohn Christopher Ibach Government & High Quality Bond Brad Fredericks Lisa Stange MidCap K. William Nolin Money Market Tracy Reeg Alice Robertson
WILLIAM C. ARMSTRONG, CFA . Mr. Armstrong is a portfolio manager for Principal. He manages multi-sector portfolios that invest in corporate bonds, mortgage-backed securities, commercial mortgage-backed securities, asset-backed securities, sovereigns, and agencies. He jointed the firm in 1992. Previously he served as a commissioned bank examiner at Federal Deposit Insurance Commission. He earned a Master's degree from the University of Iowa and a Bachelor's degree from Kearney State College. He has earned the right to use the Chartered Financial Analyst designation. PAUL H. BLANKENHAGEN, CFA . Mr. Blankenhagen joined the firm in 1992 and was named a portfolio manager in 2000. He is responsible for developing portfolio strategy and the ongoing management of core international equity portfolios. He earned a Master's degree from Drake University and a Bachelor's degree in Finance from Iowa State University. He has earned the right to use the Chartered Financial Analyst designation, and is a member of the Association for Investment Management and Research (AIMR) and the Iowa Society of Financial Analysts. JULIET COHN . Ms. Cohn is a portfolio manager at Principal. She co-manages the core international equity portfolios, with an emphasis on Europe and on the health care sector. Prior to joining the firm in 2003, she served as a director 38 Principal Variable Contracts Fund 1-800-247-4123 and senior portfolio manager at Allianz Dresdner Asset Management, managing both retail and institutional European accounts. Prior to that, she was a fund manager at London firms Capel Cure Myers and Robert Fleming. She earned a bachelor's degree in Mathematics from Trinity College, Cambridge England. BRAD FREDERICKS. . Mr. Fredericks is a portfolio manager at Principal. He is responsible for co-managing the government securities accounts. His responsibilities include general portfolio overview and security analysis. He joined the firm in 1998 as a financial accountant and was named a portfolio manager in 2002. Previously, Mr. Fredericks was an assistant trader at Norwest Mortgage. He earned a Bachelor's degree in Finance from Iowa State University. Mr. Fredericks is a Fellow of the Life Management Institute (FLMI). CHRISTOPHER IBACH, CFA . Mr. Ibach is an associate portfolio manager and equity research analyst at Principal. He specializes primarily in the analysis of international technology companies, with a particular emphasis on semi-conductor research. Prior to joining Principal in 2000, he gained six years of related industry experience with Motorola, Inc. Mr. Ibach earned an MBA in Finance and a Bachelor's degree in Electrical Engineering from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. DIRK LASCHANZKY, CFA . Mr. Laschanzky is a portfolio manager for Principal, responsible for portfolio implementation strategies, asset allocation and managing the midcap value and index portfolios. Prior to joining Principal in 1997, he was a portfolio manager and analyst for over seven years at AMR Investment Services. He earned an MBA and BA, both in Finance, from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. K. WILLIAM NOLIN, CFA . Mr. Nolin is a portfolio manager for Principal. He serves as the portfolio manager for the firm's international small-cap equity portfolios. He joined the firm in 1994. He earned an MBA from the Yale School of Management and a Bachelor's degree in Finance from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. JOHN PIHLBLAD, CFA . Mr. Pihlblad is a portfolio manager at Principal. He joined the firm in 2000 and led the development of Principal Global Investors' Global Research Platform. He has over 25 years experience in creating and managing quantitative investment systems. Prior to joining Principal, Mr. Pihlblad was a partner and co-founder of GlobeFlex Capital in San Diego where he was responsible for the development and implementation of the investment process for both domestic and international products. He earned a BA from Westminster College. He has earned the right to use the Chartered Financial Analyst designation. TRACY REEG. . Ms. Reeg is a portfolio manager at Principal. She is involved in the portfolio management of money market portfolios. She joined the firm in 1993 and began trading and portfolio management duties in 2000. Ms. Reeg earned a Bachelor's degree in Finance from the University of Northern Iowa. She is a member of the Life Office Management Association (LOMA) and is a Fellow of the Life Management Institute (FLMI). ALICE ROBERTSON . Ms. Robertson is a trader for Principal on the corporate fixed-income trading desk. She joined the Principal Financial Group in 1990 as a credit analyst and moved to her current position in 1993. Previously, Ms. Robertson was an assistant vice president/commercial paper analyst with Duff & Phelps Credit Company. Ms. Robertson earned her Master's degree in Finance and Marketing from DePaul University and her Bachelor's degree in Economics from Northwestern University. LISA A. STANGE, CFA . Ms. Stange is a portfolio manager and strategist for Principal. She is responsible for managing the government securities portfolios and the mortgage-backed securities (MBS) within the multi-sector portfolios. As a strategies, Ms. Stange is involved in the formulation of broad investment strategy, quantitative research and product development. Previously, she was co-portfolio manager for U.S. multi-sector portfolios. She joined the firm in 1989. Ms. Stange earned an MBA and a Bachelor's degree from the University of Iowa. She has earned the right to use the Chartered Financial Analyst designation. TIMOTHY R. WARRICK, CFA . Mr. Warrick is a portfolio manager at Principal with responsibility for the corporate and U.S. multi-sector portfolios. He also serves as portfolio management team leader with responsibility for overseeing portfolio Principal Variable Contracts Fund 39 www.principal.com management function for all total return fixed income products. Prior to his portfolio management responsibilities with the firm, Mr. Warrick was a fixed income credit analyst and extensively involved in product development He joined the firm in 1990. He received an MBA in Finance from Drake University and a Bachelor's degree in Accounting and Economics from Simpson College. He has earned the right to use the Chartered Financial Analyst designation. THE SUB-SUB-ADVISORS Principal Global Investors, LLC ("Principal") has entered into sub-sub-advisory agreements for various Accounts. Under these agreements, each sub-sub-advisor has agreed to assume the obligations of Principal for a certain portion of the Account's assets. The sub-sub-advisor is paid a fee by Principal. Principal is the sub-advisor for the Bond Account. Day-to-day management decisions concerning a portion of the Bond Account's portfolio are made by Spectrum Asset Management, Inc. ("Spectrum"), and Post Advisory Group, LLC ("Post") each of which serves as sub-sub-advisor. SUB-ADVISOR: Post Advisory Group, LLC ("Post") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. Post was founded in April 1992. Its address is 11755 Wilshire Boulevard, Los Angeles, CA 90025. As of December 31, 2005, Post had $8.1 billion in asset under management. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account. LAWRENCE A. POST . Mr. Post is a chief executive office and chief investment officer for Post, an affiliate of Principal. He has over 35 years experience in the investment business, including 25 years in the high yield bond market. Prior to founding Post Advisory Group in 1992, he founded the high yield bond department at Smith Barney, and subsequently served as director of high yield research at Salomon Brothers and co-director of research and senior trader at Drexel Burnham Lambert. He earned an MBA in business administration from the University of Pennsylvania's Wharton School of Business and a Bachelor's degree from Lehigh University. ALLAN SCHWEITZER . Mr. Schweitzer is a Managing Director at Post. Prior to joining Post in 2000, he was a senior high yield analyst at Trust Company of the West ("TCW"). Prior to TCW, he was a high yield research analyst at Putnam Investments. Mr. Schweitzer earned a Bachelor's degree in Business Administration from Washington University at St. Louis and a Master's in Business Administration from the University of Chicago with a concentration in analytical finance and international economics. SUB-ADVISOR: Spectrum Asset Management, Inc. ("Spectrum") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. Spectrum was founded in 1987. Its address is 4 High Ridge Park, Stamford, CT 06905. As of December 31, 2005, Spectrum, together with its affiliated asset management companies, had approximately $13.2 billion in asset under management. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account. L. PHILLIP JACOBY. . Mr. Jacoby is Sr. Vice President and Portfolio Manager for Spectrum and chairman of Spectrum's Investment Committee. Prior to joining Spectrum in 1995, he was a senior investment officer as USL Capital Corporation, a subsidiary of Ford Motor Corporate, and co-managed a $600 million preferred stock portfolio. He earned a earned a his BS in Finance from Boston University. 40 Principal Variable Contracts Fund 1-800-247-4123 BERNARD M. SUSSMAN. . Mr. Sussman is Chief Investment Officer of Spectrum and Chair of its Investment Committee. Prior to joining Spectrum in 1995, Mr. Sussman was a general partner and heard of the Preferred Stock area of Goldman Sachs & Co. He was responsible for sales, trading and underwriting for all preferred products and was instrumental in the development of the hybrid (MIPS) market. He earned both an MBA in Finance and a Bachelor's degree in Industrial Relations from Cornell University. DUTIES OF THE MANAGER AND SUB-ADVISOR The Manager or Sub-Advisor provides the Directors of the Fund with a recommended investment program. The program must be consistent with the Account's investment objective and policies. Within the scope of the approved investment program, the Sub-Advisor advises the Account on its investment policy and determines which securities are bought or sold, and in what amounts. FEES PAID TO THE MANAGER The Manager is paid a fee by each Account for its services, which includes any fee paid to the Sub-Advisor. The fee paid by each Account (as a percentage of the average daily net assets) for the fiscal year ended December 31, 2005 was:
Balanced Government & High Quality 0.59% Bond 0.44% Bond 0.45% Growth 0.60% Capital Value 0.60% MidCap 0.57% Diversified Money Market International 0.85% 0.49%
FEES PAID TO THE SUB-ADVISORThe Sub-Advisor fee paid by each Account (as a percentage of the average daily net assets) for the fiscal year ended December 31, 2005 was:
Balanced Government & High Quality 0.10% Bond 0.10% Bond 0.10% Growth 0.13% Capital Value 0.14% MidCap 0.14% Diversified Money Market International 0.10% 0.07%
The Fund and the Manager, under an order received from the SEC, may enter into and materially amend agreements with Sub-Advisors, other than those affiliated with the Manager, without obtaining shareholder approval. For any Account that is relying on that order, the Manager may: . hire one or more Sub-Advisors; . change Sub-Advisors; and . reallocate management fees between itself and Sub-Advisors. The Manager will continue to have the ultimate responsibility for the investment performance of these Accounts due to its responsibility to oversee Sub-Advisors and recommend their hiring, termination and replacement. No Account will rely on the order until it receives approval from its shareholders or, in the case of a new Account, the Account's sole initial shareholder before the Account is available to the other purchasers, and the Account states in its prospectus that it intends to rely on the order. Principal Variable Contracts Fund 41 www.principal.com GENERAL INFORMATION ABOUT AN ACCOUNT FREQUENT TRADING AND MARKET-TIMING (ABUSIVE TRADING PRACTICES) The Accounts of the Principal Variable Contracts Fund are not designed for frequent trading or market timing activity. The Fund has adopted fair valuation procedures to be used in the case of significant events, including broad market movements, occurring after the close of a foreign market in which securities are traded. The procedures will be followed if the Manager believes the events will impact the value of the foreign securities. These procedures are intended to discourage market timing transactions in shares of the Accounts. The Accounts do not knowingly accommodate frequent purchases and redemptions ("excessive trading") of Fund shares by investors. If you intend to trade frequently and/or use market timing investment strategies, do not purchase these Accounts. The Fund does not knowingly accommodate excessive trading. The Principal Variable Contracts Fund considers frequent trading and market timing activities to be abusive trading practices because they may: . Disrupt the management of the Accounts by; . forcing the Account to hold short-term (liquid) assets rather than investing for long term growth, which results in lost investment opportunities for the Account; and . causing unplanned portfolio turnover; . Hurt the portfolio performance of the Account; and . Increase expenses of the Account due to; . increased broker-dealer commissions; and . increased recordkeeping and related costs. If we are not able to identify such excessive trading practices, The Accounts may be negatively impacted and may cause investors to suffer the harms described. Certain Accounts may be at greater risk for abusive trading practices. For example, those Accounts that invest in foreign securities may appeal to investors attempting to take advantage of time-zone arbitrage. This risk is particularly relevant to the Diversified International, International Emerging Markets and International SmallCap Accounts but does apply to the purchase of foreign securities by any Account. As the Accounts of the Principal Variable Contracts Fund are only available through variable annuity or variable life contracts, the Principal Variable Contracts Fund must rely on Principal Life (as sponsor of the variable contract) to monitor customer trading activity to identify and take action against excessive trading. There can be no certainty that Principal Life will identify and prevent excessive trading in all instances. When Principal Life identifies excessive trading, Principal Life will act to curtail such trading in a fair and uniform manner. If Principal Life, or the Principal Variable Contracts Fund, deem excessive trading practices to be occurring, Principal Life will take action that may include, but is not limited to: . Rejecting exchange instructions from shareholder or other person authorized by the shareholder to direct exchanges; . Restricting submission of exchange requests by, for example, allowing exchange requests to be submitted by 1st class U.S. mail only and disallowing requests made via the internet, by facsimile, by overnight courier or by telephone; . Limiting the dollar amount of an exchange and/or the number of exchanges during a year; . Requiring a holding period of a minimum of 30 days before permitting exchanges among the Accounts where there is evidence of at least one round-trip exchange (exchange or redemption of shares that were purchased within 30 days of the exchange/redemption); and . Taking such other action as directed by the Principal Variable Contracts Fund. The Principal Variable Contracts Fund has reserved the right to accept or reject, without prior written notice, any exchange requests. In some instances, an exchange may be completed prior to a determination of abusive trading. In those instances, Principal Life will reverse an exchange (within three business days of the exchange) and return the account holdings to the positions held prior to the exchange. Principal Life will give you notice in writing in this instance. 42 Principal Variable Contracts Fund 1-800-247-4123 ELIGIBLE PURCHASERS Only certain eligible purchasers may buy shares of the Accounts. Eligible purchasers are limited to 1) separate accounts of Principal Life or of other insurance companies, 2) Principal Life or any of its subsidiaries or affiliates, 3) trustees of other managers of any qualified profit sharing, incentive or bonus plan established by Principal Life or any of its subsidiaries or affiliates for employees of such company, subsidiary or affiliate. Such trustees or managers may buy Account shares only in their capacities as trustees or managers and not for their personal accounts. The Board of Directors of the Fund reserves the right to broaden or limit the designation of eligible purchaser. Each Account serves as the underlying investment vehicle for variable annuity contracts and variable life insurance policies that are funded through separate accounts established by Principal Life. It is possible that in the future, it may not be advantageous for variable life insurance separate accounts and variable annuity separate accounts to invest in the Accounts at the same time. Although neither Principal Life nor the Fund currently foresees any such disadvantage, the Fund's Board of Directors monitors events in order to identify any material conflicts between such policy owners and contract holders. Material conflict could result from, for example, 1) changes in state insurance laws, 2) changes in Federal income tax law, 3) changes in the investment management of an Account, or 4) differences in voting instructions between those given by policy owners and those given by contract holders. Should it be necessary, the Board would determine what action, if any, should be taken. Such action could include the sale of Account shares by one or more of the separate accounts which could have adverse consequences. SHAREHOLDER RIGHTS The following information applies to each Account of the Principal Variable Contracts Fund, Inc. Each Account share is eligible to vote, either in person or by proxy, at all shareholder meetings for that Account. This includes the right to vote on the election of directors, selection of independent auditors and other matters submitted to meetings of shareholders of the Account. Each share has equal rights with every other share of the Account as to dividends, earnings, voting, assets and redemption. Shares are fully paid, non-assessable and have no preemptive or conversion rights. Shares of an Account are issued as full or fractional shares. Each fractional share has proportionately the same rights including voting as are provided for a full share. Shareholders of the Fund may remove any director with or without cause by the vote of a majority of the votes entitled to be case at a meeting of all Account shareholders. The bylaws of the Fund provide that the Board of Directors of the Fund may increase or decrease the aggregate number of shares that the Fund has the authority to issue, without a shareholder vote. The bylaws of the Fund also provide that the Fund does not need to hold an annual meeting of shareholders unless one of the following is required to be acted upon by shareholders under the Investment Company Act of 1940: election of directors; approval of an investment advisory agreement; ratification of the selection of independent auditors; and approval of the distribution agreement. The Fund intends to hold shareholder meetings only when required by law and at such other times when the Board of Directors deems it to be appropriate. Shareholder inquiries should be directed to: Principal Variable Contracts Fund, Inc., Principal Financial Group, Des Moines, Iowa 50392-2080. NON-CUMULATIVE VOTING The Fund's shares have non-cumulative voting rights. This means that the holders of more than 50% of the shares voting for the election of directors of the Fund can elect 100% of the directors if they choose to do so. In such event, the holders of the remaining shares voting for the election of directors will not be able to elect any directors. Principal Life votes each Account's shares allocated to each of its separate accounts registered under the Investment Company Act of 1940 and attributable to variable annuity contracts or variable life insurance policies participating in the separate accounts. The shares are voted in accordance with instructions received from contract holders, policy owners, participants and annuitants. Other shares of each Account held by each separate account, including shares for which no timely voting instructions are received, are voted in proportion to the instructions that are received with respect to contracts or policies participating that separate account. Shares of each of the Accounts held in the general account of Principal Life or in the unregistered separate accounts are voted in proportion to the instructions that are received with respect to contracts and policies participating in its registered and unregistered separate accounts. If Principal Life determines, under applicable law, that an Account's shares held in one or more separate accounts or in Principal Variable Contracts Fund 43 www.principal.com its general account need not be voted according to the instructions that are received, it may vote those Account shares in its own right. PURCHASE OF ACCOUNT SHARES Shares are purchased from Princor Financial Services Corporation, the Fund's principal underwriter. There are no sales charges on shares of the Accounts, however, your variable contract may impose a charge. There are no restrictions on amounts to be invested in shares of the Accounts. Shareholder accounts for each Account are maintained under an open account system. Under this system, an account is opened and maintained for each investor. Each investment is confirmed by sending the investor a statement of account showing the current purchase and the total number of shares owned. The statement of account is treated by each Account as evidence of ownership of Account shares. Share certificates are not issued. SALE OF ACCOUNT SHARES This section applies to eligible purchasers other than the separate accounts of Principal Life and its subsidiaries. Each Account sells its shares upon request. There is no charge for the sale. A shareholder sends a written request to the Account requesting the sale of any part or all of the shares. The letter must be signed exactly as the account is registered. If payment is to be made to the registered shareholder or joint shareholder, the Account does not require a signature guarantee. If payment is to be made to another party, the shareholder's signature(s) must be guaranteed by a commercial bank, trust company, credit union, savings and loan association, national securities exchange member or brokerage firm. Shares are redeemed at the net asset value per share next computed after the request is received by the Account in proper and complete form. Sales proceeds are generally sent within three business days after the request is received in proper form. However, the right to sell shares may be suspended during any period when 1) trading on the NYSE is restricted as determined by the SEC or when the NYSE is closed for other than weekends and holidays, or 2) an emergency exists, as determined by the SEC, as a result of which a) disposal by a fund of securities owned by it is not reasonably practicable, b) it is not reasonably practicable for a fund to fairly determine the value of its net assets, or c) the SEC permits suspension for the protection of security holders. If payments are delayed and the instruction is not canceled by the shareholder's written instruction, the amount of the transaction is determined as of the first valuation date following the expiration of the permitted delay. The transaction occurs within five days thereafter. In addition, payments on surrenders attributable to a premium payment made by check may be delayed up to 15 days. This permits payment to be collected on the check. RESTRICTED TRANSFERS Shares of each of the Accounts may be transferred to an eligible purchaser. However, if an Account is requested to transfer shares to other than an eligible purchaser, the Account has the right, at its election, to purchase the shares at the net asset value next calculated after the receipt of the transfer request. However, the Account must give written notification to the transferee(s) of the shares of the election to buy the shares within seven days of the request. Settlement for the shares shall be made within the seven-day period. FINANCIAL STATEMENTS You will receive an annual financial statement for the Fund, audited by the Fund's independent registered public accounting firm, Ernst & Young LLP. That report is a part of this prospectus. You will also receive a semiannual financial statement that is unaudited. FINANCIAL HIGHLIGHTS The following financial highlights tables are intended to help you understand the Fund's financial performance for the periods shown. Certain information reflects results for a single Fund share. The total returns in each table represent the 44 Principal Variable Contracts Fund 1-800-247-4123 rate that an investor would have earned or lost each period on an investment in the Fund (assuming reinvestment of all distributions). The financial statements for the Fund were audited by Ernst & Young LLP, whose report, along with the financial statements, is included in the most recent annual report for the Fund. To receive a copy of the latest annual or semiannual report for the Fund, you may telephone 1-800-247-4123. FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- BALANCED ACCOUNT ---------------- Net Asset Value, Beginning of Period.. $14.34 $13.31 $11.56 $13.73 $15.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.31 0.31 0.27 0.34 0.40/(c)/ Net Realized and Unrealized Gain (Loss) on Investments......... 0.64 1.00 1.83 (2.11) (1.42)/(c)/ ---- ---- ---- ----- ----- Total From Investment Operations 0.95 1.31 2.10 (1.77) (1.02) Less Dividends and Distributions: Dividends from Net Investment Income... (0.36) (0.28) (0.35) (0.40) (0.47) Distributions from Realized Gains...... -- -- -- -- (0.21) ---- ----- Total Dividends and Distributions (0.36) (0.28) (0.35) (0.40) (0.68) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $14.93 $14.34 $13.31 $11.56 $13.73 ====== ====== ====== ====== ====== Total Return /(a)/ ... 6.79% 10.05% 18.82% (13.18)% (6.96)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $116,927 $126,548 $124,735 $110,545 $144,214 Ratio of Expenses to Average Net Assets.. 0.64% 0.63% 0.65% 0.61% 0.61% Ratio of Gross Expenses to Average Net Assets.......... -- 0.63%/(b)/ 0.65%/(b)/ 0.62%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 2.19% 2.32% 2.23% 2.52% 2.73%/(c)/ Portfolio Turnover Rate................ 115.3% 128.3% 114.3% 87.8% 114.3% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- BOND ACCOUNT ------------ Net Asset Value, Beginning of Period.. $12.31 $12.31 $12.32 $11.84 $11.78 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.50 0.51 0.52 0.51 0.56/(c)/ Net Realized and Unrealized Gain (Loss) on Investments......... (0.20) 0.08 0.02 0.54 0.35/(c)/ ----- ---- ---- ---- ---- Total From Investment Operations 0.30 0.59 0.54 1.05 0.91 Less Dividends and Distributions: Dividends from Net Investment Income... (0.57) (0.59) (0.55) (0.57) (0.85) ----- ----- ----- ----- ----- Total Dividends and Distributions (0.57) (0.59) (0.55) (0.57) (0.85) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $12.04 $12.31 $12.31 $12.32 $11.84 ====== ====== ====== ====== ====== Total Return /(a)/ ... 2.50% 4.98% 4.59% 9.26% 8.12% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $338,044 $286,684 $263,435 $232,839 $166,658 Ratio of Expenses to Average Net Assets.. 0.47% 0.47% 0.47% 0.49% 0.50% Ratio of Net Investment Income to Average Net Assets.. 4.21% 4.23% 4.32% 5.02% 5.73%/(c)/ Portfolio Turnover Rate................ 176.2% 143.6% 82.1% 63.3% 146.1%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. /(c) /Effective January 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies. The effect of this change for the year ended December 31, 2001 was to decrease net investment income per share by $.01, increase net realized and unrealized gains/losses per share by $.01, and decrease the ratio of net investment income to average net assets by .08%. Financial highlights for prior periods have not been restated to reflect this change in presentation. 68 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- CAPITAL VALUE ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $32.39 $29.23 $23.60 $27.78 $30.72 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.54 0.44 0.38 0.39 0.34 Net Realized and Unrealized Gain (Loss) on Investments......... 1.66 3.17 5.63 (4.18) (2.80) ---- ---- ---- ----- ----- Total From Investment Operations 2.20 3.61 6.01 (3.79) (2.46) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.45) (0.38) (0.39) (0.34) Distributions from Realized Gains...... -- -- -- -- (0.14) ----- ----- Total Dividends and Distributions -- (0.45) (0.38) (0.39) (0.48) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $34.59 $32.39 $29.23 $23.60 $27.78 ====== ====== ====== ====== ====== Total Return /(b)/ ... 6.80% 12.36% 25.49% (13.66)% (8.05)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $258,490 $265,580 $248,253 $206,541 $254,484 Ratio of Expenses to Average Net Assets.. 0.61% 0.60% 0.61% 0.61% 0.61% Ratio of Gross Expenses to Average Net Assets.......... -- 0.60%/(e)/ 0.61%/(e)/ 0.61%/(e)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.62% 1.47% 1.47% 1.45% 1.20% Portfolio Turnover Rate................ 120.9% 183.3% 125.7% 142.6% 91.7% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- DIVERSIFIED INTERNATIONAL ACCOUNT --------------------------------- Net Asset Value, Beginning of Period /(a)/ ............... $13.75 $11.48 $8.78 $10.51 $13.90 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.18 0.17 0.13 0.10 0.09 Net Realized and Unrealized Gain (Loss) on Investments......... 3.05 2.22 2.67 (1.78) (3.46) ---- ---- ---- ----- ----- Total From Investment Operations 3.23 2.39 2.80 (1.68) (3.37) Less Dividends and Distributions: Dividends from Net Investment Income... (0.15) (0.12) (0.10) (0.05) (0.02) ----- ----- ----- ----- ----- Total Dividends and Distributions (0.15) (0.12) (0.10) (0.05) (0.02) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $16.83 $13.75 $11.48 $8.78 $10.51 ====== ====== ====== ===== ====== Total Return /(b)/ ... 23.79% 21.03% 32.33% (16.07)% (24.27)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $293,647 $226,753 $167,726 $119,222 $145,848 Ratio of Expenses to Average Net Assets.. 0.97% 0.96% 0.92% 0.92% 0.92% Ratio of Gross Expenses to Average Net Assets.......... 0.97%/(c)/ 0.97%/(d)/ 0.93%/(d)/ 0.93%/(d)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.27% 1.39% 1.33% 1.03% 0.78% Portfolio Turnover Rate................ 121.2% 170.1% 111.5% 82.2% 84.3%
/(a) /Effective May 1, 2005, International Account changed its name to Diversified International Account. /(b) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(c) /Expense ratio without custodian credits. /(d) /Expense ratio without commission rebates and custodian credits. /(e) /Expense ratio without commission rebates. 69 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- GOVERNMENT & HIGH QUALITY BOND ACCOUNT /(A)/ -------------------------------------- Net Asset Value, Beginning of Period.. $11.64 $11.77 $12.00 $11.58 $11.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.44 0.44 0.45 0.43 0.51 Net Realized and Unrealized Gain (Loss) on Investments......... (0.21) (0.04) (0.24) 0.55 0.32 ---- ----- ----- ---- ---- Total From Investment Operations 0.23 0.40 0.21 0.98 0.83 Less Dividends and Distributions: Dividends from Net Investment Income... (0.51) (0.53) (0.44) (0.52) (0.68) Distributions from Realized Gains...... -- -- -- (0.04) -- ---- ----- Total Dividends and Distributions (0.51) (0.53) (0.44) (0.56) (0.68) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $11.36 $11.64 $11.77 $12.00 $11.58 ====== ====== ====== ====== ====== Total Return /(b)/ ... 2.01% 3.56% 1.84% 8.80% 7.61% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $316,047 $334,034 $368,564 $342,001 $193,254 Ratio of Expenses to Average Net Assets.. 0.46% 0.44% 0.44% 0.47% 0.49% Ratio of Net Investment Income to Average Net Assets.. 3.88% 3.82% 3.83% 4.87% 5.63% Portfolio Turnover Rate................ 262.1% 67.2% 110.4% 33.8% 45.9% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- GROWTH ACCOUNT -------------- Net Asset Value, Beginning of Period.. $11.94 $10.95 $8.68 $12.24 $16.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.03 0.07 0.03 0.02 -- Net Realized and Unrealized Gain (Loss) on Investments......... 1.40 0.95 2.26 (3.58) (4.19) ---- ---- ---- ----- ----- Total From Investment Operations 1.43 1.02 2.29 (3.56) (4.19) Less Dividends and Distributions: Dividends from Net Investment Income... (0.08) (0.03) (0.02) -- -- ---- Total Dividends and Distributions (0.08) (0.03) (0.02) -- -- ---- ----- ----- ----- Net Asset Value, End of Period............ $13.29 $11.94 $10.95 $8.68 $12.24 ====== ====== ====== ===== ====== Total Return /(b)/ ... 12.09% 9.38% 26.46% (29.07)% (25.50)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $124,254 $134,956 $141,107 $124,079 $209,879 Ratio of Expenses to Average Net Assets.. 0.62% 0.60% 0.61% 0.61% 0.61% Ratio of Gross Expenses to Average Net Assets.......... -- 0.60%/(c)/ 0.61%/(c)/ 0.61%/(c)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.26% 0.67% 0.35% 0.18% 0.02% Portfolio Turnover Rate................ 78.3% 122.4% 40.8% 27.3% 39.0%
/(a) /Effective November 19, 2005, Government Securities Account changed its name to Government & High Quality Bond Account. /(b) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(c) /Expense ratio without commission rebates. 71 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MIDCAP ACCOUNT -------------- Net Asset Value, Beginning of Period.. $39.63 $37.56 $28.54 $32.09 $34.47 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.45 0.39 0.35 0.30 0.24 Net Realized and Unrealized Gain (Loss) on Investments......... 3.12 6.05 9.01 (3.08) (1.50) ---- ---- ---- ----- ----- Total From Investment Operations 3.57 6.44 9.36 (2.78) (1.26) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.39) (0.34) (0.30) (0.24) Distributions from Realized Gains...... (0.66) (3.98) -- (0.47) (0.88) ---- ----- ----- ----- ----- Total Dividends and Distributions (0.66) (4.37) (0.34) (0.77) (1.12) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $42.54 $39.63 $37.56 $28.54 $32.09 ====== ====== ====== ====== ====== Total Return /(a)/ ... 9.21% 17.76% 32.81% (8.75)% (3.71)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $420,812 $395,304 $334,204 $248,986 $278,707 Ratio of Expenses to Average Net Assets.. 0.58% 0.59% 0.61% 0.62% 0.62% Ratio of Gross Expenses to Average Net Assets.......... -- 0.59%/(b)/ 0.61%/(b)/ 0.62%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.13% 1.02% 1.09% 0.98% 0.77% Portfolio Turnover Rate................ 49.9% 38.9% 44.9% 67.9% 73.6% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MONEY MARKET ACCOUNT -------------------- Net Asset Value, Beginning of Period.. $1.000 $1.000 $1.000 $1.000 $1.000 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.027 0.009 0.007 0.014 0.039 ----- ----- ----- ----- ----- Total From Investment Operations 0.027 0.009 0.007 0.014 0.039 Less Dividends and Distributions: Dividends from Net Investment Income... (0.027) (0.009) (0.007) (0.014) (0.039) ------ ------ ------ ------ ------ Total Dividends and Distributions (0.027) (0.009) (0.007) (0.014) (0.039) ------ ------ ------ ------ ------ Net Asset Value, End of Period............ $1.000 $1.000 $1.000 $1.000 $1.000 ====== ====== ====== ====== ====== Total Return /(a)/ ... 2.69% 0.92% 0.74% 1.42% 3.92% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $150,653 $140,553 $151,545 $201,455 $180,923 Ratio of Expenses to Average Net Assets.. 0.61% 0.49% 0.49% 0.49% 0.50% Ratio of Net Investment Income to Average Net Assets.. 2.66% 0.91% 0.74% 1.40% 3.70%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. 75 Principal Variable Contracts Fund 45 www.principal.com ADDITIONAL INFORMATION Additional information about the Fund (including the Fund's policy regarding the disclosure of portfolio securities) is available in the Statement of Additional Information dated May 1, 2006 which is incorporated by reference into this prospectus. Additional information about the Funds' investments is available in the Fund's annual and semiannual reports to shareholders. In the Funds' annual report, you will find a discussion of the market conditions and investment strategies that significantly affected the Funds' performance during the last fiscal year. The Statement of Additional Information and the Fund's annual and semi-annual reports can be obtained free of charge by writing or telephoning Princor Financial Services Corporation, P.O. Box 10423, Des Moines, IA 50306. In addition, the Fund makes its Statement of Additional Information and annual and semi-annual reports available, free of charge, on http:// www.principal.com. To request this and other information about the Fund and to make shareholder inquiries, telephone 1-800-247-4123. Information about the Fund (including the Statement of Additional Information) can be reviewed and copied at the Commission's Public Reference Room in Washington, D.C. Information on the operation of the Public Reference Room may be obtained by calling the Commission at 1-202-942-8090. Reports and other information about the Fund are available on the EDGAR Database on the Commission's internet site at http://www.sec.gov. Copies of this information may be obtained, upon payment of a duplicating fee, by electronic request at the following E-mail address: publicinfo@sec.gov, or by writing the Commission's Public Reference Section, Washington, D.C. 20549-0102. The U.S. government does not insure or guarantee an investment in any of the Accounts. There can be no assurance that the Money Market Account will be able to maintain a stable share price of $1.00 per share. Shares of the Accounts are not deposits or obligations of, or guaranteed or endorsed by, any financial institution, nor are shares of the Accounts federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other agency. Principal Variable Contracts Fund, Inc. SEC File 811-01944 46 Principal Variable Contracts Fund 1-800-247-4123 PRINCIPAL VARIABLE CONTRACTS FUND, INC.
ACCOUNTS OF THE FUND -------------------- ASSET ALLOCATION ACCOUNT MIDCAP ACCOUNT BALANCED ACCOUNT MIDCAP GROWTH ACCOUNT BOND ACCOUNT MIDCAP VALUE ACCOUNT CAPITAL VALUE ACCOUNT MONEY MARKET ACCOUNT DIVERSIFIED INTERNATIONAL ACCOUNT PRINCIPAL LIFETIME 2010 ACCOUNT EQUITY GROWTH ACCOUNT PRINCIPAL LIFETIME 2020 ACCOUNT EQUITY INCOME ACCOUNT PRINCIPAL LIFETIME 2030 ACCOUNT GOVERNMENT & HIGH QUALITY BOND ACCOUNT PRINCIPAL LIFETIME 2040 ACCOUNT (previously Government Securities PRINCIPAL LIFETIME 2050 ACCOUNT Account) GROWTH ACCOUNT PRINCIPAL LIFETIME STRATEGIC INCOME ACCOUNT INTERNATIONAL EMERGING MARKETS ACCOUNT REAL ESTATE SECURITIES ACCOUNT INTERNATIONAL SMALLCAP ACCOUNT SHORT-TERM BOND ACCOUNT LARGECAP BLEND ACCOUNT (previously Limited Term Bond Account) LARGECAP GROWTH EQUITY ACCOUNT SMALLCAP ACCOUNT LARGECAP STOCK INDEX ACCOUNT SMALLCAP GROWTH ACCOUNT LARGECAP VALUE ACCOUNT SMALLCAP VALUE ACCOUNT
This Prospectus describes a mutual fund organized by Principal Life Insurance Company/(R)/ ("Principal Life"). The Fund provides a choice of investment objectives through the Accounts listed above. The date of this Prospectus is May 1, 2006. As with all mutual funds, neither the Securities and Exchange Commission ("SEC") nor any State Securities Commission has approved or disapproved of these securities or determined if this prospectus is accurate or complete. It is a criminal offense to represent otherwise. TABLE OF CONTENTS ACCOUNT DESCRIPTIONS....................................................3 Asset Allocation Account..............................................5 Balanced Account......................................................8 Bond Account..........................................................11 Capital Value Account.................................................15 Diversified International Account.....................................18 Equity Growth Account.................................................21 Equity Income Account .................................................24 Government & High Quality Bond Account (f/k/a Government Securities Account)....................................27 Growth Account........................................................31 International Emerging Markets Account................................33 International SmallCap Account........................................36 LargeCap Blend Account................................................39 LargeCap Growth Equity Account ........................................42 LargeCap Stock Index Account..........................................44 LargeCap Value Account................................................46 MidCap Account........................................................48 MidCap Growth Account.................................................51 MidCap Value Account..................................................54 Money Market Account..................................................57 Principal LifeTime 2010 Account .......................................60 Principal LifeTime 2020 Account.......................................63 Principal LifeTime 2030 Account.......................................67 Principal LifeTime 2040 Account.......................................71 Principal LifeTime 2050 Account.......................................75 Principal LifeTime Strategic Income Account...........................79 Real Estate Securities Account ........................................82 Short-Term Bond Account (f/k/a Limited Term Bond Account).............85 SmallCap Account......................................................88 SmallCap Growth Account...............................................91 SmallCap Value Account................................................94 CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.........................97 PRICING OF ACCOUNT SHARES...............................................103 DIVIDENDS AND DISTRIBUTIONS.............................................103 MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE..........................104 The Manager...........................................................104 The Sub-Advisors......................................................104 Duties of the Manager and Sub-Advisors................................117 Fees Paid to the Manager..............................................117 Fees Paid to the Sub-Advisor..........................................117 GENERAL INFORMATION ABOUT AN ACCOUNT....................................118 Frequent Trading and Market-Timing (Abusive Trading Practices) ........118 Eligible Purchasers...................................................119 Shareholder Rights....................................................119 Non-Cumulative Voting.................................................120 Purchase of Account Shares............................................120 Sale of Account Shares................................................120 Restricted Transfers..................................................121 Financial Statements..................................................121 FINANCIAL HIGHLIGHTS....................................................121 ADDITIONAL INFORMATION..................................................137 2 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 ACCOUNT DESCRIPTIONS The Principal Variable Contracts Fund (the "Fund") is made up of Accounts. Each Account has its own investment objective. Principal Management Corporation*, the "Manager" of the Fund, has selected a Sub-Advisor for the Accounts based on the Sub-Advisor's experience with the investment strategy for which it was selected. The Manager seeks to provide a wide range of investment approaches through the Fund. The Sub-Advisors are: . AllianceBernstein L.P. ("AllianceBernstein") . Columbus Circle Investors ("CCI")* . Emerald Advisors, Inc. ("Emerald") . Grantham, Mayo, Van Otterloo & Co. LLC ("GMO") . J.P. Morgan Investment Management Inc. ("Morgan") . Mellon Equity Associates, LLP ("Mellon Equity") . Morgan Stanley Investment Management Inc. ("MSIM Inc.") doing business as "Van Kampen" . Neuberger Berman Management Inc. ("Neuberger Berman") . Principal Global Investors, LLC ("Principal")* . Principal Real Estate Investors, LLC ("Principal - REI")* . T. Rowe Price Associates, Inc. ("T. Rowe Price") . UBS Global Asset Management (Americas) Inc. ("UBS Global AM") * CCI, Principal, Principal - REI, Principal Management Corporation and Princor Financial Services Corporation ("Princor") are affiliates of Principal Life Insurance Company and with it are subsidiaries of Principal Financial Group, Inc. and members of the Principal Financial Group/(R)/. In the description for each Account, there is important information about the Account's: MAIN STRATEGIES AND RISKS These sections describe each Account's investment objective and summarize how each Account intends to achieve its investment objective. The Board of Directors may change an Account's objective or the investment strategies without a shareholder vote if it determines such a change is in the best interests of the Account. If there is a material change to the Account's investment objective or investment strategies, you should consider whether the Account remains an appropriate investment for you. There is no guarantee that an Account will meet its objective. The sections also describe each Account's primary investment strategies (including the type or types of securities in which the Account invests), any policy of the Account to concentrate in securities of issuers in a particular industry or group of industries and the main risks associated with an investment in the Account. A fuller discussion of risks appears later in the Prospectus under the caption "Certain Investment Strategies and Related Risks." Each Account may invest up to 100% of its assets in cash and cash equivalents for temporary defensive purposes in response to adverse market, economic or political condition as more fully described under the caption "Certain Investment Strategies and Related Risks-Temporary Defensive Measures." Each Account is designed to be a portion of an investor's portfolio. None of the Accounts is intended to be a complete investment program. You should consider the risks of each Account before making an investment and be prepared to maintain the investment during periods of adverse market conditions. INVESTMENT RESULTS A bar chart and a table are included with each Account that has annual returns for a full calendar year. They show the Account's annual returns and its long-term performance. The chart shows how the Account's performance has varied from year-to-year. The table compares the Account's performance over time to that of: . a broad-based securities market index (An index measures the market price of a specific group of securities in a particular market or securities in a market sector. You cannot invest directly in an index. An index does not have an investment advisor and does not pay any commissions or expenses. If an index had expenses, its performance would be lower.); and PRINCIPAL VARIABLE CONTRACTS FUND 3 www.principal.com . an average of mutual funds with a similar investment objective and management style. The averages used are prepared by independent statistical services. An Account's past performance is not necessarily an indication of how the Account will perform in the future. Call the Principal Variable Contracts Fund at 1-800-247-4123 to get the current 7-day yield for the Money Market Account. FEES AND EXPENSES The annual operating expenses for each Account are deducted from that Account's assets. Each Account's operating expenses are shown with the description of the Account and are stated as a percentage of Account assets. A discussion of fees and expenses appears later in the Prospectus under the caption "The Costs of Investing." The fees and expenses shown do not include the effect of any separate account expenses or other contract level expenses. If such charges were included, overall expenses would be higher and would lower performance. The description of each Account includes examples of the costs associated with investing in the Account. The examples are intended to help you compare the cost of investing in a particular Account with the cost of investing in other mutual funds. The examples assume you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The examples also assume that your investment has a 5% total return each year and that the Account's operating expenses remain the same. Your actual costs of investing in a particular Account may be higher or lower than the costs assumed for purposes of the examples. NOTES: . No salesperson, dealer or other person is authorized to give information or make representations about an Account other than those contained in this Prospectus. Information or representations not contained in this Prospectus may not be relied upon as having been made by the Principal Variable Contracts Fund, an Account, the Manager, any Sub-Advisor or Princor. . Investments in these Accounts are not deposits of a bank and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. 4 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 ASSET ALLOCATION ACCOUNT The Account seeks to generate a total investment return consistent with preservation of capital. MAIN STRATEGIES The Account invests in a portfolio of securities that is broadly diversified by asset class, global region, country, economic sector, and currency. The Portfolio Manager makes the Account's broad asset allocation decisions and delegates responsibility for selection specific individual securities to the internal, active management teams of the Sub-Advisor, Van Kampen. In deciding how to allocate the Account's assets, Van Kampen assesses three sets of factors: . the relative value of the stock, bond and money markets in the various regions, countries and economic sectors; . the long-term dynamic forces that are driving economies, economic sectors, and companies; and . the short-term technical forces that are affecting market pricing. Factors evaluated include growth rates in gross domestic product, inflation and corporation earnings, labor market conditions, interest rate levels, sales growth, return on equity, dividend yields, price to book ratios and currency valuations. From time-to-time, Van Kampen changes the Account's allocation of assets in various ways, including by asset class, by global region, by country, by economic sector and by currency, in order to keep the portfolio in alignment with global investment outlook. Allocation among asset classes is designed to lessen overall investment risk by diversifying the Account's assets among different types of investments in different markets. Van Kampen reallocates among asset classes and eliminates asset classes for a period of time, when in its judgement the shift offers better prospects of achieving the investment objective of the Account. Under normal market conditions, abrupt reallocations among asset classes will not occur. Van Kampen does not allocate a specific percentage of the Account's assets to a class. Over time, it expects the asset mix to be within the following ranges: . 25% to 75% in equity securities; . 20% to 60% in fixed-income securities; and . 0% to 40% in money market instruments. The Account may invest up to 100% of its assets in foreign securities. Allowable instruments include individual securities (stocks (without regard to the market capitalization of the issuing company) and bonds), equity and interest rate futures, currency forward contracts, futures contracts, Exchange Traded Funds, fixed-income TRAINS and listed options. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. Van Kampen may utilize currency contracts, currency or index futures or other derivatives for hedging or other purposes, including modifying the Account's exposure to various currency, equity or fixed-income market. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. PRINCIPAL VARIABLE CONTRACTS FUND 5 www.principal.com CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.) FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. HEDGING STRATEGIES . Use of forward foreign currency exchange contracts, currency or index futures or other derivatives involves risks. The contracts may increase the Account's volatility and, thus, could involve a significant risk. If the Sub-Advisor's predictions are inaccurate, the adverse consequences to the Account (e.g., a reduction in the Account's net asset value) may leave the Account in a worse position than if these strategies were not used. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking a moderate risk approach towards long-term growth. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. 6 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Van Kampen has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"12.92 "1997"18.19 "1998"9.18 "1999"19.49 "2000"1.61 "2001"-3.92 "2002"-12.94 "2003"21.61 "2004"8.49 The Account's highest/lowest quarterly returns "2005"5.79 during this time period were: HIGHEST Q2 '03 12.11% LOWEST Q3 '02 -12.41% LOGO The year-to-date return as of March 31, 2006 is 3.34%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* ASSET ALLOCATION ACCOUNT .............. 5.79 3.14 7.52 8.25 S&P 500 Index ........ 4.91 0.54 9.07 11.02 Lehman Brothers Aggregate Bond Index . 2.43 5.87 6.17 6.92 MSCI EAFE (Europe, Australia, Far East) Index - ND ........... 13.54 4.56 5.84 6.03 Morningstar Moderate Allocation Category Average .............. 5.29 2.93 7.35 8.55 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (June 1, 1994).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM THE ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.80% Other Expenses................... 0.06 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.86%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 ASSET ALLOCATION ACCOUNT $88 $274 $477 $1,061
PRINCIPAL VARIABLE CONTRACTS FUND 7 www.principal.com BALANCED ACCOUNT The Account seeks to generate a total return consisting of current income and capital appreciation. MAIN STRATEGIES The Account seeks growth of capital and current income by investing primarily in common stocks and corporate bonds. It may also invest in other equity securities, government bonds and notes (obligations of the U.S. government or its agencies or instrumentalities) and cash. Though the percentages in each category are not fixed, common stocks generally represent 40% to 70% of the Account's assets. The remainder of the Account's assets is invested in bonds and cash. The Sub-Advisor, Principal, utilizes an asset allocation approach to the management and development of a diversified balanced account. The strategy incorporates a wide range of asset classes and investment styles with primary emphasis placed on equity versus fixed income allocation decisions. Secondary focus is then placed on growth versus value, large cap versus small cap, and domestic versus international equity exposure. Strategic or long-term asset class targets are determined with gradual adjustments to the mix to enhance risk-adjusted results over time. Any asset allocation adjustments fall within a predetermined range and do not deviate by more than 10% of the long-term asset class targets. All marginal shifts in the asset mix are based on a consistent three-dimensional analytical framework. First, securities are reviewed based on price, earnings, and yield measures relative to long-term historical norms. Next, fundamental economic and market conditions are analyzed to identify opportunities, and finally, market trends are used to compare relative price strength and investor sentiment. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. Because the Account invests in both stocks and bonds, the Account may underperform stock funds when stocks are in favor and underperform bond funds when bonds are in favor. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. Risks for this Account include: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade are commonly referred to as "junk bonds" or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.) FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some 8 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates. This may increase the volatility of the Account. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 115.3%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking current income as well as long-term growth of capital. PRINCIPAL VARIABLE CONTRACTS FUND 9 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"13.13 "1997"17.93 "1998"11.91 "1999"2.4 "2000"0.13 "2001"-6.96 "2002"-13.18 "2003"18.82 "2004"10.05 The Account's highest/lowest quarterly returns "2005"6.79 during this time period were: HIGHEST Q2 '03 9.82% LOWEST Q3 '02 -9.61% LOGO The year-to-date return as of March 31, 2006 is 3.69%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* BALANCED ACCOUNT ..... 6.79 2.44 5.61 8.43 60% S&P 500 Index/40% Lehman Brothers Aggregate Bond Index . 4.01 2.96 8.24 10.52 Morningstar Moderate Allocation Category Average .............. 5.29 2.93 7.35 9.52 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (December 18, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.59% Other Expenses................... 0.05 ---- TOTAL ACCOUNT OPERATING EXPENSES 0.64%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 BALANCED ACCOUNT $65 $205 $357 $798
10 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 BOND ACCOUNT The Account seeks to provide as high a level of income as is consistent with preservation of capital and prudent investment risk. MAIN STRATEGIES Under normal circumstances, the Account invests at least 80% of its assets in intermediate maturity fixed-income or debt securities rated BBB or higher by Standard & Poor's Rating Service ("S&P") or Baa or higher by Moody's Investors Service, Inc. ("Moody's"). The Account considers the term "bond" to mean any debt security. Under normal circumstances, the Account invests in: . securities issued or guaranteed by the U.S. government or its agencies or instrumentalities; . mortgage-backed securities representing an interest in a pool of mortgage loans; . debt securities and taxable municipal bonds rated, at the time of purchase, in one of the top four categories by S&P or Moody's or, if not rated, in the opinion of the Sub-Advisor, Principal, of comparable quality; and . securities issued or guaranteed by the governments of Canada (provincial or federal government) or the United Kingdom payable in U.S. dollars. The rest of the Account's assets may be invested in: . preferred and common stock that may be convertible (may be exchanged for a fixed number of shares of common stock of the same issuer) or may be non-convertible; or . securities rated less than the four highest grades of S&P or Moody's (i.e. less than investment grade (commonly known as "junk bonds")) but not lower than CCC- (S&P) or Caa (Moody's). The Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income. Under a reverse repurchase agreement, the Account sells securities and agrees to repurchase them at a specified date and price. The Account pays interest on this "secured financing" and attempts to make money on the difference between the financing rate and the interest it earns by investing the proceeds of the financing. While a reverse repurchase agreement is outstanding, the Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account may lend its portfolio securities to brokers, dealers and other financial institutions. In connection with such loans, the Account remains the owner of the loaned securities and continues to be entitled to payments in amounts equal to the interest, dividends or other distributions payable on the loaned securities. Loans of portfolio securities may not exceed 33 1/3% of the value of the Account's total assets (including the value of all assets received as collateral for loan). In connection with such loans the Account will receive collateral from the borrower equal to at least 100% of the value of the loaned securities. The Account may actively trade securities in an attempt to achieve its investment objective. During the fiscal year ended December 31, 2005, the average ratings of the Account's assets, based on market value at each month-end, were as follows (all ratings are by Moody's):
57.40% in securities 15.45% in securities 0.62% in securities rated rated Aaa rated Baa Caa 5.59% in securities 3.66% in securities rated 0.04% in securities rated rated Aa Ba Ca 13.12% in securities 4.11% in securities rated 0.01% in securities rated rated A B C
The above percentages for A&B rated securities include 0.08% and 0.06% respectively, of unrated securities which have been determined by the Manager to be of comparable quality. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: PRINCIPAL VARIABLE CONTRACTS FUND 11 www.principal.com MUNICIPAL SECURITIES . Principal and interest payments of municipal securities may not be guaranteed by the issuing body and may be payable only from monies derived from a particular source. If the source does not perform as expected, principal and income payments may not be made on time or at all. In addition, the market for municipal securities is often thin and may be temporarily affected by large purchases and sales, including those of the Account. General conditions in the financial markets and the size of a particular offering may also negatively affect the returns of a municipal security. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates. This may increase the volatility of the Account. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation maybe chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. REVERSE REPURCHASE AGREEMENTS. . This strategy involves the risk that interest costs on money borrowed may exceed the return on securities purchased with the borrowed money. In addition, reverse repurchase agreements may increase the volatility of the Fund. LENDING OF SECURITIES . If the Account lends its portfolio securities and the borrower of the securities fail financially, the Account may experience delays in recovering the loaned securities or exercising its rights in the collateral. Loans are made only to borrowers that are deemed by the Sub-Advisor to be of good financial standing. PORTFOLIO DURATION . The average portfolio duration of the Account normally varies within a three- to six-year time frame based on Sub-Advisor's forecast for interest rates. Duration is a measure of the expected life of a fixed-income security that is used to determine the sensitivity of a security's price to changes in interest rates. For example, if the portfolio duration of the Account is three years, a change of 1% in the market's yield results in a change of approximately 3% in the value of the Account's securities. The longer a security's duration, the more sensitive it is to changes in interest rates. An Account with a longer average portfolio duration will be more sensitive to changes in interest rates than an Account with a shorter average portfolio duration. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates. When interest rates rise, the value of fixed-income securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of fixed-income securities. Some fixed-income investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.) 12 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. COMMODITY-LINKED DERIVATIVE INSTRUMENTS . The use of commodity-linked derivative instruments may subject the Account to greater volatility than investments in traditional securities. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 176.2%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking diversification by investing in a fixed-income mutual fund. PRINCIPAL VARIABLE CONTRACTS FUND 13 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"2.36 "1997"10.6 "1998"7.69 "1999"-2.59 "2000"8.17 "2001"8.12 "2002"9.26 "2003"4.59 "2004"4.98 The Account's highest/lowest quarterly returns "2005"2.5 during this time period were: HIGHEST Q3 '97 4.37% LOWEST Q1 '96-3.24% LOGO The year-to-date return as of March 31, 2006 is -0.55%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* BOND ACCOUNT ......... 2.50 5.86 5.50 7.69 Lehman Brothers Aggregate Bond Index . 2.43 5.87 6.17 7.78 Morningstar Intermediate-Term Bond Category Average...... 1.79 5.32 5.38 7.11 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (December 18, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.45% Other Expenses................... 0.02% ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.47%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 BOND ACCOUNT $48 $151 $263 $591
14 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 CAPITAL VALUE ACCOUNT The Account seeks to provide long-term capital appreciation and secondarily growth of investment income. MAIN STRATEGIES The Account invests primarily in common stock and other equity securities of large capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with large market capitalizations (those with market capitalizations similar to companies in the Russell 1000/(R)// /Value Index (as of March 31, 2006 this range was between approximately $688 million and $387.4 billion) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Up to 25% of Account assets may be invested in foreign securities. The Account invests in stocks that, in the opinion of the Sub-Advisor, Principal, are undervalued in the marketplace at the time of purchase. Value stocks are often characterized by below average price/earnings ratios (P/E) and above average dividend yields relative to the overall market. Securities for the Account are selected by consideration of the quality and price of individual issuers rather than forecasting stock market trends. The selection process focuses on four key elements: . determination that a stock is selling below its fair market value; . early recognition of changes in a company's underlying fundamentals; . evaluation of the sustainability of fundamental changes; and . by monitoring a stock's behavior in the market, evaluation of the timeliness of the investment. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization value stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. PRINCIPAL VARIABLE CONTRACTS FUND 15 www.principal.com ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 120.9%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks, but who prefer investing in companies that appear to be considered undervalued relative to similar companies. 16 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"23.5 "1997"28.53 "1998"13.58 "1999"-4.29 "2000"2.16 "2001"-8.05 "2002"-13.66 "2003"25.49 "2004"12.36 The Account's highest/lowest quarterly returns "2005"6.8 during this time period were: HIGHEST Q2 '03 15.52% LOWEST Q3 '02 -15.10% LOGO The year-to-date return as of March 31, 2006 is 6.07%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT CAPITAL VALUE ACCOUNT 6.80 3.64 7.74 11.92* Russell 1000 Value Index................. 7.05 5.28 10.94 14.32** Morningstar Large Value Category Average 5.88 3.96 8.85 13.21** Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 13, 1970). ** Lifetime results are measured from December 31, 1978 (earliest date for which information is available).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.60% Other Expenses................... 0.01% ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.61%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 CAPITAL VALUE ACCOUNT $62 $195 $340 $762
PRINCIPAL VARIABLE CONTRACTS FUND 17 www.principal.com DIVERSIFIED INTERNATIONAL ACCOUNT The Account seeks long-term growth of capital by investing in a portfolio of equity securities of companies established outside of the U.S. MAIN STRATEGIES The Account invests in a portfolio of equity securities of companies domiciled in any of the nations of the world. The Account invests in securities of: . companies with their principal place of business or principal office outside the U.S.; . companies for which the principal securities trading market is outside the U.S.; and . companies, regardless of where their securities are traded, that derive 50% or more of their total revenue from goods or services produced or sales made outside the U.S. The Account has no limitation on the percentage of assets that are invested in any one country or denominated in any one currency. However, under normal market conditions, the Account intends to have at least 80% of its assets invested in companies in at least three different countries. One of those countries may be the U.S. though currently the Account does not intend to invest in equity securities of U.S. companies. Investments may be made anywhere in the world. Primary consideration is given to securities of corporations of Western Europe, North America and Australasia (Australia, Japan and Far East Asia). Changes in investments are made as prospects change for particular countries, industries or companies. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. The Account may actively trade securities in an attempt to achieve its investment objective. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as companies in more developed countries. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more 18 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 121.2%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital in markets outside of the U.S. who are able to assume the increased risks of higher price volatility and currency fluctuations associated with investments in international stocks which trade in non-U.S. currencies. PRINCIPAL VARIABLE CONTRACTS FUND 19 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"25.09 "1997"12.24 "1998"9.98 "1999"25.93 "2000"-8.34 "2001"-24.27 "2002"-16.07 "2003"32.33 "2004"21.03 The Account's highest/lowest quarterly returns "2005"23.79 during this time period were: HIGHEST Q2 '03 17.25% LOWEST Q3 '02 -18.68% LOGO The year-to-date return as of March 31, 2006 is 11.97%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS DIVERSIFIED INTERNATIONAL ACCOUNT. 23.79 4.73 8.43 Citigroup BMI Global ex-US Index/(1)/...... 19.59 8.09 7.79 MSCI EAFE (Europe, Australia, Far East) Index - ND ........... 13.54 4.56 5.84 Morningstar Foreign Large Blend Category Average .............. 14.55 2.93 6.47 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 2, 1994). ** Lifetime results are measured from the Index inception date (December 31, 1994). ///(1)/ This index is now the benchmark against which the Account measures its performance. The Manager and the portfolio manager believe it better represents the universe of investment choices open to the Account under its investment philosophy. The index formerly used is also shown. LIFE OF ACCOUNT* DIVERSIFIED 8.09 INTERNATIONAL ACCOUNT. Citigroup BMI Global 8.02** ex-US Index/(1)/...... MSCI EAFE (Europe, 5.94 Australia, Far East) Index - ND ........... Morningstar Foreign 6.27 Large Blend Category Average .............. Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured f the date the Account was first sold (May 2, 1994). ** Lifetime results are measured the Index inception date (December 31, 1994). ///(1)/ This index is now the benchmark against which the Account measures its performance. The Manager and the portfolio manager believe it better represents the universe of investment choices open to the Account under its investment philosophy. The index formerly used is also shown.
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES
Management Fees.................... 0.85% Other Expenses..................... 0.12 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.97%
(EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005 EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate 20 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES -------------------------------------------------------------------------------------------- 1 3 5 10 DIVERSIFIED INTERNATIONAL ACCOUNT $99 $309 $536 $1,190
PRINCIPAL VARIABLE CONTRACTS FUND 21 www.principal.com EQUITY GROWTH ACCOUNT The Account seeks to provide long-term capital appreciation by investing primarily in equity securities. MAIN STRATEGIES The Account seeks to maximize long-term capital appreciation by investing primarily in growth-oriented equity securities of U.S. and, to a limited extent, foreign companies that exhibit strong growth and free cash flow potential. These companies are generally characterized as "growth" companies. Under normal market conditions, the Account invests at least 80% of its net assets in equity securities of companies with market capitalizations within the range of companies in the Russell 1000/(R)// /Growth Index (as of March 31, 2006, this range was between approximately $952 million and $368.9 billion) at the time of purchase. The Account's investments in foreign companies will be limited to 25% of its total assets. The Account may also purchase futures and options, in keeping with Account objectives. The Sub-Advisor, T. Rowe Price, generally looks for companies with an above-average rate of earnings and cash flow growth and a lucrative niche in the economy that gives them the ability to sustain earnings momentum even during times of slow economic growth. As a growth investor, T. Rowe Price believes that when a company increases its earnings faster than both inflation and the overall economy, the market will eventually reward it with a higher stock price. In pursuing its investment objective, the Sub-Advisor has the discretion to purchase some securities that do not meet its normal investment criteria, as described above, when it perceives an unusual opportunity for gain. These special situations might arise when the Sub-Advisor believes a security could increase in value for a variety of reasons, including a change in management, an extraordinary corporate event, or a temporary imbalance in the supply of or demand for the securities. The Account may sell securities for a variety of reasons, such as to secure gains, limit losses, or redeploy assets into more promising opportunities. The Account may actively trade securities in an attempt to achieve its investment objective. Futures and options contracts may be bought or sold for any number of reasons, including: to manage exposure to changes in interest rates and foreign currencies; as an efficient means of increasing or decreasing fund overall exposure to a specific part or broad segment of the U.S. or a foreign market; in an effort to enhance income; to protect the value of portfolio securities; and to serve as a cash management tool. Call or put options may be purchased or sold on securities, financial indices, and foreign currencies. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization growth-oriented stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation, making returns more dependent on market increases and decreases. Growth stocks may therefore be more vulnerable than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's 22 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed an Account's initial investment in such contracts. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 51.6%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks that may have greater risks than stocks of companies with lower potential for earnings growth. PRINCIPAL VARIABLE CONTRACTS FUND 23 www.principal.com T. Rowe Price became the Sub-Advisor to the Account on August 24, 2004. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"28.05 "1997"30.86 "1998"18.95 "1999"39.5 "2000"-11.71 "2001"-14.86 "2002"-27.72 "2003"25.95 "2004"9.33 The Account's highest/lowest quarterly returns "2005"7.55 during this time period were: HIGHESTQ4 '9822.68% LOWEST Q1 '01-18.25% LOGO The year-to-date return as of March 31, 2006 is 1.57%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* EQUITY GROWTH ACCOUNT 7.55 -1.84 8.39 10.89 Russell 1000 Growth Index................. 5.26 -3.58 6.73 9.20 Morningstar Large Growth Category Average .............. 6.46 -3.36 6.95 9.09 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (June 1, 1994).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.76% Other Expenses................... 0.01 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.77%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 EQUITY GROWTH ACCOUNT $79 $246 $428 $954
24 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 EQUITY INCOME ACCOUNT The Account seeks to achieve high current income and long-term growth of income and capital. MAIN STRATEGIES The Account seeks to achieve its objective by investing primarily in equity securities (such as common stocks), preferred securities, shares of real estate investment trusts (REITs) and convertible securities. In selecting securities, the Sub-Advisor, Principal, places an emphasis on securities with potentially high dividend yields. Under normal market conditions, the Account invests at least 80% of its assets in equity securities. The Account may invest up to 25% of its assets in securities of foreign companies. When determining how to invest the Account's assets in equity securities, Principal seeks stocks that it believes are undervalued in the marketplace at the time of purchase. Securities for the Account are selected by consideration of the quality and price of individual issuers rather than forecasting stock market trends. The selection process focuses on: . the determination that a stock is selling below its fair market value; . an early recognition of changes in a company's underlying fundamentals; . an evaluation of the sustainability of fundamental changes; and . monitoring a stock's behavior in the market. In selecting preferred securities for the Account, Principal focuses on the financial services industry (i.e., banking, insurance and commercial finance). For a security to be considered for the Account, Principal will assess the credit risk within the context of the yield available on the preferred security. The Sub-Advisor also may consider whether the companies' securities have a favorable income-paying history and whether income payments are expected to continue to increase. REITs are corporations or business trusts that are permitted to eliminate corporate level federal income taxes by meeting certain requirements of the Internal Revenue Code. In selecting REITs for the Account, Principal focuses on equity REITs which primarily own property and generate revenue from rental income. Principal seeks to diversify the Account's REIT holdings by property types (e.g. apartment REITs, mall REITs, office and industrial REITs). MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. VALUE STOCKS . The Account's potential investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. INTEREST RATE CHANGES . Changes in interest rates may adversely affect the value of an investor's securities. When interest rates rise, the value of preferred securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of preferred securities. Some investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. PREPAYMENT OR CALL RISK . Some investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the PRINCIPAL VARIABLE CONTRACTS FUND 25 www.principal.com Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. EQUITY REITS . Equity REITs are affected by the changes in the value of the properties owned by the trust. In addition, they: . may not be diversified with regard to the types of tenants (thus subject to business developments of the tenant(s)); . may not be diversified with regard to the geographic locations of the properties (thus subject to regional economic developments); and . are subject to cash flow dependency of its tenants. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. INVESTOR PROFILE The Account may be an appropriate investment for investors who seek dividends to generate income or to be reinvested for growth and accept fluctuations in the value of investments. 26 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999"2.29 "2000"19.18 "2001"-27.7 "2002"-12.61 "2003"13.83 "2004"17.6 The Account's highest/lowest quarterly returns "2005"8.67 during this time period were: HIGHESTQ3 '0018.18% LOWEST Q3 '01-16.65% LOGO The year-to-date return as of March 31, 2006 is 7.04%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* EQUITY INCOME ACCOUNT ........ 8.67 -1.67 3.40 Russell 1000 Value Index ..... 7.05 5.28 5.69 Morningstar Moderate Allocation Category Average .. 5.29 2.93 4.29 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.60% Other Expenses............................. 0.06 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.66%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 EQUITY INCOME ACCOUNT $67 $211 $368 $822
PRINCIPAL VARIABLE CONTRACTS FUND 27 www.principal.com GOVERNMENT & HIGH QUALITY BOND ACCOUNT F/K/A GOVERNMENT SECURITIES ACCOUNT The Account seeks a high level of current income, liquidity and safety of principal. MAIN STRATEGIES The Account seeks to achieve its investment objective by investing primarily (at least 80% of its assets) in securities that are issued by the U.S. Government, its agencies or instrumentalities. The Account may invest in mortgage-backed securities representing an interest in a pool of mortgage loans. These securities are rated AAA by Standard & Poor's Corporation or Aaa by Moody's Investor Services, Inc. or, if unrated, determined by the Sub-Advisor, Principal, to be of equivalent quality. The Account relies on the professional judgment of Principal to make decisions about the Account's portfolio securities. The basic investment philosophy of Principal is to seek undervalued securities that represent good long-term investment opportunities. Securities may be sold when Principal believes they no longer represent good long-term value. The Account may also hold cash and cash equivalents. The size of the Account's cash position depends on various factors, including market conditions and purchases and redemptions of Account shares. A large cash position could impact the ability of the Account to achieve its objective but it also would reduce the Account's exposure in the event of a market downturn and provide liquidity to make additional investments or to meet redemptions. The Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income. Under a reverse repurchase agreement, the Account sells securities and agrees to repurchase them at a specified date and price. The Account pays interest on this "secured financing" and attempts to make money on the difference between the financing rate and the interest it earns by investing the proceeds of the financing. While a reverse repurchase agreement is outstanding, the Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account may lend its portfolio securities to brokers, dealers and other financial institutions. In connection with such loans, the Account remains the owner of the loaned securities and continues to be entitled to payments in amounts equal to the interest, dividends or other distributions payable on the loaned securities. Loans of portfolio securities may not exceed 33 1/3% of the value of the Account's total assets (including the value of all assets received as collateral for loan). In connection with such loans the Account will receive collateral from the borrower equal to at least 100% of the value of the loaned securities. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: U.S. GOVERNMENT SECURITIES . U.S. Government securities do not involve the degree of credit risk associated with investments in lower quality fixed-income securities. As a result, the yields available from U.S. Government securities are generally lower than the yields available from many other fixed-income securities. Like other fixed-income securities, the values of U.S. Government securities change as interest rates fluctuate. Fluctuations in the value of the Account's securities do not affect interest income on securities already held by the Account, but are reflected in the Account's price per share. Since the magnitude of these fluctuations generally is greater at times when the Account's average maturity is longer, under certain market conditions the Account may invest in short-term investments yielding lower current income rather than investing in higher yielding longer term securities. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates. When interest rates rise, the value of fixed-income securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of fixed-income securities. Some fixed-income investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. 28 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. U.S. GOVERNMENT SPONSORED SECURITIES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. Prepayments, unscheduled principal payments, may result from voluntary prepayment, refinancing or foreclosure of the underlying mortgage. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates and potentially increasing the volatility of the Account. In addition, prepayments may cause losses on securities purchased at a premium (dollar amount by which the price of the bond exceeds its face value). At times, mortgage-backed securities may have higher than market interest rates and are purchased at a premium. Unscheduled prepayments are made at par and cause the Account to experience a loss of some or all of the premium. DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. REVERSE REPURCHASE AGREEMENTS. . This strategy involves the risk that interest costs on money borrowed may exceed the return on securities purchased with the borrowed money. In addition, reverse repurchase agreements may increase the volatility of the Fund. LENDING OF SECURITIES . If the Account lends its portfolio securities and the borrower of the securities fail financially, the Account may experience delays in recovering the loaned securities or exercising its rights in the collateral. The Account lends its securities only to borrowers that the Sub-Advisor determines are creditworthy. PORTFOLIO DURATION . The average portfolio duration of the Account normally varies within a three- to six-year time frame based on Sub-Advisor's forecast for interest rates. Duration is a measure of the expected life of a fixed-income security that is used to determine the sensitivity of a security's price to changes in interest rates. For example, if the portfolio duration of the Account is three years, a change of 1% in the market's yield results in a change of approximately 3% in the value of the Account's securities. The longer a security's duration, the more sensitive it is to changes in interest rates. An Account with a longer average portfolio duration will be more sensitive to changes in interest rates than an Account with a shorter average portfolio duration. PRINCIPAL VARIABLE CONTRACTS FUND 29 www.principal.com ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading cost which may have an adverse impact on the Account's performance. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 262.1%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking diversification by investing in a fixed-income mutual fund. 30 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"3.35 "1997"10.39 "1998"8.27 "1999"-0.29 "2000"11.4 "2001"7.61 "2002"8.8 "2003"1.84 "2004"3.56 The Account's highest/lowest quarterly returns "2005"2.01 during this time period were: HIGHEST Q2 '97 4.52% LOWEST Q1 '96 -1.90% LOGO The year-to-date return as of March 31, 2006 is -0.45%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* GOVERNMENT & HIGH QUALITY BOND ACCOUNT . 2.01 4.72 5.62 7.30 Lehman Brothers Government/Mortgage Index................. 2.63 5.40 6.01 7.56 Morningstar Intermediate Government Category Average .............. 1.90 4.62 5.12 6.67 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (April 9, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.44% Other Expenses................... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.46%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 GOVERNMENT & HIGH QUALITY BOND ACCOUNT $47 $148 $258 $579
PRINCIPAL VARIABLE CONTRACTS FUND 31 www.principal.com GROWTH ACCOUNT The Account seeks long-term growth of capital through the purchase primarily of common stocks, but the Account may invest in other securities. MAIN STRATEGIES The Account invests primarily in common stocks and other equity securities of large capitalization companies with strong earnings growth potential. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with large market capitalizations (those with market capitalizations similar to companies in the Russell 1000/(R)/ Growth Index (as of March 31, 2006 this range was between approximately $952 million and $368.9 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. The Sub-Advisor, CCI, uses a bottom-up approach (focusing on individual stock selection rather than forecasting stock market trends) in its selection of individual securities that it believes have an above average potential for earnings growth. Selection is based on the premise that companies doing better than expected will have rising securities prices, while companies producing less than expected results will not. CCI refers to its discipline as positive momentum and positive surprise. Through in-depth analysis of company fundamentals in the context of the prevailing economic environment, CCI seeks to select companies that meet the criteria of positive momentum and positive surprise in reported results. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization growth-oriented stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks that may have greater risks than stocks of companies with lower potential for earnings growth. 32 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 CCI became the Sub-Advisor to the Account on January 5, 2005. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"12.51 "1997"26.96 "1998"21.36 "1999"16.44 "2000"-10.15 "2001"-25.5 "2002"-29.07 "2003"26.46 "2004"9.38 The Account's highest/lowest quarterly returns "2005"12.09 during this time period were: HIGHESTQ4 '9821.35% LOWEST Q1 '01-23.55% LOGO The year-to-date return as of March 31, 2006 is 4.86%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* GROWTH ACCOUNT ....... 12.09 -3.91 4.04 5.97 Russell 1000 Growth Index................. 5.26 -3.58 6.73 9.27 Morningstar Large Growth Category Average .............. 6.46 -3.36 6.95 9.05 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (May 2, 1994).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.60% Other Expenses................... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.62%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 GROWTH ACCOUNT $63 $199 $346 $774
PRINCIPAL VARIABLE CONTRACTS FUND 33 www.principal.com INTERNATIONAL EMERGING MARKETS ACCOUNT The Account seeks long-term growth of capital by investing primarily in equity securities of issuers in emerging market countries. MAIN STRATEGIES The Account seeks to achieve its objective by investing in common stocks of companies in emerging market countries. For this Account, the term "emerging market country" means any country which is considered to be an emerging country by the international financial community (including the International Bank for Reconstruction and Development (also known as the World Bank) and the International Financial Corporation). These countries generally include every nation in the world except the United States, Canada, Japan, Australia, New Zealand and most nations located in Western Europe. Investing in many emerging market countries is not feasible or may involve unacceptable political risk. Principal, the Sub-Advisor, focuses on those emerging market countries that it believes have strongly developing economies and markets which are becoming more sophisticated. Under normal conditions, at least 80% of the Account's assets are invested in emerging market country equity securities. The Account invests in securities of: . companies with their principal place of business or principal office in emerging market countries; . companies for which the principal securities trading market is an emerging market country; or . companies, regardless of where their securities are traded, that derive 50% or more of their total revenue from either goods or services produced in emerging market countries or sales made in emerging market countries. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. EMERGING MARKET COUNTRIES . Investments in emerging market countries involve special risks. Certain emerging market countries have historically experienced, and may continue to experience, certain economic problems. These may include: high rates of inflation, high interest rates, exchange rate fluctuations, large amounts of debt, balance of payments and trade difficulties, and extreme poverty and unemployment. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect 34 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading cost which may have an adverse impact on the Account's performance. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 169.6%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital in securities of emerging market countries who are able to assume the increased risks of higher price volatility and currency fluctuations associated with investments in international stocks which trade in non-U.S. currencies. PRINCIPAL VARIABLE CONTRACTS FUND 35 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2001"-4.24 "2002"-7.63 "2003"57.2 "2004"24.89 The Account's highest/lowest quarterly returns "2005"34.29 during this time period were: HIGHESTQ4 '0126.63% LOWEST Q3 '01-23.90% LOGO The year-to-date return as of March 31, 2006 is 15.59%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* INTERNATIONAL EMERGING MARKETS ACCOUNT....... 34.29 18.45 16.31 MSCI Emerging Markets Free Index - NDTR/(1)/ 34.00 19.08 18.64 MSCI Emerging Markets Free Index - ID ...... 30.31 16.23 14.18 Morningstar Diversified Emerging Markets Category Average .............. 31.64 18.59 16.26 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (October 24, 2000). ///(1)/ This index is now the benchmark against which the Account measures its performance. The Manager and portfolio manager believe it better represents the universe of investment choices open to the Account under its investment philosophy. The index formerly used is also shown.
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.25% Other Expenses............................. 0.35 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.60%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate 36 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------- 1 3 5 10 INTERNATIONAL EMERGING MARKETS ACCOUNT $163 $505 $871 $1,900
PRINCIPAL VARIABLE CONTRACTS FUND 37 www.principal.com INTERNATIONAL SMALLCAP ACCOUNT The Account seeks long-term growth of capital by investing in a portfolio of equity securities of companies established outside of the U.S. MAIN STRATEGIES The Account invests primarily in equity securities of non-U.S. companies with comparatively smaller market capitalizations. Under normal market conditions, the Account invests at least 80% of its assets in securities of companies similar in size to companies included in the Citigroup Extended Market Index (EMI) World ex US (as of March 31, 2006 this range was between approximately $3.3 million and $26.1 billion). Market capitalization is defined as total current market value of a company's outstanding common stock. The Account invests in securities of: . companies with their principal place of business or principal office outside the U.S.; . companies for which the principal securities trading market is outside the U.S.; and . companies, regardless of where their securities are traded, that derive 50% or more of their total revenue from goods or services produced or sales made outside the U.S. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller 38 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 132.3%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital in smaller companies outside of the U.S. who are able to assume the increased risks of higher price volatility and currency fluctuations associated with investments in international stocks which trade in non-U.S. currencies. PRINCIPAL VARIABLE CONTRACTS FUND 39 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999"93.81 "2000"-11.5 "2001"-21.85 "2002"-16.2 "2003"54.15 "2004"30.2 The Account's highest/lowest quarterly returns "2005"29.12 during this time period were: HIGHESTQ4 '9936.59% LOWEST Q3 '01-21.49% LOGO The year-to-date return as of March 31, 2006 is 15.21%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* INTERNATIONAL SMALLCAP ACCOUNT 29.12 11.16 13.32 Citigroup Extended Market Index (EMI) World ex US ...... 11.70 4.32 9.36 Morningstar Foreign Small/Mid Growth Category Average ...... 24.79 8.46 12.37 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.19% Other Expenses............................. 0.14 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.33%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 INTERNATIONAL SMALLCAP ACCOUNT $135 $421 $729 $1,601
40 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 LARGECAP BLEND ACCOUNT The Account seeks long-term growth of capital. MAIN STRATEGIES The Account pursues its investment objective by investing primarily in equity securities of U.S. companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with large market capitalizations (those with market capitalizations within the range of companies in the Standard & Poor's 500 Stock Index ("S&P 500 Index") (as of March 31, 2006 this range was between approximately $579 million and $371.6 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. The market capitalization of companies in the Account's portfolio and the S&P 500 Index will change over time, and the Account will not automatically sell or cease to purchase a stock of a company it already owns just because the company's market capitalization grows or falls outside of the index range. In addition, the Account has the ability to purchase stocks whose market capitalization falls below the range of companies in the S&P 500 Index. The Account's Sub-Advisor, T. Rowe Price, uses a disciplined portfolio construction process whereby it weights each sector approximately the same as the S&P 500 Index. Individual holdings within each sector, and their weights within the portfolio, can vary substantially from the S&P 500 Index. A team of T. Rowe Price equity analysts is directly responsible for selecting stocks for the Account. Analysts select stocks from the industries they cover based on rigorous fundamental analysis that assesses the quality of the business franchise, earnings growth potential for the company, and stock valuation. The Account seeks to take full advantage of the analysts' focused expertise in their industries. A team of portfolio managers supervises the analysts and has the responsibility for the overall structure of the Account and coordinating Account investments. They also oversee the quantitative analysis that helps the analysts manage their industry-specific portfolios. In pursuing its investment objective, the Account's management has the discretion to purchase some securities that do not meet its normal investment criteria, as described above, when it perceives an unusual opportunity for gain. These special situations might arise when T. Rowe Price believes a security could increase in value for a variety of reasons, including a change in management, an extraordinary corporate event, or a temporary imbalance in the supply of or demand for the securities. The Account will generally remain fully invested (less than 5% cash reserves) and will be sector neutral when compared to the S&P 500 Index. While the majority of assets will be invested in large-capitalization U.S. common stocks, small- and mid-capitalization stocks and foreign stocks (up to 25% of total assets) may also be purchased in keeping with Account objectives. Securities may be sold for a variety of reasons, such as to secure gains, limit losses, or redeploy assets into more promising opportunities. Futures and options contracts may be bought or sold for any number of reasons, including: to manage exposure to changes in interest rates and foreign currencies; as an efficient means of increasing or decreasing fund overall exposure to a specific part or broad segment of the U.S. or a foreign market; in an effort to enhance income; to protect the value of portfolio securities; and to serve as a cash management tool. Call or put options may be purchased or sold on securities, financial indices, and foreign currencies. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's equity securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: PRINCIPAL VARIABLE CONTRACTS FUND 41 www.principal.com STOCK MARKET VOLATILITY . The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation, making returns more dependent on market increases and decreases. Growth stocks may therefore be more vulnerable than non-growth stocks to market changes. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. SECTOR RISK . The Sub-Advisor may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As the Sub-Advisor allocates more of the Account's portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in an aggressively managed portfolio of common stocks, but who prefer investing in larger, established companies. 42 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 T. Rowe Price became the Sub-Advisor to the Account effective March 9, 2004. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2003"23.76 "2004"10.36 "2005"4.74 The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q2 '03 14.07% LOGO LOWEST Q1 '03 -3.91% The year-to-date return as of March 31, 2006 is 4.21%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF ACCOUNT* LARGECAP BLEND ACCOUNT...................... 4.74 5.31 S&P 500 Index ................... .......... 4.91 5.99 Morningstar Large Blend Category Average ... 5.77 5.57 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 2002).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees...................................... 0.75% Other Expenses....................................... 0.03 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.78%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. This Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 LARGECAP BLEND ACCOUNT $80 $249 $433 $966
PRINCIPAL VARIABLE CONTRACTS FUND 43 www.principal.com LARGECAP GROWTH EQUITY ACCOUNT The Account seeks to achieve long-term growth of capital. MAIN STRATEGIES The Account invests primarily in common stock of U.S. companies, with a focus on growth stocks. Growth stocks are issues (or securities) that the Sub-Advisor, GMO, believes are fast-growing and whose earnings are believed to likely increase over time. Growth in earnings may lead to an increase in the price of the stock. The Sub-Advisor invests mainly in large companies, although investments can be made in companies of any size. Under normal market conditions, the Account invests at least 80% of its assets in equity securities of companies with large market capitalizations. The Account typically makes equity investments in companies chosen from among the 1,000 U.S. exchange-listed companies with the largest market capitalization. Market capitalization is defined as total current market value of a company's outstanding common stock. In addition, the Account may invest up to 25% of its assets in foreign securities, including American Depository Receipts (ADRs), at the time of purchase. When deciding whether to buy or sell stocks for the Account, GMO considers, among other factors, a company's valuation, financial strength, competitive position in its industry, projected future earnings, cash flows and dividends. In addition to the main investment strategies described above, GMO may make other investments, such as investments in preferred stocks, convertible securities and debt instruments. These investments may be subject to other risks as described later in this prospectus and/or the Statement of Additional Information. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization growth-oriented stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. INTEREST RATE CHANGES . Changes in interest rates may adversely affect the value of an investor's securities. When interest rates rise, the value of preferred securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of preferred securities. Some investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. 44 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 INVESTOR PROFILE The Account may be an appropriate investment for investors who are seeking long-term growth and are willing to accept the potential for short-term, volatile fluctuations in the value of their investment. This Account is designed as a long-term investment with growth potential. PRINCIPAL VARIABLE CONTRACTS FUND 45 www.principal.com GMO became the Sub-Advisor to the Account on March 31, 2004. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2001"-30.08 "2002"-33.27 "2003"23.14 "2004"3.16 The Account's highest/lowest quarterly returns "2005"3.63 during this time period were: HIGHESTQ4 '0112.16% LOWEST Q3 '01-21.14% LOGO The year-to-date return as of March 31, 2006 is 1.26%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* LARGECAP GROWTH EQUITY ACCOUNT 3.63 -9.29 -13.27 Russell 1000 Growth Index .... 5.26 -3.58 -6.99 Morningstar Large Growth Category Average.............. 6.46 -3.36 -5.29 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (October 24, 2000).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.00% Other Expenses............................. 0.09% ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.09%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------- 1 3 5 10 LARGECAP GROWTH EQUITY ACCOUNT $111 $347 $601 $1,329
46 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 LARGECAP STOCK INDEX ACCOUNT The Account seeks long-term growth of capital. MAIN STRATEGIES Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies that compose the Standard & Poor's ("S&P") 500 Index. The Sub-Advisor, Principal, attempts to mirror the investment performance of the Index by allocating the Account's assets in approximately the same weightings as the S&P 500. The S&P 500 is an unmanaged index of 500 common stocks chosen to reflect the industries of the U.S. economy and is often considered a proxy for the stock market in general. Each stock is weighted by its market capitalization which means larger companies have greater representation in the Index than smaller ones. As of March 31, 2006, the market capitalization range of the Index was between approximately $579 million and $371.6 billion. Over the long-term, Principal seeks a very close correlation between performance of the Account, before expenses, and that of the S&P 500. It is unlikely that a perfect correlation of 1.00 will be achieved. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. Because of the difficulty and expense of executing relatively small stock trades, the Account may not always be invested in the less heavily weighted S&P 500 stocks. At times, the Account's portfolio may be weighted differently from the S&P 500, particularly if the Account has a small level of assets to invest. In addition, the Account's ability to match the performance of the S&P 500 is affected to some degree by the size and timing of cash flows into and out of the Account. The Account is managed to attempt to minimize such effects. Principal reserves the right to omit or remove any of the S&P 500 stocks from the Account if it determines that the stock is not sufficiently liquid. In addition, a stock might be excluded or removed from the Account if extraordinary events or financial conditions lead Principal to believe that it should not be a part of the Account's assets. Principal may also elect to omit any S&P 500 stocks from the Account if such stocks are issued by an affiliated company. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's equity securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth stocks typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. PRINCIPAL VARIABLE CONTRACTS FUND 47 www.principal.com INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital, willing to accept the potential for volatile fluctuations in the value of investments and preferring a passive, rather than active, management style. NOTE: "Standard & Poor's 500" and "S&P 500/(R)/" are trademarks of The McGraw-Hill Companies, Inc. and have been licensed by the Manager. The Account is not sponsored, endorsed, sold or promoted by Standard and Poor's and Standard & Poor's makes no representation regarding the advisability of investing in the Account. 48 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2000"-9.67 "2001"-12.1 "2002"-22.44 "2003"28.32 "2004"10.39 The Account's highest/lowest quarterly returns "2005"4.47 during this time period were: HIGHEST Q2 '03 15.28% LOWEST Q3 '02 -17.27% LOGO The year-to-date return as of March 31, 2006 is 4.17%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* LARGECAP STOCK INDEX ACCOUNT . 4.47 0.18 -0.11 S&P 500 Index ................ 4.91 0.54 0.54 Morningstar Large Blend Category Average.............. 5.77 0.50 1.55 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 3, 1999).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees ................. ......... 0.25%* Other Expenses .................. ......... 0.03 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.28% *Effective January 1, 2006.
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 LARGECAP STOCK INDEX ACCOUNT $29 $90 $157 $356
PRINCIPAL VARIABLE CONTRACTS FUND 49 www.principal.com LARGECAP VALUE ACCOUNT The Account seeks long-term growth of capital. MAIN STRATEGIES The Account invests primarily in undervalued equity securities of companies among the 750 largest by market capitalization that the Sub-Advisor, AllianceBernstein, believes offer above-average potential for growth in future earnings. Under normal market conditions, the Account generally invests at least 80% of its assets in companies with large market capitalizations (those with market capitalizations similar to companies in the Russell 1000/(R)/ Value Index (as of March 31, 2006, this range was between approximately $688 million and $387.4 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. The Account may invest up to 25% of its assets in securities of foreign companies. AllianceBernstein employs an investment strategy, generally described as "value" investing, that involves seeking securities that: . exhibit low financial ratios (particularly stock price-to-book value (liquidation value), but also stock price-to-earnings and stock price-to-cash flow); . can be acquired for less than what AllianceBernstein believes is the issuer's intrinsic value; or . whose price appears attractive relative to the value of the dividends expected to be paid by the issuer in the future. Value oriented investing entails a strong "sell discipline" in that it generally requires the sale of securities that have reached their intrinsic value or a target financial ratio. Value oriented investments may include securities of companies in cyclical industries during periods when such securities appear to AllianceBernstein to have strong potential for capital appreciation or securities of "special situation" companies. A special situation company is one that AllianceBernstein believes has potential for significant future earnings growth but has not performed well in the recent past. These situations include companies with management changes, corporate or asset restructuring or significantly undervalued assets. For AllianceBernstein, identifying special situation companies and establishing an issuer's intrinsic value involves fundamental research about such companies and issuers. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization value stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks but who prefer investing in companies that appear to be considered undervalued relative to similar companies. 50 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 AllianceBernstein has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2003"28.05 "2004"13.09 "2005"5.44 The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q2 '03 16.19% LOGO LOWEST Q1 '03 -5.04% The year-to-date return as of March 31, 2006 is 5.20%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF ACCOUNT* LARGECAP VALUE ACCOUNT...................... 5.44 7.63 Russell 1000 Value Index ........ .......... 7.05 8.81 Morningstar Large Value Category Average ... 5.88 6.76 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 2002).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees...................................... 0.75% Other Expenses....................................... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.77%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 LARGECAP VALUE ACCOUNT $79 $246 $428 $954
PRINCIPAL VARIABLE CONTRACTS FUND 51 www.principal.com MIDCAP ACCOUNT The Account seeks to achieve capital appreciation by investing primarily in securities of emerging and other growth-oriented companies. MAIN STRATEGIES The Account invests primarily in common stocks and other equity securities of medium capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with medium market capitalizations (those with market capitalizations similar to companies in the Russell MidCap/(R)/ Index (as of March 31, 2006, this range was between approximately $688 million and $22.1 billion) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Up to 25% of Account assets may be invested in foreign securities. In selecting securities for investment, the Sub-Advisor, Principal, looks at stocks with value and/or growth characteristics and constructs an investment portfolio that has a "blend" of stocks with these characteristics. In managing the assets of the Account, Principal does not have a policy of preferring one of these categories to the other. The value orientation emphasizes buying stocks at less than their inherent value and avoiding stocks whose price has been artificially built up. The growth orientation emphasizes buying stocks of companies whose potential for growth of capital and earnings is expected to be above average. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. MAIN RISKS The Account is subject to the risk that its principal market segment, medium capitalization stocks, may underperform compared to other market segments or to the equity markets as a whole. Because different types of stocks tend to shift in and out of favor depending on market and economic conditions, the Account's performance may sometimes be lower or higher than that of other types of funds. The value of the Account's equity securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. 52 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 MEDIUM CAPITALIZATIONS . Companies with medium capitalizations may have a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the potential for short-term fluctuations in the value of investments. PRINCIPAL VARIABLE CONTRACTS FUND 53 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"21.11 "1997"22.75 "1998"3.69 "1999"13.04 "2000"14.59 "2001"-3.71 "2002"-8.75 "2003"32.81 "2004"17.76 The Account's highest/lowest quarterly returns "2005"9.21 during this time period were: HIGHESTQ4 '9923.31% LOWEST Q3 '98-20.01% LOGO The year-to-date return as of March 31, 2006 is 4.55%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* MIDCAP ACCOUNT ....... 9.21 8.46 11.60 14.11 Russell Midcap Index . 12.65 8.45 12.49 14.57 Morningstar Mid-Cap Blend Category Average 9.21 8.14 11.74 14.12 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (December 18, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.57% Other Expenses................... 0.01 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.58%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MIDCAP ACCOUNT $59 $186 $324 $726
54 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 MIDCAP GROWTH ACCOUNT The Account seeks long-term growth of capital. MAIN STRATEGIES Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with medium market capitalization (those with market capitalizations similar to companies in the Russell Midcap/(R)/ Growth Index (as of March 31, 2006, this range was between approximately $952 million and $21.9 billion)) at the time of purchase. In the view of the Sub-Advisor, Mellon Equity, many medium-sized companies: . are in fast growing industries; . offer superior earnings growth potential; and . are characterized by strong balance sheets and high returns on equity. The Account may also hold investments in large and small capitalization companies, including emerging and cyclical growth companies. The Account may invest up to 25% of its net assets in securities of foreign companies, including securities of issuers in emerging countries and securities quoted in foreign currencies. Mellon Equity uses valuation models designed to identify common stocks of companies that have demonstrated consistent earnings momentum and delivered superior results relative to market analyst expectations. Other considerations include profit margins, growth in cash flow and other standard balance sheet measures. The securities held are generally characterized by strong earnings momentum measures and higher expected earnings per share growth. The valuation model incorporates information about the relevant criteria as of the most recent period for which data are available. Once ranked, the securities are categorized under the headings "buy," "sell" or "hold." The decision to buy, sell or hold is made by Mellon Equity based primarily on output of the valuation model. However, that decision may be modified due to subsequently available or other specific relevant information about the security. In addition, Mellon Equity manages risk by diversifying across companies and industries, limiting the potential adverse impact from any one stock or industry. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. MEDIUM CAPITALIZATIONS . Companies with medium capitalizations may have a limited operating history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency PRINCIPAL VARIABLE CONTRACTS FUND 55 www.principal.com exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. EMERGING MARKET COUNTRIES . Investments in emerging market countries involve special risks. Certain emerging market countries have historically experienced, and may continue to experience, certain economic problems. These may include: high rates of inflation, high interest rates, exchange rate fluctuations, large amounts of debt, balance of payments and trade difficulties, and extreme poverty and unemployment. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth and willing to accept the potential for short-term fluctuations in the value of their investments. 56 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Mellon Equity has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999"10.67 "2000"8.1 "2001"-16.92 "2002"-26.27 "2003"40.58 "2004"11.82 The Account's highest/lowest quarterly returns "2005"13.72 during this time period were: HIGHESTQ4 '0124.12% LOWEST Q3 '01-25.25% LOGO The year-to-date return as of March 31, 2006 is 7.08%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* MIDCAP GROWTH ACCOUNT ........ 13.72 1.83 3.12 Russell Midcap Growth Index .. 12.10 1.38 5.30 Morningstar Mid-Cap Growth Category Average.............. 9.70 0.01 6.65 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.90% Other Expenses............................. 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.92%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MIDCAP GROWTH ACCOUNT $94 $293 $509 $1,131
PRINCIPAL VARIABLE CONTRACTS FUND 57 www.principal.com MIDCAP VALUE ACCOUNT The Account seeks long-term growth of capital by investing primarily in equity securities of companies with value characteristics and market capitalizations. MAIN STRATEGIES The Account invests primarily in common stocks of medium capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with a medium market capitalization (those with market capitalizations similar to companies in the Russell Midcap/(R)/ Value Index (as of March 31, 2006, this range was between approximately $688 million and $22.1 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Companies may range from the well-established and well known to the new and unseasoned. The Account may invest up to 25% of its assets in securities of foreign companies. The stocks are selected using a value oriented investment approach by Neuberger Berman, the Sub-Advisor. Neuberger Berman identifies value stocks in several ways. Factors it considers in identifying value stocks may include: . strong fundamentals, such as a company's financial, operational and competitive positions; . consistent cash flow; and . a sound earnings record through all phases of the market cycle. Neuberger Berman may also look for other characteristics in a company, such as a strong position relative to competitors, a high level of stock ownership among management, and a recent sharp decline in stock price that appears to be the result of a short-term market overreaction to negative news. Neuberger Berman believes that, over time, securities that are undervalued are more likely to appreciate in price and are subject to less risk of price decline than securities whose market prices have already reached their perceived economic value. This approach also involves selling portfolio securities when Neuberger Berman believes they have reached their potential, when the securities fail to perform as expected or when other opportunities appear more attractive. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. MEDIUM CAPITALIZATIONS . Companies with medium capitalizations may have a limited operating history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency 58 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth and willing to accept short-term fluctuations in the value of investments. PRINCIPAL VARIABLE CONTRACTS FUND 59 www.principal.com Neuberger Berman has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2000"31.03 "2001"-2.58 "2002"-9.96 "2003"36.49 "2004"22.67 The Account's highest/lowest quarterly returns "2005"10.55 during this time period were: HIGHEST Q2 '03 14.93% LOWEST Q3 '02 -14.54% LOGO The year-to-date return as of March 31, 2006 is 4.70%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* MIDCAP VALUE ACCOUNT ......... 10.55 10.18 13.65 Russell Midcap Value Index ... 12.65 12.21 10.93 Morningstar Mid-Cap Value Category Average.............. 8.41 9.36 10.54 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 3, 1999).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees ................. ......... 1.05% Other Expenses .................. ......... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.07%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MIDCAP VALUE ACCOUNT $109 $340 $590 $1,306
60 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 MONEY MARKET ACCOUNT The Account has an investment objective of as high a level of current income available from investments in short-term securities as is consistent with preservation of principal and maintenance of liquidity. MAIN STRATEGIES The Account invests its assets in a portfolio of high quality, short-term money market instruments. The investments are U.S. dollar denominated securities which the Sub-Advisor, Principal, believes present minimal credit risks. At the time the Account purchases each security, it is an "eligible security" as defined in the regulations issued under the Investment Company Act of 1940, as amended. The Account maintains a dollar weighted average portfolio maturity of 90 days or less. It intends to hold its investments until maturity. However, the Account may sell a security before it matures: . to take advantage of market variations; . to generate cash to cover sales of Account shares by its shareholders; or . upon revised credit opinions of the security's issuer. The sale of a security by the Account before maturity may not be in the best interest of the Account. The sale of portfolio securities is usually a taxable event. The Account does have an ability to borrow money to cover the redemption of Account shares. It is the policy of the Account to be as fully invested as possible to maximize current income. Securities in which the Account invests include: . securities issued or guaranteed by the U.S. government, including treasury bills, notes and bonds; . securities issued or guaranteed by agencies or instrumentalities of the U.S. government. These are backed either by the full faith and credit of the U.S. government or by the credit of the particular agency or instrumentality; . bank obligations including: . certificates of deposit which generally are negotiable certificates against funds deposited in a commercial bank; or . bankers acceptances which are time drafts drawn on a commercial bank, usually in connection with international commercial transactions. . commercial paper which is short-term promissory notes issued by U.S. or foreign corporations primarily to finance short-term credit needs; . corporate debt consisting of notes, bonds or debentures which at the time of purchase by the Account has 397 days or less remaining to maturity; . repurchase agreements under which securities are purchased with an agreement by the seller to repurchase the security at the same price plus interest at a specified rate. Generally these have a short maturity (less than a week) but may also have a longer maturity; and . taxable municipal obligations which are short-term obligations issued or guaranteed by state and municipal issuers which generate taxable income. Among the certificates of deposit typically held by the Account are Eurodollar and Yankee obligations which are issued in U.S. dollars by foreign banks and foreign branches of U.S. banks. Before the Sub-Advisor selects a Eurodollar or Yankee obligation, however, the foreign issuer undergoes the same credit-quality analysis and tests of financial strength as an issuer of domestic securities. MAIN RISKS As with all mutual funds, the value of the Account's assets may rise or fall. Although the Account seeks to preserve the value of an investment at $1.00 per share, it is possible to lose money by investing in the Account. An investment in the Account is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. As with any security, the securities in which the Account invests have associated risks. These include risks of: CREDIT RISK . Credit risk pertains to the issuer's ability to make scheduled principal or interest payments. This may reduce the Account's stream of income and decrease the Account's yield. PRINCIPAL VARIABLE CONTRACTS FUND 61 www.principal.com INTEREST RATE RISK . The value of the Account's shares is directly impacted by trends in interest rates. If interest rates rise, the value of debt securities generally will fall. REPURCHASE AGREEMENTS . The Account may invest in repurchase agreements with commercial banks, brokers and dealers considered by the Sub-Advisor to be creditworthy. Default or insolvency of the other party is a potential risk to the Account. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in securities issued by government-sponsored enterprises. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. EURODOLLAR AND YANKEE OBLIGATIONS . Eurodollar and Yankee obligations have risks similar to U.S. money market instruments, such as income risk and credit risk. Other risks of Eurodollar and Yankee obligations include the possibilities that: a foreign government will not let U.S. dollar-denominated assets leave the country; the banks that issue Eurodollar obligations may not be subject to the same regulations as U.S. banks; and adverse political or economic developments will affect investments in a foreign country. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking monthly dividends without incurring much principal risk. 62 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"5.07 "1997"5.04 "1998"5.2 "1999"4.84 "2000"6.07 "2001"3.92 "2002"1.42 "2003"0.74 "2004"0.92 "2005"2.69 TO OBTAIN THE ACCOUNT'S CURRENT YIELD INFORMATION, PLEASE CALL 1-800-247-4123 LOGO The year-to-date return as of March 31, 2006 is 1.00%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* Money Market Account . 2.69 1.93 3.60 3.15 *Lifetime results are measured from the date the Account was first sold (March 18, 1983).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.49% Other Expenses................... 0.12 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.61%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MONEY MARKET ACCOUNT $62 $195 $340 $762
PRINCIPAL VARIABLE CONTRACTS FUND 63 www.principal.com PRINCIPAL LIFETIME 2010 ACCOUNT The Account seeks a total return consisting of long-term growth of capital and current income. MAIN STRATEGIES To pursue its goal, the Account invests in shares of other Principal Variable Contracts Fund Accounts (the "underlying funds"). The underlying funds are intended to give the Account broad exposure to the domestic and foreign equity and fixed-income markets. The Manager and the Sub-Advisor, Principal, both provide investment advisory services to the Account. The Manager has hired Principal to develop, implement, and monitor the strategic or long-term asset class targets and target ranges for the Account. In deciding how to allocate the Account's assets among several asset classes, Principal considers long-term asset class returns, volatility assumptions and the Account's target time horizon. Principal is also responsible for employing an active rebalancing strategy that, within the target ranges, directs cash flows or Account assets towards or away from asset classes that Principal determines to be attractive or unattractive over shorter time periods, so long as the target asset class ranges are not violated. The Manager is responsible for implementing the strategic asset allocation set by Principal. In this role, the Manager selects the underlying funds and their respective weights. The Manager is also responsible for monitoring the Sub-Advisor of each underlying fund and may, at any time, add or substitute underlying funds in which the Account invests. Over time, shifts in the asset class targets and underlying funds will be designed to accommodate investors progressing from asset accumulation years to income-generation years; shifts in the asset class targets or underlying funds may also occur when market forces or Account circumstances change allocations. In allocating Account assets among the underlying funds, the Manager relies on a combination of quantitative measures, such as past performance and style consistency, and qualitative factors. Qualitative factors that the Manager considers include the fund advisor's organizational stability, investment experience, consistency of investment process, risk management processes, and information, trading and compliance systems. There are no minimum or maximum percentages in which the Account must invest in a specific asset class or underlying fund. Principal intends to gradually shift the Account's asset allocation so that within five to ten years after the year 2010, the Account's asset allocation matches that of the Principal LifeTime Strategic Income Account. At that time, the Account may be combined with the Principal LifeTime Strategic Income Account if the Board of Directors determines that the combination is in the best interests of Account shareholders. MAIN RISKS The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The Account's investments are concentrated in the underlying funds and, as a result, the Account's performance is directly related to their performance. The Account's ability to meet its investment objective depends on the ability of the underlying funds to achieve their investment objectives. Consequently, the Account is subject to the particular risks of the underlying funds in the proportions in which the Account invests in them. The Account's broad diversification is designed to cushion severe losses in any one investment sector and moderate the Account's overall price swings. However, the Account's share prices will fluctuate as the prices of the underlying funds rise or fall with changing market conditions. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the underlying funds invest have associated risks. These include risks of: INTEREST RATE CHANGES . The value of fixed-income securities held by an underlying fund may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by an underlying fund may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. 64 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 U.S. GOVERNMENT SPONSORED ENTERPRISES . An underlying fund may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. STOCK MARKET VOLATILITY . The prices of equity securities held by an underlying fund may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. FOREIGN INVESTING . The underlying funds may invest in foreign securities. Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. SMALL AND MEDIUM CAPITALIZATIONS . The underlying funds may invest in small and medium capitalization companies. Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. HEDGING STRATEGIES . The underlying funds may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The underlying funds may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the underlying funds and, therefore, the Account. However, the Account's performance could be worse than if the underlying funds had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; use of them by the underlying funds could lower Account total return; and the potential loss from the use of futures can exceed an underlying fund's initial investment in such contracts. INITIAL PUBLIC OFFERINGS ("IPOS") . An underlying fund's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors expecting to retire around the year 2010. UNDERLYING FUND ALLOCATION As of December 31, 2005, the Account's assets were allocated among the underlying funds as follows:
Bond 38.8 LargeCap Stock Index 10.1 Capital Value 3.0 LargeCap Value 5.1 Diversified International 5.6 Money Market 10.7 Equity Income 6.1 Real Estate Securities 8.5 LargeCap Growth Equity 8.1 SmallCap 4.0
Based on this allocation, the weighted average of the total account operating expenses of the underlying funds is 0.64%. The combined total expenses for the Account may be higher or lower depending on the allocation of its assets among the underlying funds. PRINCIPAL VARIABLE CONTRACTS FUND 65 www.principal.com The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2005"5.7 LOGO The Account's highest/lowest quarterly returns during this time period were: HIGHESTQ2 '053.59% LOWEST Q1 '05-1.64% The year-to-date return as of March 31, 2006 is 3.76%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF FUND* PRINCIPAL LIFETIME 2010 ACCOUNT ...... 5.70 11.41 S&P 500 Index ........................ 4.91 11.66 Lehman Brothers Aggregate Bond Index . 2.43 2.75 Morningstar Conservative Allocation Category Average...................... 3.05 5.88 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (August 30, 2004).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES
Management Fees....... 0.12% Other Expenses........ 0.08 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.20% Fee Reduction and/or Expense Reimbursement. 0.04 ---- NET EXPENSES 0.16% The Manager has contractually agreed to reimburse operating expenses so that the total Account operating expenses will not be greater than 0.16% through April 30, 2007. The Manager may choose not to continue this arrangement after April 30, 2007. As a shareholder in the underlying funds, the Account indirectly bears its pro rata share of the operating expenses incurred by each underlying fund. As of December 31, 2005, the operating expenses of the underlying funds ranged from 0.38% to 1.09%. The Account's investment return is net of the underlying funds' operating expenses.
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If the 66 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 operating expenses of the underlying funds, separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 PRINCIPAL LIFETIME 2010 ACCOUNT $16 $59 $107 $250
PRINCIPAL VARIABLE CONTRACTS FUND 67 www.principal.com PRINCIPAL LIFETIME 2020 ACCOUNT The Account seeks a total return consisting of long-term growth of capital and current income. MAIN STRATEGIES To pursue its goal, the Account invests in shares of other Principal Variable Contracts Fund Accounts (the "underlying funds"). The underlying funds are intended to give the Account broad exposure to the domestic and foreign equity and fixed-income markets. The Manager and the Sub-Advisor, Principal, both provide investment advisory services to the Account. The Manager has hired Principal to develop, implement, and monitor the strategic or long-term asset class targets and target ranges for the Account. In deciding how to allocate the Account's assets among several asset classes, Principal considers long-term asset class returns, volatility assumptions and the Account's target time horizon. Principal is also responsible for employing an active rebalancing strategy that, within the target ranges, directs cash flows or Account assets towards or away from asset classes that Principal determines to be attractive or unattractive over shorter time periods, so long as the target asset class ranges are not violated. The Manager is responsible for implementing the strategic asset allocation set by Principal. In this role, the Manager selects the underlying funds and their respective weights. The Manager is also responsible for monitoring the Sub-Advisor of each underlying fund and may, at any time, add or substitute underlying funds in which the Account invests. Over time, shifts in the asset class targets and underlying funds will be designed to accommodate investors progressing from asset accumulation years to income-generation years; shifts in the asset class targets or underlying funds may also occur when market forces or Account circumstances change allocations. In allocating Account assets among the underlying funds, the Manager relies on a combination of quantitative measures, such as past performance and style consistency, and qualitative factors. Qualitative factors that the Manager considers include the fund advisor's organizational stability, investment experience, consistency of investment process, risk management processes, and information, trading and compliance systems. There are no minimum or maximum percentages in which the Account must invest in a specific asset class or underlying fund. Principal intends to gradually shift the Account's asset allocation so that within five to ten years after the year 2020, the Account's asset allocation matches that of the Principal LifeTime Strategic Income Account. At that time, the Account may be combined with the Principal LifeTime Strategic Income Account if the Board of Directors determines that the combination is in the best interests of Account shareholders. MAIN RISKS The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The Account's investments are concentrated in the underlying funds and, as a result, the Account's performance is directly related to their performance. The Account's ability to meet its investment objective depends on the ability of the underlying funds to achieve their investment objectives. Consequently, the Account is subject to the particular risks of the underlying funds in the proportions in which the Account invests in them. The Account's broad diversification is designed to cushion severe losses in any one investment sector and moderate the Account's overall price swings. However, the Account's share prices will fluctuate as the prices of the underlying funds rise or fall with changing market conditions. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the underlying funds invest have associated risks. These include risks of: STOCK MARKET VOLATILITY . The prices of equity securities held by an underlying fund may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL AND MEDIUM CAPITALIZATIONS . The underlying funds may invest in small and medium capitalization companies. Companies with small or medium capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such 68 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. SECTOR RISK . The underlying funds may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As the Sub-Advisor allocates more of the Account's portfolio holdings to an underlying fund that allocates more of its portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . The underlying funds may invest in foreign securities. Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. HEDGING STRATEGIES . The underlying funds may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The underlying funds may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the underlying funds and, therefore, the Account. However, the Account's performance could be worse than if the underlying funds had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; use of them by the underlying funds could lower Account total return; and the potential loss from the use of futures can exceed an underlying fund's initial investment in such contracts. INITIAL PUBLIC OFFERINGS ("IPOS") . An underlying fund's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INTEREST RATE CHANGES . The value of fixed-income securities held by an underlying fund may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by an underlying fund may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. U.S. GOVERNMENT SPONSORED ENTERPRISES . An underlying fund may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. INVESTOR PROFILE The Fund may be an appropriate investment for investors expecting to retire around the year 2020 or fund a cashflow need in the year 2020. UNDERLYING FUND ALLOCATION As of December 31, 2005, the Account's assets were allocated among the underlying funds as follows:
Bond 34.5 LargeCap Value 5.6 Capital Value 7.3 Real Estate Securities 8.8 Diversified International 9.9 SmallCap 2.0 Equity Income 6.1 SmallCap Growth 1.5 LargeCap Growth Equity 5.9 SmallCap Value 1.5 LargeCap Stock Index 16.9
PRINCIPAL VARIABLE CONTRACTS FUND 69 www.principal.com Based on this allocation, the weighted average of the total account operating expenses of the underlying funds is 0.64%. The combined total expenses for the Account may be higher or lower depending on the allocation of its assets among the underlying funds. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2005"6.77 LOGO The Account's highest/lowest quarterly returns during this time period were: HIGHESTQ2 '053.27% LOWEST Q1 '05 -1.60% The year-to-date return as of March 31, 2006 is 5.00%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF FUND* PRINCIPAL LIFETIME 2020 ACCOUNT ...... 6.77 13.26 S&P 500 Index ........................ 4.91 11.66 Lehman Brothers Aggregate Bond Index . 2.43 2.75 Morningstar Moderate Allocation Category Average...................... 5.29 10.47 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (August 30, 2004).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees....... 0.12% Other Expenses........ 0.04 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.16% Fee Reduction and/or Expense Reimbursement. 0.03 ---- NET EXPENSES 0.13% The Manager has contractually agreed to reimburse operating expenses so that the total Account operating expenses will not be greater than 0.13% through April 30, 2007. The Manager may choose not to continue this arrangement after April 30, 2007. As a shareholder in the underlying funds, the Account indirectly bears its pro rata share of the operating expenses incurred by each underlying fund. As of December 31, 2005, the operating expenses of the underlying funds ranged from 0.38% to 1.13%. The Account's investment return is net of the underlying funds' operating expenses.
70 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If the operating expenses of the underlying funds, separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ------------------------------------------------------------------------------------------------- 1 3 5 10 PRINCIPAL LIFETIME 2020 ACCOUNT $13 $47 $86 $201
PRINCIPAL VARIABLE CONTRACTS FUND 71 www.principal.com PRINCIPAL LIFETIME 2030 ACCOUNT The Account seeks a total return consisting of long-term growth of capital and current income. MAIN STRATEGIES To pursue its goal, the Account invests in shares of other Principal Variable Contracts Fund Accounts (the "underlying funds"). The underlying funds are intended to give the Account broad exposure to the domestic and foreign equity and fixed-income markets. The Manager and the Sub-Advisor, Principal, both provide investment advisory services to the Account. The Manager has hired Principal to develop, implement, and monitor the strategic or long-term asset class targets and target ranges for the Account. In deciding how to allocate the Account's assets among several asset classes, Principal considers long-term asset class returns, volatility assumptions and the Account's target time horizon. Principal is also responsible for employing an active rebalancing strategy that, within the target ranges, directs cash flows or Account assets towards or away from asset classes that Principal determines to be attractive or unattractive over shorter time periods, so long as the target asset class ranges are not violated. The Manager is responsible for implementing the strategic asset allocation set by Principal. In this role, the Manager selects the underlying funds and their respective weights. The Manager is also responsible for monitoring the Sub-Advisor of each underlying fund and may, at any time, add or substitute underlying funds in which the Account invests. Over time, shifts in the asset class targets and underlying funds will be designed to accommodate investors progressing from asset accumulation years to income-generation years; shifts in the asset class targets or underlying funds may also occur when market forces or Account circumstances change allocations. In allocating Account assets among the underlying funds, the Manager relies on a combination of quantitative measures, such as past performance and style consistency, and qualitative factors. Qualitative factors that the Manager considers include the fund advisor's organizational stability, investment experience, consistency of investment process, risk management processes, and information, trading and compliance systems. There are no minimum or maximum percentages in which the Account must invest in a specific asset class or underlying fund. Principal intends to gradually shift the Account's asset allocation so that within five to ten years after the year 2030, the Account's asset allocation matches that of the Principal LifeTime Strategic Income Account. At that time, the Account may be combined with the Principal LifeTime Strategic Income Account if the Board of Directors determines that the combination is in the best interests of Account shareholders. MAIN RISKS The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The Account's investments are concentrated in the underlying funds and, as a result, the Account's performance is directly related to their performance. The Account's ability to meet its investment objective depends on the ability of the underlying funds to achieve their investment objectives. Consequently, the Account is subject to the particular risks of the underlying funds in the proportions in which the Account invests in them. The Account's broad diversification is designed to cushion severe losses in any one investment sector and moderate the Account's overall price swings. However, the Account's share prices will fluctuate as the prices of the underlying funds rise or fall with changing market conditions. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the underlying funds invest have associated risks. These include risks of: STOCK MARKET VOLATILITY . The prices of equity securities held by an underlying fund may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL AND MEDIUM CAPITALIZATIONS . The underlying funds may invest in small and medium capitalization companies. Companies with small or medium capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such 72 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. SECTOR RISK . The underlying funds may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As the Sub-Advisor allocates more of the Account's portfolio holdings to an underlying fund that allocates more of its portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . An underlying fund may invest in foreign securities. Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. HEDGING STRATEGIES . The underlying funds may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The underlying funds may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the underlying funds and, therefore, the Account. However, the Account's performance could be worse than if the underlying funds had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; use of them by the underlying funds could lower Account total return; and the potential loss from the use of futures can exceed an underlying fund's initial investment in such contracts. INITIAL PUBLIC OFFERINGS ("IPOS") . An underlying fund's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INTEREST RATE CHANGES . The value of fixed-income securities held by an underlying fund may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by an underlying fund may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. U.S. GOVERNMENT SPONSORED ENTERPRISES . An underlying fund may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. INVESTOR PROFILE The Fund may be an appropriate investment for investors expecting to retire around the year 2030 or fund a cashflow need in the year 2030. UNDERLYING FUND ALLOCATION As of December 31, 2005, the Account's assets were allocated among the underlying funds as follows:
Bond 24.8 LargeCap Value 9.0 Capital Value 5.0 Real Estate Securities 7.2 Diversified International 10.2 SmallCap 2.0 Equity Income 5.0 SmallCap Growth 2.0 LargeCap Growth Equity 14.4 SmallCap Value 2.0 LargeCap Stock Index 18.4
PRINCIPAL VARIABLE CONTRACTS FUND 73 www.principal.com Based on this allocation, the weighted average of the total account operating expenses of the underlying funds is 0.70%. The combined total expenses for the Account may be higher or lower depending on the allocation of its assets among the underlying funds. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2005"6.76 LOGO The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q3 '05 3.35% LOWEST Q1 '05 -1.59% The year-to-date return as of March 31, 2006 is 5.02%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF FUND* PRINCIPAL LIFETIME 2030 ACCOUNT ...... 6.76 13.23 S&P 500 Index ........................ 4.91 11.66 Lehman Brothers Aggregate Bond Index . 2.43 2.75 Morningstar Moderate Allocation Category Average...................... 5.29 10.47 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (August 30, 2004).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees....... 0.12% Other Expenses........ 0.26 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.38% Fee Reduction and/or Expense Reimbursement. 0.22 ---- NET EXPENSES 0.16% The Manager has contractually agreed to reimburse operating expenses so that the total Account operating expenses will not be greater than 0.16% through April 30, 2007. The Manager may choose not to continue this arrangement after April 30, 2007. As a shareholder in the underlying funds, the Account indirectly bears its pro rata share of the operating expenses incurred by each underlying fund. As of December 31, 2005, the operating expenses of the underlying funds ranged from 0.38% to 1.13%. The Account's investment return is net of the underlying funds' operating expenses.
74 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If the operating expenses of the underlying funds, separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ------------------------------------------------------------------------------------------------- 1 3 5 10 PRINCIPAL LIFETIME 2030 ACCOUNT $16 $92 $183 $451
PRINCIPAL VARIABLE CONTRACTS FUND 75 www.principal.com PRINCIPAL LIFETIME 2040 ACCOUNT The Account seeks a total return consisting of long-term growth of capital and current income. MAIN STRATEGIES To pursue its goal, the Account invests in shares of other Principal Variable Contracts Fund Accounts (the "underlying funds"). The underlying funds are intended to give the Account broad exposure to the domestic and foreign equity and fixed-income markets. The Manager and the Sub-Advisor, Principal, both provide investment advisory services to the Account. The Manager has hired Principal to develop, implement, and monitor the strategic or long-term asset class targets and target ranges for the Account. In deciding how to allocate the Account's assets among several asset classes, Principal considers long-term asset class returns, volatility assumptions and the Account's target time horizon. Principal is also responsible for employing an active rebalancing strategy that, within the target ranges, directs cash flows or Account assets towards or away from asset classes that Principal determines to be attractive or unattractive over shorter time periods, so long as the target asset class ranges are not violated. The Manager is responsible for implementing the strategic asset allocation set by Principal. In this role, the Manager selects the underlying funds and their respective weights. The Manager is also responsible for monitoring the Sub-Advisor of each underlying fund and may, at any time, add or substitute underlying funds in which the Account invests. Over time, shifts in the asset class targets and underlying funds will be designed to accommodate investors progressing from asset accumulation years to income-generation years; shifts in the asset class targets or underlying funds may also occur when market forces or Account circumstances change allocations. In allocating Account assets among the underlying funds, the Manager relies on a combination of quantitative measures, such as past performance and style consistency, and qualitative factors. Qualitative factors that the Manager considers include the fund advisor's organizational stability, investment experience, consistency of investment process, risk management processes, and information, trading and compliance systems. There are no minimum or maximum percentages in which the Account must invest in a specific asset class or underlying fund. Principal intends to gradually shift the Account's asset allocation so that within five to ten years after the year 2040, the Account's asset allocation matches that of the Principal LifeTime Strategic Income Account. At that time, the Account may be combined with the Principal LifeTime Strategic Income Account if the Board of Directors determines that the combination is in the best interests of Account shareholders. MAIN RISKS The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The Account's investments are concentrated in the underlying funds and, as a result, the Account's performance is directly related to their performance. The Account's ability to meet its investment objective depends on the ability of the underlying funds to achieve their investment objectives. Consequently, the Account is subject to the particular risks of the underlying funds in the proportions in which the Account invests in them. The Account's broad diversification is designed to cushion severe losses in any one investment sector and moderate the Account's overall price swings. However, the Account's share prices will fluctuate as the prices of the underlying funds rise or fall with changing market conditions. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the underlying funds invest have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of an underlying fund's shares is affected by changes in the value of the securities it owns. The prices of equity securities held by the underlying fund may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL AND MEDIUM CAPITALIZATIONS . An underlying fund may invest in small and medium capitalization companies. Companies with small or medium capitalizations are often companies with a limited operation history. Such companies 76 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. SECTOR RISK . The underlying funds may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As the Sub-Advisor allocates more of the Account's portfolio holdings to an underlying fund that allocates more of its portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . The underlying funds may invest in foreign securities. Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. HEDGING STRATEGIES . The underlying funds may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The underlying funds may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the underlying funds and, therefore, the Account. However, the Account's performance could be worse than if the underlying funds had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; use of them by the underlying funds could lower Account total return; and the potential loss from the use of futures can exceed an underlying fund's initial investment in such contracts. INITIAL PUBLIC OFFERINGS ("IPOS") . An underlying fund's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. FIXED-INCOME RISKS . Interest rate changes. The value of fixed-income securities held by an underlying fund may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. . Credit risk. Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by an underlying fund may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. . High yield securities. Fixed-income securities in which an underlying fund may invest that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.). . U.S. Government Sponsored Enterprises. An underlying fund may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. PRINCIPAL VARIABLE CONTRACTS FUND 77 www.principal.com INVESTOR PROFILE The Fund may be an appropriate investment for investors expecting to retire around the year 2040 or fund a cashflow need in the year 2040. UNDERLYING FUND ALLOCATION As of December 31, 2005, the Account's assets were allocated among the underlying funds as follows:
Bond 16.6 LargeCap Value 10.9 Capital Value 5.9 Real Estate Securities 4.8 Diversified International 13.1 SmallCap 3.5 Equity Income 2.7 SmallCap Growth 2.5 LargeCap Growth Equity 16.0 SmallCap Value 2.5 LargeCap Stock Index 21.5
Based on this allocation, the weighted average of the total account operating expenses of the underlying funds is 0.73%. The combined total expenses for the Account may be higher or lower depending on the allocation of its assets among the underlying funds. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2005"7.27 LOGO The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q3 '05 3.95% LOWEST Q1 '05-1.44% The year-to-date return as of March 31, 2006 is 5.40%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF FUND* PRINCIPAL LIFETIME 2040 ACCOUNT ...... 7.27 14.55 S&P 500 Index ........................ 4.91 11.66 Lehman Brothers Aggregate Bond Index . 2.43 2.75 Morningstar Moderate Allocation Category Average...................... 5.29 10.47 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (August 30, 2004).
78 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees....... 0.12% Other Expenses........ 0.44 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.56% Fee Reduction and/or Expense Reimbursement. 0.43 ---- NET EXPENSES 0.13% The Manager has contractually agreed to reimburse operating expenses so that the total Account operating expenses will not be greater than 0.13% through April 30, 2007. The Manager may choose not to continue this arrangement after April 30, 2007. As a shareholder in the underlying funds, the Account indirectly bears its pro rata share of the operating expenses incurred by each underlying fund. As of December 31, 2005, the operating expenses of the underlying funds ranged from 0.38% to 1.13%. The Account's investment return is net of the underlying funds' operating expenses.
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If the operating expenses of the underlying funds, separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ------------------------------------------------------------------------------------------------- 1 3 5 10 PRINCIPAL LIFETIME 2040 ACCOUNT $13 $121 $255 $646
PRINCIPAL VARIABLE CONTRACTS FUND 79 www.principal.com PRINCIPAL LIFETIME 2050 ACCOUNT The Account seeks a total return consisting of long-term growth of capital and current income. MAIN STRATEGIES To pursue its goal, the Account invests in shares of other Principal Variable Contracts Fund Accounts (the "underlying funds"). The underlying funds are intended to give the Account broad exposure to the domestic and foreign equity and fixed-income markets. The Manager and the Sub-Advisor, Principal, both provide investment advisory services to the Account. The Manager has hired Principal to develop, implement, and monitor the strategic or long-term asset class targets and target ranges for the Account. In deciding how to allocate the Account's assets among several asset classes, Principal considers long-term asset class returns, volatility assumptions and the Account's target time horizon. Principal is also responsible for employing an active rebalancing strategy that, within the target ranges, directs cash flows or Account assets towards or away from asset classes that Principal determines to be attractive or unattractive over shorter time periods, so long as the target asset class ranges are not violated. The Manager is responsible for implementing the strategic asset allocation set by Principal. In this role, the Manager selects the underlying funds and their respective weights. The Manager is also responsible for monitoring the Sub-Advisor of each underlying fund and may, at any time, add or substitute underlying funds in which the Account invests. Over time, shifts in the asset class targets and underlying funds will be designed to accommodate investors progressing from asset accumulation years to income-generation years; shifts in the asset class targets or underlying funds may also occur when market forces or Account circumstances change allocations. In allocating Account assets among the underlying funds, the Manager relies on a combination of quantitative measures, such as past performance and style consistency, and qualitative factors. Qualitative factors that the Manager considers include the fund advisor's organizational stability, investment experience, consistency of investment process, risk management processes, and information, trading and compliance systems. There are no minimum or maximum percentages in which the Account must invest in a specific asset class or underlying fund. Principal intends to gradually shift the Account's asset allocation so that within five to ten years after the year 2050, the Account's asset allocation matches that of the Principal LifeTime Strategic Income Account. At that time, the Account may be combined with the Principal LifeTime Strategic Income Account if the Board of Directors determines that the combination is in the best interests of Account shareholders. MAIN RISKS The Account's investments are concentrated in the underlying funds and, as a result, the Account's performance is directly related to their performance. The Account's ability to meet its investment objective depends on the ability of the underlying funds to achieve their investment objectives. Consequently, the Account is subject to the particular risks of the underlying funds in the proportions in which the Account invests in them. The Account's broad diversification is designed to cushion severe losses in any one investment sector and moderate the Account's overall price swings. However, the Account's share prices will fluctuate as the prices of the underlying funds rise or fall with changing market conditions. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the underlying funds invest have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of an underlying fund's shares is affected by changes in the value of the securities it owns. The prices of equity securities held by the underlying fund may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL AND MEDIUM CAPITALIZATIONS . The underlying funds may invest in small and medium capitalization companies. Companies with small or medium capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such 80 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. SECTOR RISK . The underlying funds may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As the Sub-Advisor allocates more of the Account's portfolio holdings to an underlying fund that allocates more of its portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . The underlying funds may invest in foreign securities. Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. HEDGING STRATEGIES . The underlying funds may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The underlying funds may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the underlying funds and, therefore, the Account. However, the Account's performance could be worse than if the underlying funds had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; use of them by the underlying funds could lower Account total return; and the potential loss from the use of futures can exceed an underlying fund's initial investment in such contracts. INITIAL PUBLIC OFFERINGS ("IPOS") . The underlying fund's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. FIXED-INCOME RISKS . Interest rate changes. The value of fixed-income securities held by an underlying fund may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. . Credit risk. Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by an underlying fund may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. . High yield securities. Fixed-income securities in which an underlying fund may invest that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.). . U.S. Government Sponsored Enterprises. An underlying fund may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. INVESTOR PROFILE The Fund may be an appropriate investment for investors expecting to retire around the year 2050 or fund a cashflow need in the year 2050. PRINCIPAL VARIABLE CONTRACTS FUND 81 www.principal.com UNDERLYING FUND ALLOCATION As of December 31, 2005, the Account's assets were allocated among the underlying funds as follows:
Bond 8.7 LargeCap Value 12.4 Capital Value 6.5 Real Estate Securities 2.1 Diversified International 14.8 SmallCap 4.0 Equity Income 2.0 SmallCap Growth 3.0 LargeCap Growth Equity 18.8 SmallCap Value 3.0 LargeCap Stock Index 24.7
Based on this allocation, the weighted average of the total account operating expenses of the underlying funds is 0.75%. The combined total expenses for the Account may be higher or lower depending on the allocation of its assets among the underlying funds. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2005"7.56 LOGO The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q3 '05 4.41% LOWEST Q1 '05-1.33% The year-to-date return as of March 31, 2006 is 5.69%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF FUND* PRINCIPAL LIFETIME 2050 ACCOUNT ...... 7.56 14.75 S&P 500 Index ........................ 4.91 11.66 Lehman Brothers Aggregate Bond Index . 2.43 2.75 Morningstar Large Blend Category Average .............................. 5.77 12.85 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (August 30, 2004).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) 82 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees....... 0.12% Other Expenses........ 0.99 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.11% Fee Reduction and/or Expense Reimbursement. 0.99 ---- NET EXPENSES 0.12% The Manager has contractually agreed to reimburse operating expenses so that the total Account operating expenses will not be greater than 0.12% through April 30, 2007. The Manager may choose not to continue this arrangement after April 30, 2007. As a shareholder in the underlying funds, the Account indirectly bears its pro rata share of the operating expenses incurred by each underlying fund. As of December 31, 2005, the operating expenses of the underlying funds ranged from 0.38% to 1.13%. The Account's investment return is net of the underlying funds' operating expenses.
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If the operating expenses of the underlying funds, separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES --------------------------------------------------------------------------------------------------- 1 3 5 10 PRINCIPAL LIFETIME 2050 ACCOUNT $12 $220 $482 $1,232
PRINCIPAL VARIABLE CONTRACTS FUND 83 www.principal.com PRINCIPAL LIFETIME STRATEGIC INCOME ACCOUNT The Account seeks current income. MAIN STRATEGIES To pursue its goal, the Account invests in shares of other Principal Variable Contracts Fund Accounts (the "underlying funds"). The underlying funds are intended to give the Account broad exposure to the domestic and foreign equity and fixed-income markets. The Manager and the Sub-Advisor, Principal, both provide investment advisory services to the Account. The Manager has hired Principal to develop, implement, and monitor the strategic or long-term asset class targets and target ranges for the Account. In deciding how to allocate the Account's assets among several asset classes, Principal considers long-term asset class returns, volatility assumptions and the Account's target time horizon. Principal is also responsible for employing an active rebalancing strategy that, within the target ranges, directs cash flows or Account assets towards or away from asset classes that Principal determines to be attractive or unattractive over shorter time periods, so long as the target asset class ranges are not violated. The Manager is responsible for implementing the strategic asset allocation set by Principal. In this role, the Manager selects the underlying funds and their respective weights. The Manager is also responsible for monitoring the Sub-Advisor of each underlying fund and may, at any time, add or substitute underlying funds in which the Account invests. In allocating Account assets among the underlying funds, the Manager relies on a combination of quantitative measures, such as past performance and style consistency, and qualitative factors. Qualitative factors that the Manager considers include the fund advisor's organizational stability, investment experience, consistency of investment process, risk management processes, and information, trading and compliance systems. MAIN RISKS The Account's investments are concentrated in the underlying funds and, as a result, the Account's performance is directly related to their performance. The Account's ability to meet its investment objective depends on the ability of the underlying funds to achieve their investment objectives. Consequently, the Account is subject to the particular risks of the underlying funds in the proportions in which the Account invests in them. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the underlying funds invest have associated risks. These include risks of: INTEREST RATE CHANGES . The value of fixed-income securities held by an underlying fund may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by an underlying fund may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. U.S. GOVERNMENT SPONSORED ENTERPRISES . An underlying fund may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. EQUITY SECURITY RISKS . Stock market volatility. The net asset value of the underlying fund shares is affected by change in the value of the securities it owns. The net asset value of the underlying fund shares is effected by changes in the value of the securities it owns. The prices of equity securities held by an underlying fund may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. 84 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 . Foreign investing. The underlying funds may invest in foreign securities. Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries may negatively impact the portfolios of underlying funds. An underlying fund may make investments in instruments denominated in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. . Small and Medium Capitalizations. The underlying funds may invest in small and medium capitalization companies. Companies with small capitalizations are often companies with a limited operation history. Smaller capitalization companies securities may be more volatile in price than larger company securities, especially over the short-term. . Hedging strategies. Use of forward foreign currency exchange contracts, currency or index futures or other derivatives involves risks. . Initial Public Offerings ("IPOs"). An underlying fund's purchase of shares issued in IPOs exposes an underlying fund to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. INVESTOR PROFILE The Fund may be an appropriate investment for investors in retirement. UNDERLYING FUND ALLOCATION As of December 31, 2005, the Account's assets were allocated among the underlying funds as follows:
Bond 41.7 LargeCap Stock Index 5.5 Capital Value 1.5 LargeCap Value 3.0 Diversified International 3.4 Money Market 23.4 Equity Income 6.2 Real Estate Securities 9.3 LargeCap Growth Equity 4.0 SmallCap 2.0
Based on this allocation, the weighted average of the total account operating expenses of the underlying funds is 0.61%. The combined total expenses for the Account may be higher or lower depending on the allocation of its assets among the underlying funds. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2005"4.96 LOGO The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q2 '05 3.87% LOWEST Q1 '05-1.78% The year-to-date return as of March 31, 2006 is 3.00%.
PRINCIPAL VARIABLE CONTRACTS FUND 85 www.principal.com AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF FUND* PRINCIPAL LIFETIME STRATEGIC INCOME ACCOUNT .............................. 4.96 9.57 S&P 500 Index ........................ 4.91 11.66 Lehman Brothers Aggregate Bond Index . 2.43 2.75 Morningstar Conservative Allocation Category Average...................... 3.05 5.88 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (August 30, 2004).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES
Management Fees....... 0.12% Other Expenses........ 0.15 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.27% Fee Reduction and/or Expense Reimbursement. 0.13 ---- NET EXPENSES 0.14% The Manager has contractually agreed to reimburse operating expenses so that the total Account operating expenses will not be greater than 0.14% through April 30, 2007. The Manager may choose not to continue this arrangement after April 30, 2007. As a shareholder in the underlying funds, the Account indirectly bears its pro rata share of the operating expenses incurred by each underlying fund. As of December 31, 2005, the operating expenses of the underlying funds ranged from 0.38% to 1.09%. The Account's investment return is net of the underlying funds' operating expenses.
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If the operating expenses of the underlying funds, separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES --------------------------------------------------------------------------------------------- 1 3 5 10 PRINCIPAL LIFETIME STRATEGIC INCOME ACCOUNT $14 $69 $134 $326
86 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 REAL ESTATE SECURITIES ACCOUNT The Account seeks to generate a total return by investing primarily in equity securities of companies principally engaged in the real estate industry. MAIN STRATEGIES Under normal market conditions, the Account invests at least 80% of its net assets in equity securities of companies principally engaged in the real estate industry. For purposes of the Account's investment policies, a real estate company has at least 50% of its assets, income or profits derived from products or services related to the real estate industry. Real estate companies include real estate investment trusts and companies with substantial real estate holdings such as paper, lumber, hotel and entertainment companies. Companies whose products and services relate to the real estate industry include building supply manufacturers, mortgage lenders and mortgage servicing companies. Real estate investment trusts ("REITs") are corporations or business trusts that are permitted to eliminate corporate level federal income taxes by meeting certain requirements of the Internal Revenue Code. REITs are characterized as: . equity REITs, which primarily own property and generate revenue from rental income; . mortgage REITs, which invest in real estate mortgages; and . hybrid REITs, which combine the characteristics of both equity and mortgage REITs. In selecting securities for the Account, the Sub-Advisor focuses on equity REITs. The Account may invest up to 25% of its assets in securities of foreign real estate companies. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SECTOR RISK . Because the Account invests at least 80% of its net assets in securities of companies principally engaged in the real estate industry, the Account is also subject to sector risk; that is, the possibility that the real estate sector may underperform other sectors or the market as a whole. As more of the Account's portfolio holdings to the real estate sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. The share price of the Account may fluctuate more widely than the value of shares of a fund that invests in a broader range of industries. Securities of real estate companies are subject to securities market risks as well as risks similar to those of direct ownership of real estate. These include: . declines in the value of real estate . risks related to general and local economic conditions . dependency on management skills . heavy cash flow dependency . possible lack of available mortgage funds . overbuilding . extended vacancies in properties . increases in property taxes and operating expenses . changes in zoning laws . expenses incurred in the cleanup of environmental problems . casualty or condemnation losses . changes in interest rates PRINCIPAL VARIABLE CONTRACTS FUND 87 www.principal.com In addition to the risks listed above, equity REITs are affected by the changes in the value of the properties owned by the trust. Mortgage REITs are affected by the quality of the credit extended. Both equity and mortgage REITs: . may not be diversified with regard to the types of tenants (thus subject to business developments of the tenant(s)); . may not be diversified with regard to the geographic locations of the properties (thus subject to regional economic developments); and . are subject to cash flow dependency of its tenants. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. INVESTOR PROFILE The Account may be an appropriate investment for investors who seek a total return, want to invest in companies engaged in the real estate industry and accept the potential for volatile fluctuations in the value of investments. 88 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Principal REI has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999"-4.48 "2000"30.97 "2001"8.75 "2002"7.72 "2003"38.91 "2004"34.53 The Account's highest/lowest quarterly returns "2005"15.85 during this time period were: HIGHEST Q4 '04 17.84% LOWEST Q3 '99-8.40% LOGO The year-to-date return as of March 31, 2006 is 16.34%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* REAL ESTATE SECURITIES ACCOUNT 15.85 20.46 15.23 MSCI US REIT Index ........... 12.52 18.80 12.60 Morningstar Specialty - Real Estate Category Average ...... 11.59 18.58 12.68 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.88% Other Expenses............................. 0.01 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.89%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ------------------------------------------------------------------------------------------ 1 3 5 10 REAL ESTATE SECURITIES ACCOUNT $91 $284 $493 $1,096
PRINCIPAL VARIABLE CONTRACTS FUND 89 www.principal.com SHORT-TERM BOND ACCOUNT F/K/A LIMITED TERM BOND ACCOUNT The Account seeks to provide current income. MAIN STRATEGIES The Account invests primarily in short-term fixed-income securities. Under normal circumstances, the Account maintains a dollar-weighted effective maturity of not more than three years. In determining the average effective maturity of the Fund's assets, the maturity date of a callable security or prepayable securities may be adjusted to reflect the judgment of Principal, the Sub-Advisor, regarding the likelihood of the security being called or prepaid. The Account considers the term "bond" to mean any debt security. Under normal circumstances, it invests at least 80% of its assets in: . securities issued or guaranteed by the U.S. government or its agencies or instrumentalities; . debt securities of U.S. issuers rated in the three highest grades by Standard & Poor's Rating Service or Moody's Investors Service, Inc. or, if unrated, in the opinion of the Sub-Advisor, Principal, of comparable quality; and . mortgage-backed securities representing an interest in a pool of mortgage loans. The rest of the Account's assets may be invested in a variety of financial instruments, including securities in the fourth highest rating category or their equivalent. Securities in the fourth highest category are "investment grade." While they are considered to have adequate capacity to pay interest and repay principal, they do have speculative characteristics. Changes in economic and other conditions are more likely to affect the ability of the issuer to make principal and interest payments than is the case with issuers of higher rated securities. The Account may invest up to 15% of its assets in below-investment-grade fixed-income securities. Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (please see "High Yield Securities" in the section of the prospectus entitled "Certain Investment Strategies and Related Risks) The Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income. Under a reverse repurchase agreement, the Account sells securities and agrees to repurchase them at a specified date and price. The Account pays interest on this "secured financing" and attempts to make money on the difference between the financing rate and the interest it earns by investing the proceeds of the financing. While a reverse repurchase agreement is outstanding, the Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account may lend its portfolio securities to brokers, dealers and other financial institutions. In connection with such loans, the Account remains the owner of the loaned securities and continues to be entitled to payments in amounts equal to the interest, dividends or other distributions payable on the loaned securities. Loans of portfolio securities may not exceed 33 1/3% of the value of the Account's total assets (including the value of all assets received as collateral for loan). In connection with such loans the Account will receive collateral from the borrower equal to at least 100% of the value of the loaned securities. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates. When interest rates rise, the value of fixed-income securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of fixed-income securities. Some fixed-income investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. 90 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. PORTFOLIO DURATION. . The average portfolio duration of the Account normally is less than three years and is based on Principal's forecast for interest rates. Duration is a measure of the expected life of a fixed-income security that is used to determine the sensitivity of a security's price to changes in interest rates. For example, if the portfolio duration of the Account is three years, a change of 1% in the market's yield results in a change of approximately 3% in the value of the Account's securities. The longer a security's duration, the more sensitive it is to changes in interest rates. An Account with a longer average portfolio duration will be more sensitive to changes in interest rates than an Account with a shorter average portfolio duration. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates. This may increase the volatility of the Account. REVERSE REPURCHASE AGREEMENTS. . This strategy involves the risk that interest costs on money borrowed may exceed the return on securities purchased with the borrowed money. In addition, reverse repurchase agreements may increase the volatility of the Fund. LENDING OF SECURITIES . If the Account lends its portfolio securities and the borrower of the securities fail financially, the Account may experience delays in recovering the loaned securities or exercising its rights in the collateral. Loans are made only to borrowers that are deemed by the Sub-Advisor to be of good financial standing. HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.) DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. COMMODITY-LINKED DERIVATIVE INSTRUMENTS . The use of commodity-linked derivative instruments may subject the Account to greater volatility than investments in traditional securities. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-- PRINCIPAL VARIABLE CONTRACTS FUND 91 www.principal.com Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking diversification by investing in a fixed-income mutual fund. 92 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2004"1.3 "2005"1.8 The Account's highest/lowest quarterly returns LOGO during this time period were: HIGHEST Q1 '04 1.50% LOWEST Q2 '04 -1.58% The year-to-date return as of March 31, 2006 is 0.28%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF ACCOUNT* SHORT-TERM BOND ACCOUNT .................... 1.80 1.46 Lehman Brothers Mutual Fund 1-5 Gov't/Credit Index ...................................... 1.44 1.87 Morningstar Short-Term Bond Category Average 1.43 1.64 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 2003).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees...................................... 0.50% Other Expenses....................................... 0.07 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.57%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SHORT-TERM BOND ACCOUNT $58 $183 $318 $714
PRINCIPAL VARIABLE CONTRACTS FUND 93 www.principal.com SMALLCAP ACCOUNT The Account seeks long-term growth of capital by investing primarily in equity securities of companies with comparatively small market capitalizations. MAIN STRATEGIES The Account invests primarily in common stocks of small capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with small market capitalizations (those with market capitalizations similar to companies in the Russell 2000/(R)/ Index (as of March 31, 2006, this range was between approximately $23 million and $5.4 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. The Account may invest up to 25% of its assets in securities of foreign companies. In selecting securities for investment, the Sub-Advisor, Principal, looks at stocks with value and/or growth characteristics and constructs an investment portfolio that has a "blend" of stocks with these characteristics. In managing the assets of the Account, Principal does not have a policy of preferring one of these categories to the other. The value orientation emphasizes buying stocks at less than their investment value and avoiding stocks whose price has been artificially built up. The growth orientation emphasizes buying stocks of companies whose potential for growth of capital and earnings is expected to be above average. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. Principal may purchase securities issued as part of, or a short period after, companies' initial public offerings ("IPOs"), and may at times dispose of those shares shortly after their acquisition. MAIN RISKS The Account's share price may fluctuate more than that of funds primarily invested in stocks of mid-sized and large companies and may underperform as compared to the securities of larger companies. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. 94 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 125.8%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the potential for volatile fluctuations in the value of investments. PRINCIPAL VARIABLE CONTRACTS FUND 95 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999 "43.58 "2000"-11.73 "2001 "2.55 "2002"-27.33 "2003 "36.82 "2004 "19.82 The Account's highest/lowest quarterly returns "2005 "7.04 during this time period were: HIGHESTQ2 '9926.75% LOWEST Q3 '01-25.61% LOGO The year-to-date return as of March 31, 2006 is 11.13%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* SMALLCAP ACCOUNT ............. 7.04 5.51 3.66 Russell 2000 Index ........... 4.55 8.22 5.77 Morningstar Small Blend Category Average.............. 6.62 9.89 8.23 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.85% Other Expenses............................. 0.03 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.88%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SMALLCAP ACCOUNT $90 $281 $488 $1,084
96 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 SMALLCAP GROWTH ACCOUNT The Account seeks long-term growth of capital. The Manager has selected UBS Global AM and Emerald as Sub-Advisors to the Account. MAIN STRATEGIES The Account pursues its investment objective by investing primarily in equity securities. Under normal market conditions, the Account invests at least 80% of its assets in equity securities of companies with small market capitalizations (those with market capitalizations equal to or smaller than the greater of 1) $2.5 billion or 2) the highest market capitalization of the companies in the Russell 2000/(R)/ Growth Index at the time of purchase (as of March 31, 2005, this range was between approximately $23 million and $5.4 billion)). Market capitalization is defined as total current market value of a company's outstanding common stock. The Account may invest up to 25% of its assets in securities of foreign companies. UBS Global AM seeks to invest in companies that possess dominant market positions or franchises, a major technical edge, or a unique competitive advantage. To this end, UBS Global AM considers earnings revision trends, positive stock price momentum and strong fundamentals when selecting securities. The Account may also invest in securities of emerging growth companies which are companies that UBS Global AM expects to experience above average earnings or cash flow growth or meaningful changes in underlying asset values. Investments in equity securities may include common stock and preferred stock. Utilizing fundamental analysis, Emerald seeks to invest in the common stock of companies with distinct competitive advantages, strong management teams, leadership positions, high revenue and earnings growth rates versus peers, differentiated growth drivers and limited sell-side research. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. The Manager may, from time-to-time, reallocate Account assets among the Sub-Advisors. The decision to do so may be based on a variety of factors, including but not limited to: the investment capacity of each Sub-Advisor, portfolio diversification, volume of net cash flows, fund liquidity, investment performance, investment strategies, changes in each Sub-Advisor's firm or investment professionals, or changes in the number of Sub-Advisors. Ordinarily, reallocations of Account assets among Sub-Advisors will occur as a Sub-Advisor liquidates assets in the normal course of portfolio management and with net new cash flows; however, at times reallocations may occur by transferring assets in cash or in kind among Sub-Advisors. MAIN RISKS The Account's share price may fluctuate more than that of funds primarily invested in stocks of mid-sized and large companies and may underperform as compared to the securities of larger companies. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. PRINCIPAL VARIABLE CONTRACTS FUND 97 www.principal.com SECTOR RISK . UBS Global AM may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As UBS Global AM allocates more of the Account's portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries . INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks that may have greater risks than stocks of companies with lower potential for earnings growth. 98 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 UBS Global AM became the Sub-Advisor to the Account on October 1, 2002. On August 24, 2004, Emerald also became Sub-Advisor to the Account. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999 "95.69 "2000"-13.91 "2001"-32.01 "2002"-45.85 "2003 "45.64 The Account's highest/lowest quarterly returns "2004"11.24 during this time period were: HIGHESTQ4 '9959.52% LOWEST Q3 '01-37.66% LOGO The year-to-date return as of March 31, 2006 is 13.41%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* SMALLCAP GROWTH ACCOUNT ...... 6.67 -8.64 1.29 Russell 2000 Growth Index .... 4.15 2.28 1.46 Morningstar Small Growth Category Average.............. 5.74 2.17 6.26 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.00% Other Expenses............................. 0.05 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.05%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SMALLCAP GROWTH ACCOUNT $107 $334 $579 $1,283
PRINCIPAL VARIABLE CONTRACTS FUND 99 www.principal.com SMALLCAP VALUE ACCOUNT The Account seeks long-term growth of capital. The Manager has selected Mellon Equity and Morgan as Sub-Advisors to the Account. MAIN STRATEGIES The Account invests primarily in a diversified group of equity securities of U.S. companies with small market capitalizations (those with market capitalizations similar to companies in the Russell 2000/(R)/ Value Index (as of March 31, 2006, this range was between approximately $29 million and $4.2 billion)) at the time of purchase. Under normal market conditions, the Account invests at least 80% of its assets in equity securities of such companies. Emphasis is given to those companies that exhibit value characteristics. Value securities generally have above average dividend yield and below average price to earnings (P/E) ratios. Up to 25% of the Account's assets may be invested in foreign securities. The Sub-Advisor, Morgan, uses quantitative and fundamental research, systematic stock valuation and a disciplined portfolio construction process. It seeks to enhance returns and reduce the volatility in the value of the Account relative to that of the U.S. small company value universe, represented by the Russell 2000/(R)/ Value Index. Morgan continuously screens the small company universe to identify for further analysis those companies that exhibit favorable factor rankings. Such factors include various valuation and momentum measures. Morgan ranks these companies within economic sectors according to their relative attractiveness. Morgan then selects for purchase the companies it feels to be most attractive within each economic sector. Under normal market conditions, the portion of the Account sub-advised by Morgan will have sector weightings comparable to that of the U.S. small company value universe though it may under or over-weight selected economic sectors. In addition, as a company moves out of the market capitalization range of the small company universe, it generally becomes a candidate for sale. Morgan may also purchase securities issued as part of, or a short period after, companies' initial public offerings ("IPOs"), and may at times dispose of those shares shortly after their acquisition. In selecting investments for the Account, the Sub-Advisor, Mellon Equity, uses a disciplined investment process that combines fundamental analysis and risk management with a multi-factor model that searches for undervalued stocks. Undervalued stocks are those selling at a low price relative to their profits and prospective earnings growth. The stock evaluation process uses several different characteristics, including changes in earnings estimates and change in price-to-earnings ratios, in an attempt to identify value among individual stocks. Rather than using broad economic or market trends, Mellon Equity selects stocks on a company-by-company basis. To ensure ample diversification, the portion of the Account's assets managed by Mellon Equity are allocated among industries and economic sectors in similar proportions to those of the Index. The portfolio is generally kept broadly diversified in an attempt to capture opportunities that may be realized quickly during periods of above-average market volatility. By maintaining such a diversified stance, stock selection drives performance. Since the Account has a long-term investment perspective, Mellon Equity does not intend to respond to short-term market fluctuations or to acquire securities for the purpose of short-term trading. The Manager may, from time-to-time, reallocate Account assets among the Sub-Advisors. The decision to do so may be based on a variety of factors, including but not limited to: the investment capacity of each Sub-Advisor, portfolio diversification, volume of net cash flows, fund liquidity, investment performance, investment strategies, changes in each Sub-Advisor's firm or investment professionals, or changes in the number of Sub-Advisors. Ordinarily, reallocations of Account assets among Sub-Advisors will occur as a Sub-Advisor liquidates assets in the normal course of portfolio management and with net new cash flows; however, at times reallocations may occur by transferring assets in cash or in kind among Sub-Advisors. 100 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 MAIN RISKS The Account's share price may fluctuate more than that of funds primarily invested in stocks of mid-sized and large companies and may underperform as compared to the securities of larger companies. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operational history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities that may be more volatile in price than larger company securities, especially over the short-term. VALUE STOCKS . The Account's investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Companies doing business in emerging markets may not have the same range of opportunities as companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, neither Sub-Advisor can guarantee continued access to IPO offerings and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth and willing to accept volatile fluctuations in the value of their investment. The Account is not designed for investors seeking income or conservation of capital. PRINCIPAL VARIABLE CONTRACTS FUND 101 www.principal.com Morgan has been the Account's Sub-Advisor since its inception. On August 8, 2005, Mellon Equity also became Sub-Advisor to the Account. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999 "21.45 "2000 "23.87 "2001"6.25 "2002"-8.86 "2003 "50.61 "2004 "23.08 The Account's highest/lowest quarterly returns "2005"6.22 during this time period were: HIGHEST Q2 '03 23.76% LOWEST Q3 '02 -17.74% LOGO The year-to-date return as of March 31, 2006 is 13.36%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* SMALLCAP VALUE ACCOUNT ....... 6.22 13.78 12.31 Russell 2000 Value Index ..... 4.71 13.55 9.19 Morningstar Small Value Category Average.............. 6.13 13.50 9.60 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.09% Other Expenses............................. 0.04 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.13%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SMALLCAP VALUE ACCOUNT $115 $359 $622 $1,375
102 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS The information in this section does not directly apply to the Principal LifeTime Accounts. It does apply to the underlying funds in which the LifeTime Accounts invest.The Statement of Additional Information (SAI) contains additional information about investment strategies and their related risks. SECURITIES AND INVESTMENT PRACTICES MARKET VOLATILITY . Equity securities include common stocks, preferred stocks, convertible securities, depositary receipts, rights and warrants. Common stocks, the most familiar type, represent an equity (ownership) interest in a corporation. The value of a company's stock may fall as a result of factors directly relating to that company, such as decisions made by its management or lower demand for the company's products or services. A stock's value may also fall because of factors affecting not just the company, but also companies in the same industry or in a number of different industries, such as increases in production costs. The value of a company's stock may also be affected by changes in financial markets that are relatively unrelated to the company or its industry, such as changes in interest rates or currency exchange rates. In addition, a company's stock generally pays dividends only after the company invests in its own business and makes required payments to holders of its bonds and other debt. For this reason, the value of a company's stock will usually react more strongly than its bonds and other debt to actual or perceived changes in the company's financial condition or prospects. Stocks of smaller companies may be more vulnerable to adverse developments than those of larger companies. Fixed-income securities include bonds and other debt instruments that are used by issuers to borrow money from investors. The issuer generally pays the investor a fixed, variable or floating rate of interest. The amount borrowed must be repaid at maturity. Some debt securities, such as zero coupon bonds, do not pay current interest, but are sold at a discount from their face values. INTEREST RATE CHANGES . Fixed-income securities are sensitive to changes in interest rates. In general, fixed-income security prices rise when interest rates fall and fall when interest rates rise. Longer term bonds and zero coupon bonds are generally more sensitive to interest rate changes. CREDIT RISK . Fixed-income security prices are also affected by the credit quality of the issuer. Investment grade debt securities are medium and high quality securities. Some bonds, such as lower grade or "junk" bonds, may have speculative characteristics and may be particularly sensitive to economic conditions and the financial condition of the issuers. REPURCHASE AGREEMENTS AND LOANED SECURITIES Although not a principal investment strategy, each of the Accounts may invest a portion of its assets in repurchase agreements. Repurchase agreements typically involve the purchase of debt securities from a financial institution such as a bank, savings and loan association or broker-dealer. A repurchase agreement provides that the Account sells back to the seller and that the seller repurchases the underlying securities at a specified price on a specific date. Repurchase agreements may be viewed as loans by an Account collateralized by the underlying securities. This arrangement results in a fixed rate of return that is not subject to market fluctuation while the Account holds the security. In the event of a default or bankruptcy by a selling financial institution, the affected Account bears a risk of loss. To minimize such risks, the Account enters into repurchase agreements only with large, well-capitalized and well-established financial institutions. In addition, the value of the securities collateralizing the repurchase agreement is, and during the entire term of the repurchase agreement remains, at least equal to the repurchase price, including accrued interest. Each of the Accounts may lend its portfolio securities to unaffiliated broker-dealers and other unaffiliated qualified financial institutions. REVERSE REPURCHASE AGREEMENTS An Account may use reverse repurchase agreements to obtain cash to satisfy unusually heavy redemption requests or for other temporary or emergency purposes without the necessity of selling portfolio securities, or to earn additional income on portfolio securities, such as Treasury bills or notes. In a reverse repurchase agreement, an Account sells a portfolio security to another party, such as a bank or broker-dealer, in return for cash and agrees to repurchase the PRINCIPAL VARIABLE CONTRACTS FUND 103 www.principal.com instrument at a particular price and time. While a reverse repurchase agreement is outstanding, an Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account will enter into reverse repurchase agreements only with parties that the Sub-Advisor deems creditworthy. Using reverse repurchase agreements to earn additional income involves the risk that the interest earned on the invested proceeds is less than the expense of the reverse repurchase agreement transaction. This technique may also have a leveraging effect on the Account, although the Account's intent to segregate assets in the amount of the repurchase agreement minimizes this effect. CURRENCY CONTRACTS The Accounts may enter into currency contracts, currency futures contracts and options, and options on currencies for hedging and other purposes. A forward currency contract involves a privately negotiated obligation to purchase or sell a specific currency at a future date at a price set in the contract. An Account will not hedge currency exposure to an extent greater than the aggregate market value of the securities held or to be purchased by the Account (denominated or generally quoted or currently convertible into the currency). Hedging is a technique used in an attempt to reduce risk. If an Account's Sub-Advisor hedges market conditions incorrectly or employs a strategy that does not correlate well with the Account's investment, these techniques could result in a loss. These techniques may increase the volatility of an Account and may involve a small investment of cash relative to the magnitude of the risk assumed. In addition, these techniques could result in a loss if the other party to the transaction does not perform as promised. There is also a risk of government action through exchange controls that would restrict the ability of the Account to deliver or receive currency. FORWARD COMMITMENTS Although not a principal investment strategy, each of the Accounts may enter into forward commitment agreements. These agreements call for the Account to purchase or sell a security on a future date at a fixed price. Each of the Accounts may also enter into contracts to sell its investments either on demand or at a specific interval. WARRANTS Each of the Accounts may invest in warrants though none of the Accounts use such investments as a principal investment strategy. A warrant is a certificate granting its owner the right to purchase securities from the issuer at a specified price, normally higher than the current market price. HIGH YIELD SECURITIES The Asset Allocation, Balanced, Bond, MidCap Value and Short-Term Bond Accounts may invest in debt securities rated lower than BBB by S&P or Baa by Moody's or, if not rated, determined to be of equivalent quality by the Manager or the Sub-Advisor. Such securities are sometimes referred to as high yield or "junk bonds" and are considered speculative. Investment in high yield bonds involves special risks in addition to the risks associated with investment in highly rated debt securities. High yield bonds may be regarded as predominantly speculative with respect to the issuer's continuing ability to meet principal and interest payments. Moreover, such securities may, under certain circumstances, be less liquid than higher rated debt securities. Analysis of the creditworthiness of issuers of high yield securities may be more complex than for issuers of higher quality debt securities. The ability of an Account to achieve its investment objective may, to the extent of its investment in high yield bonds, be more dependent on such credit analysis than would be the case if the Account were investing in higher quality bonds. High yield bonds may be more susceptible to real or perceived adverse economic and competitive industry conditions than higher-grade bonds. The prices of high yield bonds have been found to be less sensitive to interest rate changes than more highly rated investments, but more sensitive to adverse economic downturns or individual corporate developments. If the issuer of high yield bonds defaults, an Account may incur additional expenses to seek recovery. 104 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 The secondary market on which high yield bonds are traded may be less liquid than the market for higher-grade bonds. Less liquidity in the secondary trading market could adversely affect the price at which an Account could sell a high yield bond and could adversely affect and cause large fluctuations in the daily price of the Account's shares. Adverse publicity and investor perceptions, whether or not based on fundamental analysis, may decrease the value and liquidity of high yield bonds, especially in a thinly traded market. The use of credit ratings for evaluating high yield bonds also involves certain risks. For example, credit ratings evaluate the safety of principal and interest payments, not the market value risk of high yield bonds. Also, credit rating agencies may fail to change credit ratings in a timely manner to reflect subsequent events. If a credit rating agency changes the rating of a portfolio security held by an Account, the Account may retain the security if the Manager or Sub-Advisor thinks it is in the best interest of shareholders. INITIAL PUBLIC OFFERINGS ("IPOS") Certain of the Accounts may invest in IPOs. An IPO is a company's first offering of stock to the public. IPO risk is that the market value of IPO shares will fluctuate considerably due to factors such as the absence of a prior public market, unseasoned trading, the small number of shares available for trading and limited information about the issuer. The purchase of IPO shares may involve high transaction costs. IPO shares are subject to market risk and liquidity risk. In addition, the market for IPO shares can be speculative and/or inactive for extended periods of time. The limited number of shares available for trading in some IPOs may make it more difficult for an Account to buy or sell significant amounts of shares without an unfavorable impact on prevailing prices. Investors in IPO shares can be affected by substantial dilution in the value of their shares by sales of additional shares and by concentration of control in existing management and principal shareholders. When an Account's asset base is small, a significant portion of the Account's performance could be attributable to investments in IPOs because such investments would have a magnified impact on the Account. As the Account's assets grow, the effect of the Account's investments in IPOs on the Account's performance probably will decline, which could reduce the Account's performance. Because of the price volatility of IPO shares, an Account may choose to hold IPO shares for a very short period of time. This may increase the turnover of the Account's portfolio and lead to increased expenses to the Account, such as commissions and transaction costs. By selling IPO shares, the Account may realize taxable gains it will subsequently distribute to shareholders. DERIVATIVES To the extent permitted by its investment objectives and policies, each of the Accounts (except Money Market) may invest in securities that are commonly referred to as derivative securities. Generally, a derivative is a financial arrangement, the value of which is derived from, or based on, a traditional security, asset, or market index. Certain derivative securities are described more accurately as index/structured securities. Index/structured securities are derivative securities whose value or performance is linked to other equity securities (such as depositary receipts), currencies, interest rates, indices or other financial indicators (reference indices). Some derivatives, such as mortgage-related and other asset-backed securities, are in many respects like any other investment, although they may be more volatile or less liquid than more traditional debt securities. There are many different types of derivatives and many different ways to use them. Futures and options are commonly used for traditional hedging purposes to attempt to protect an Account from exposure to changing interest rates, securities prices, or currency exchange rates and for cash management purposes as a low-cost method of gaining exposure to a particular securities market without investing directly in those securities. The Accounts may enter into put or call options, future contracts, options on futures contracts and over-the-counter swap contracts (e.g., interest rate swaps, total return swaps and credit default swaps) for both hedging and non-hedging purposes. Generally, no Account may invest in a derivative security unless the reference index or the instrument to which it relates is an eligible investment for the Account. The return on a derivative security may increase or decrease, depending upon changes in the reference index or instrument to which it relates. The risks associated with derivative investments include: . the risk that the underlying security, interest rate, market index or other financial asset will not move in the direction the Manager or Sub-Advisor anticipated; PRINCIPAL VARIABLE CONTRACTS FUND 105 www.principal.com . the possibility that there may be no liquid secondary market which may make it difficult or impossible to close out a position when desired; . the risk that adverse price movements in an instrument can result in a loss substantially greater than an Account's initial investment; and . the counterparty may fail to perform its obligations. EXCHANGE TRADED FUNDS (ETFS) These are a type of index fund bought and sold on a securities exchange. An ETF trades like common stock and represents a fixed portfolio of securities designed to track a particular market index. The Accounts could purchase shares issued by an ETF to temporarily gain exposure to a portion of the U.S. or a foreign market while awaiting purchase of underlying securities. The risks of owning an ETF generally reflect the risks of owning the underlying securities they are designed to track, although ETFs have management fees that increase their costs. CONVERTIBLE SECURITIES Convertible securities are fixed-income securities that an Account has the right to exchange for equity securities at a specified conversion price. The option allows the Account to realize additional returns if the market price of the equity securities exceeds the conversion price. For example, the Account may hold fixed-income securities that are convertible into shares of common stock at a conversion price of $10 per share. If the market value of the shares of common stock reached $12, the Account could realize an additional $2 per share by converting its fixed-income securities. Convertible securities have lower yields than comparable fixed-income securities. In addition, at the time a convertible security is issued the conversion price exceeds the market value of the underlying equity securities. Thus, convertible securities may provide lower returns than non-convertible fixed-income securities or equity securities depending upon changes in the price of the underlying equity securities. However, convertible securities permit the Account to realize some of the potential appreciation of the underlying equity securities with less risk of losing its initial investment. The Accounts treat convertible securities as both fixed-income and equity securities for purposes of investment policies and limitations because of their unique characteristics. The Accounts may invest in convertible securities without regard to their ratings. FOREIGN INVESTING As a principal investment strategy, the Asset Allocation, Diversified International, International Emerging Markets and International SmallCap Accounts may invest Account assets in securities of foreign companies. The other Accounts (except Government & High Quality Bond) may invest in securities of foreign companies but not as a principal investment strategy. For the purpose of this restriction, foreign companies are: . companies with their principal place of business or principal office outside the U.S.; and . companies for which the principal securities trading market is outside the U.S. Foreign companies may not be subject to the same uniform accounting, auditing and financial reporting practices as are required of U.S. companies. In addition, there may be less publicly available information about a foreign company than about a U.S. company. Securities of many foreign companies are less liquid and more volatile than securities of comparable U.S. companies. Commissions on foreign securities exchanges may be generally higher than those on U.S. exchanges, although each Account seeks the most favorable net results on its portfolio transactions. Foreign markets also have different clearance and settlement procedures than those in U.S. markets. In certain markets there have been times when settlements have been unable to keep pace with the volume of securities transactions, making it difficult to conduct these transactions. Delays in settlement could result in temporary periods when a portion of Account assets is not invested and earning no return. If an Account is unable to make intended security purchases due to settlement problems, the Account may miss attractive investment opportunities. In addition, an Account may incur a loss as a result of a decline in the value of its portfolio if it is unable to sell a security. With respect to certain foreign countries, there is the possibility of expropriation or confiscatory taxation, political or social instability, or diplomatic developments that could affect an Account's investments in those countries. In addition, an Account may also suffer losses due to nationalization, expropriation or differing accounting practices and 106 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 treatments. Investments in foreign securities are subject to laws of the foreign country that may limit the amount and types of foreign investments. Changes of governments or of economic or monetary policies, in the U.S. or abroad, changes in dealings between nations, currency convertibility or exchange rates could result in investment losses for an Account. Finally, even though certain currencies may be convertible into U.S. dollars, the conversion rates may be artificial relative to the actual market values and may be unfavorable to Account investors. Foreign securities are often traded with less frequency and volume, and therefore may have greater price volatility, than is the case with many U.S. securities. Brokerage commissions, custodial services, and other costs relating to investment in foreign countries are generally more expensive than in the U.S. Though the Accounts intend to acquire the securities of foreign issuers where there are public trading markets, economic or political turmoil in a country in which an Account has a significant portion of its assets or deterioration of the relationship between the U.S. and a foreign country may negatively impact the liquidity of an Account's portfolio. An Account may have difficulty meeting a large number of redemption requests. Furthermore, there may be difficulties in obtaining or enforcing judgments against foreign issuers. An Account may choose to invest in a foreign company by purchasing depositary receipts. Depositary receipts are certificates of ownership of shares in a foreign-based issuer held by a bank or other financial institution. They are alternatives to purchasing the underlying security but are subject to the foreign securities to which they relate. Investments in companies of developing countries may be subject to higher risks than investments in companies in more developed countries. These risks include: . increased social, political and economic instability; . a smaller market for these securities and low or nonexistent volume of trading that results in a lack of liquidity and in greater price volatility; . lack of publicly available information, including reports of payments of dividends or interest on outstanding securities; . foreign government policies that may restrict opportunities, including restrictions on investment in issuers or industries deemed sensitive to national interests; . relatively new capital market structure or market-oriented economy; . the possibility that recent favorable economic developments may be slowed or reversed by unanticipated political or social events in these countries; . restrictions that may make it difficult or impossible for the Account to vote proxies, exercise shareholder rights, pursue legal remedies, and obtain judgments in foreign courts; and . possible losses through the holding of securities in domestic and foreign custodial banks and depositories. In addition, many developing countries have experienced substantial, and in some periods, extremely high rates of inflation for many years. Inflation and rapid fluctuations in inflation rates have had and may continue to have negative effects on the economies and securities markets of those countries. Repatriation of investment income, capital and proceeds of sales by foreign investors may require governmental registration and/or approval in some developing countries. An Account could be adversely affected by delays in or a refusal to grant any required governmental registration or approval for repatriation. Further, the economies of developing countries generally are heavily dependent upon international trade and, accordingly, have been and may continue to be adversely affected by trade barriers, exchange controls, managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries with which they trade. SMALL AND MEDIUM CAPITALIZATION COMPANIES The Accounts (except Bond, Government & High Quality Bond, Money Market and Short-Term Bond) may invest in securities of companies with small- or mid-sized market capitalizations. The Capital Value, LargeCap Blend, LargeCap Growth Equity and LargeCap Value Accounts may hold securities of small and medium capitalization companies but not as a principal investment strategy. Market capitalization is defined as total current market value of a company's outstanding common stock. Investments in companies with smaller market capitalizations may involve greater risks and price volatility (wide, rapid fluctuations) than investments in larger, more mature companies. Small companies may PRINCIPAL VARIABLE CONTRACTS FUND 107 www.principal.com be less significant within their industries and may be at a competitive disadvantage relative to their larger competitors. While smaller companies may be subject to these additional risks, they may also realize more substantial growth than larger or more established companies. Smaller companies may be less mature than larger companies. At this earlier stage of development, the companies may have limited product lines, reduced market liquidity for their shares, limited financial resources or less depth in management than larger or more established companies. Unseasoned issuers are companies with a record of less than three years continuous operation, including the operation of predecessors and parents. Unseasoned issuers by their nature have only a limited operating history that can be used for evaluating the company's growth prospects. As a result, investment decisions for these securities may place a greater emphasis on current or planned product lines and the reputation and experience of the company's management and less emphasis on fundamental valuation factors than would be the case for more mature growth companies. TEMPORARY DEFENSIVE MEASURES From time to time, as part of its investment strategy, each Account (other than the Money Market Account which may invest in high quality money market securities at any time) may invest without limit in cash and cash equivalents for temporary defensive purposes in response to adverse market, economic or political conditions. To the extent that the Account is in a defensive position, it may lose the benefit of upswings and limit its ability to meet its investment objective. For this purpose, cash equivalents include: bank notes, bank certificates of deposit, bankers' acceptances, repurchase agreements, commercial paper, and commercial paper master notes which are floating rate debt instruments without a fixed maturity. In addition, an Account may purchase U.S. government securities, preferred stocks and debt securities, whether or not convertible into or carrying rights for common stock. LIFETIME ACCOUNTS The performance and risks of each LifeTime Account directly corresponds to the performance and risks of the underlying funds in which the Account invests. By investing in many underlying funds, the LifeTime Accounts have partial exposure to the risks of many different areas of the market. The more a LifeTime Account allocates to stock funds, the greater the expected risk. For Accounts that are farthest from their stated retirement dates, allocations to stocks are relatively high so that investors may benefit from their long-term growth potential, while allocations to fixed-income securities are relatively low. This approach is designed to help investors accumulate the assets needed during their retirement years. Principal intends to gradually shift each LifeTime Account's (except the Lifetime Strategic Income Account) allocation among the underlying funds so that within five to ten years after the stated retirement date, the Account's underlying fund allocation matches the underlying fund allocation of the Principal LifeTime Strategic Income Account. If you are considering investing in a LifeTime Account, you should take into account your estimated retirement date and risk tolerance. In general, each LifeTime Account is managed with the assumption that the investor will invest in a LifeTime Account whose stated date is closest to the date the shareholder retires. Choosing an Account targeting an earlier date represents a more conservative choice; targeting an Account with a later date represents a more aggressive choice. It is important to note that the retirement year of the Account you select should not necessarily represent the specific year you intend to start drawing retirement assets. It should be a guide only. Generally, the potential for higher returns over time is accompanied by the higher risk of a decline in the value of your principal. Investors should realize that the LifeTime Accounts are not a complete solution to their retirement needs. Investors must weigh many factors when considering when to retire, what their retirement needs will be, and what sources of income they may have. Each LifeTime Account indirectly bears its pro-rata share of the expenses of the underlying funds in which it invests, as well as directly incurring expenses. Therefore, investment in a LifeTime Account is more costly than investing directly in shares of the underlying funds. PORTFOLIO TURNOVER "Portfolio Turnover" is the term used in the industry for measuring the amount of trading that occurs in an Account's portfolio during the year. For example, a 100% turnover rate means that on average every security in the portfolio has been replaced once during the year. 108 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Accounts with high turnover rates (more than 100%) often have higher transaction costs (which are paid by the Account) and may have an adverse impact on the Account's performance. No turnover rate can be calculated for the Money Market Account because of the short maturities of the securities in which it invests. Turnover rates for each of the other Accounts may be found in the Account's Financial Highlights table. Please consider all the factors when you compare the turnover rates of different funds. A fund with consistently higher total returns and higher turnover rates than another fund may actually be achieving better performance precisely because the managers are active traders. You should also be aware that the "total return" line in the Financial Highlights section already includes portfolio turnover costs. PRICING OF ACCOUNT SHARES Each Account's shares are bought and sold at the current share price. The share price of each Account is calculated each day the New York Stock Exchange ("NYSE") is open (shares are not priced on the days on which the NYSE is closed for trading). The share price is determined at the close of business of the NYSE (normally 3:00 p.m. Central time). When an order to buy or sell shares is received, the share price used to fill the order is the next price calculated after the order is received. For all Accounts, except the Money Market Account, the share price is calculated by: . taking the current market value of the total assets of the Account . subtracting liabilities of the Account . dividing the remainder by the total number of shares owned by the Account. The securities of the Money Market Account are valued at amortized cost. The calculation procedure is described in the SAI. The Money Market Account reserves the right to determine a share price more than once each day. NOTES: . If current market values are not readily available for a security owned by an Account, its fair value is determined using a policy adopted by the Directors. . An Account's securities may be traded on foreign securities markets that generally complete trading at various times during the day prior to the close of the NYSE. Generally, the values of foreign securities used in computing a Fund's NAV are determined at the time the foreign market closes. Foreign securities and currencies are converted to U.S. dollars using the exchange rate in effect at the close of the London Exchange (generally 11:00 a.m. Eastern Time). Occasionally, events affecting the value of foreign securities occur when the foreign market is closed and the NYSE is open. The Account has adopted policies and procedures to "fair value" some or all securities held by an Account if significant events occur after the close of the market on which the foreign securities are traded but before the Account's NAV is calculated. Significant events can be specific to a single security or can include events that affect a particular foreign market or markets. A significant event can also include a general market movement in the U.S. securities markets. If the Manager believes that the market value of any or all of the foreign securities is materially affected by such an event, the securities will be valued, and the Account's NAV will be calculated, using the policy adopted by the Account. These fair valuation procedures are intended to discourage shareholders from investing in the Account for the purpose of engaging in market timing or arbitrage transactions. The trading of foreign securities generally or in a particular country or countries may not take place on all days the NYSE is open, or may trade on days the NYSE is closed. Thus, the value of the foreign securities held by the Account may change on days when shareholders are unable to purchase or redeem shares. . Certain securities issued by companies in emerging market countries may have more than one quoted valuation at any point in time. These may be referred to as local price and premium price. The premium price is often a negotiated price that may not consistently represent a price at which a specific transaction can be effected. The Fund has a policy to value such securities at a price at which the Sub-Advisor expects the securities may be sold. PRINCIPAL VARIABLE CONTRACTS FUND 109 www.principal.com DIVIDENDS AND DISTRIBUTIONS The Accounts earn dividends, interest and other income from investments and distribute this income (less expenses) as dividends. The Accounts also realize capital gains from investments and distribute these gains (less any losses) as capital gain distributions. The Accounts normally make dividends and capital gain distributions at least annually, in February. Dividends and capital gain distributions are automatically reinvested in additional shares of the Account making the distribution. MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE THE MANAGER Principal Management Corporation serves as the manager for the Fund. In its handling of the business affairs of the Fund, the Manager provides clerical, recordkeeping and bookkeeping services, and keeps the required financial and accounting records. THE SUB-ADVISORS The Manager has signed a contract with a Sub-Advisor under which the Sub-Advisor agrees to assume the obligations of the Manager to provide investment advisory service for the Account. For these services, the Sub-Advisor is paid a fee by the Manager. Information regarding Sub-Advisors and individual portfolio managers is set forth below. The Statement of Additional Information provides additional information about each portfolio manager's compensation, other accounts managed by the portfolio manager and the portfolio manager's ownership of securities in the Account. MANAGER: The Manager is an indirect subsidiary of Principal Financial Services, Inc. and has managed mutual funds since 1969. As of December 31, 2005, the mutual funds it manages had assets of approximately $28.6 billion. The Manager's address is Principal Financial Group, Des Moines, Iowa 50392-2080.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Principal LifeTime 2010 Doug Loeffler Principal LifeTime 2020 Doug Loeffler Principal LifeTime 2030 Doug Loeffler Principal LifeTime 2040 Doug Loeffler Principal LifeTime 2050 Doug Loeffler Principal LifeTime Strategic Income Doug Loeffler
DOUG LOEFFLER, CFA . - Mr. Loeffler is a Vice President with Principal Management Corporation. He is the senior member of the Manager Research Team that is responsible for analyzing, interpreting and coordinating investment performance data and evaluation of the investment managers under the due diligence program. He is responsible for preparing periodic evaluation reports including both qualitative and quantitative analysis. Mr. Loeffler participates in the manager selection process and portfolio reviews. Joining Principal Management Corporation in 2004, he has 16 years of investment experience including 14 years in the mutual fund industry (Scudder and Founders Asset Management). His background includes quantitative analysis, fundamental analysis and portfolio management focusing on non-U.S. stocks. Mr. Loeffler earned an MBA in Finance at the University of Chicago and a degree in Economics from Washington State University. He has earned the right to use the Chartered Financial Analyst designation. Mr. Loeffler shares responsibility for the day-today management of the LifeTime Accounts with Mr. Laschanzky, a portfolio manager representing Principal. On behalf of Principal, Mr. Laschanzky develops, implements and monitors the Account's strategic or long-term asset class targets and target ranges. On behalf of the Manager, Mr. Loeffler implements the strategic asset allocation Mr. Laschanzky sets. 110 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 SUB-ADVISOR: AllianceBernstein L.P. ("AllianceBernstein") managed $579 billion in assets as of December 31, 2005. AllianceBernstein is located at 1345 Avenue of the Americas, New York, NY 10105. The management of and investment decisions for the Account's portfolio are made by the US Value Investment Policy Group, comprised of senior US Value Investment Team members. The US Value Investment Policy Group relies heavily on the fundamental analysis and research of the Adviser's large internal research staff. No one person is principally responsible for making recommendations for the Account's portfolio. the members of the US Value Investment Policy Group with the most significant responsibility for the day-to-day management of the Account's portfolio are: Marilyn Fedak, John Mahedy, John Phillips and Chris Marx. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ LargeCap Value Marilyn Fedak John Mahedy Chris Marx John Phillips
MARILYN G. FEDAK, CFA . Ms. Fedak joined Bernstein in 1984 as a senior portfolio manager. An Executive Vice President of AllianceBernstein since 2000, she is Head of Global Value Equities and chair of the US Large Cap Value Equity Investment Policy Group. Ms. Fedak serves on AllianceBernstein's Management Executive Committee and is also a Director of SCB Inc. She earned a BA from Smith College and an MBA from Harvard University. She has also earned the right to use the Chartered Financial Analyst designation. JOHN MAHEDY, CPA . Mr. Mahedy was named Co-CIO-US Value equities in 2003. He continues to serve as director of research-US Value Equities, a position he has held since 2001. Previously, Mr. Mahedy was a senior research analyst at Bernstein's institutional research and brokerage unit, covering the domestic and international energy industry from 1995 to 2001. He earned a BS and an MBA from New York University. CHRISTOPHER W. MARX . Mr. Marx joined the firm in 1997 as a research analyst. He covered a variety of industries both domestically and internationally, including chemicals, food, supermarkets, beverages and tobacco. Mr. Marx earned an AB in Economics from Harvard, and an MBA from the Stanford Graduate School of Business. JOHN D. PHILLIPS, JR., CFA . Mr. Phillips joined the firm in 1994 and is a senior portfolio manager and member of the US Value Equities Investment Policy Group. He is also chairman of Bernstein's Proxy Voting Committee. Mr. Phillips earned a BA from Hamilton College and an MBA from Harvard University. He has also earned the right to use the Chartered Financial Analyst designation. SUB-ADVISOR: Columbus Circle Investors ("CCI") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. CCI was founded in 1975. Its address is Metro Center, One Station Place, Stamford, CT 06902. As of December 31, 2005, CCI had approximately $5.9 billion in assets under management. The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account. PRINCIPAL VARIABLE CONTRACTS FUND 111 www.principal.com
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Growth Anthony Rizza
ANTHONY RIZZA, CFA . Mr. Rizza, portfolio manager, joined CCI in 1991. He received a BS in Business from the University of Connecticut. Mr. Rizza has earned the right to use the Chartered Financial Analyst designation and is a member of the Hartford Society of Security Analysts. SUB-ADVISOR: Emerald Advisers, Inc. ("Emerald") is a wholly-owned subsidiary of Emerald Asset Management. Emerald provides professional investment advisory services to institutional investors, high net worth individuals and the general public. As of December 31, 2005, Emerald managed approximately $2.36 billion in assets. Emerald's offices are located at 1703 Oregon Pike Road, Suite 101, Lancaster, Pennsylvania 17601.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ SmallCap Growth Joseph W. Garner Kenneth G. Mertz Stacey L. Sears
The portfolio management and strategy team have long tenures at Emerald, with Ms. Sears joining Emerald in 1991, Mr. Mertz in 1992 and Mr. Garner in 1994. JOSEPH W. GARNER . Mr. Garner joined Emerald in 1994 and serves as Director of Emerald Research and Portfolio Manager. Prior to joining Emerald, Mr. Garner was the Program Manager of the Pennsylvania Economic Development Financing Authority (PEDFA); an Economic Development Analyst with the PA Department of Commerce's Office of Technology Development; and an Industry Research Analyst with the Pittsburgh High Technology Council. Mr. Garner earned an MBA from the Katz Graduate School of Business, University of Pittsburgh, and graduated magna cum laude with a BA in Economics from Millersville University. KENNETH G. MERTZ II, CFA. . Mr. Mertz joined Emerald in 1992 and serves as President of Emerald Advisers, Inc. Formerly he served as Past Trustee, Vice President of the Emerald Mutual Funds (1992-2005) and Chief Investment Officer of the Pennsylvania State Employees' Retirement System (1985-1992). He earned a BA in Economics from Millersville University. Mr. Mertz supervises the entire portfolio management and trading process. As Chief Investment Officer, he has full discretion over all portfolios. Mr. Mertz, Ms. Sears and Mr. Garner work as a team developing strategy. STACEY L. SEARS . Ms. Sears joined Emerald in 1991 and serves as Senior Vice President and Portfolio Manager of Emerald Advisers, Inc. She is co-manager of the Forward Emerald Growth Fund and a member of the Portfolio Management team. Additionally, Ms. Sears maintains research coverage of retail, apparel, consumer goods and consumer technology companies. Ms. Sears earned a BS in Business Administration from Millersville University and an MBA from Villanova University. SUB-ADVISOR: Grantham, Mayo, Van Otterloo & Co. LLC ("GMO") is a privately held global investment management firm servicing clients in the corporate, public, endowment and foundation marketplace located at 40 Rowes Wharf, Boston, MA 02110. As of December 31, 2005, GMO managed $111 billion in client assets. 112 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ LargeCap Growth Equity Sam Wilderman
Day-to-day management of the Partners LargeCap Growth Fund is the responsibility of GMO's U.S. Quantitative Division. The Division's members work collaboratively to manage the Account's portfolio, and no one person is primarily responsible for day-to-day management. The individual responsible for managing the implementation and monitoring of the overall portfolio management of the Account is Sam Wilderman. Mr. Wilderman allocates responsibility for portions of the Account's portfolio to various members of the Division, oversees the implementation of trades, reviews the overall composition of the Account's portfolio, including compliance with stated investment objectives and strategies and monitors cash flows. Mr. Wilderman is a member (partner) of GMO and is Director of GMO's U.S. Quantitative Division. Mr. Wilderman served as co-director of U.S. equity management in 2005. Prior to this position, he was responsible for research and portfolio management for the GMO Emerging Markets Fund, the GMO Emerging Countries Fund and the GMO Emerging Markets Quality Fund. He joined GMO in 1996 following the completion of his B.A. in Economics from Yale University. The SAI contains other information about how GMO determines the compensation of the Division's senior member, other accounts managed by the team's senior member, and ownership of mutual fund shares by the Division's senior member. SUB-ADVISOR: J.P. Morgan Investment Management Inc. ("Morgan"), 522 Fifth Avenue, New York, NY 10036 is an indirect wholly-owned subsidiary of JPMorgan Chase & Co. ("JPMorgan"), a bank holding company. Morgan offers a wide range of services to governmental, institutional, corporate and individual customers and acts as investment advisor to individual and institutional clients. As of December 31, 2005, Morgan had total combined assets under management of approximately $847 billion. The portfolio managers operate as a team, sharing responsibility for the day-to-day management of the portfolio, each strategy does, however, have lead portfolio managers with responsibility for implementing the insight of the team into individual portfolios. The Statement of Additional Information provides additional information about the portfolio managers' compensation, other accounts managed by the portfolio managers and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ SmallCap Value Christopher T. Blum Dennis S. Ruhl
CHRISTOPHER T. BLUM, CFA . Managing Director of Morgan. Mr. Blum is a portfolio manager in the U.S. Small Cap Equity Group. He rejoined the firm in 2001. Previously, he spent two years as a research analyst responsible for the valuation and acquisition of private equity assets at Pomona Capital. Prior to that, Mr. Blum spent over three years with Morgan where he focused on structured small-cap core and small-cap value accounts. He earned his BBA in Finance at the Bernard M. Baruch School for Business and is a holder of the CFA designation. DENNIS S. RUHL, CFA . Mr. Ruhl, Vice President of Morgan, joined the company in 1999. He is a portfolio manager in the U.S. Small Cap Equity Group. His current responsibilities include managing structured small cap core and value accounts. Previously, he worked on quantitative equity research (focusing on trading) as well as business PRINCIPAL VARIABLE CONTRACTS FUND 113 www.principal.com development. Mr. Ruhl earned Bachelor's degrees in Mathematics and Computer Science and a Master's degree in Computer Science, all from MIT. He has earned the right to use the Chartered Financial Analyst designation. SUB-ADVISOR: Mellon Equity Associates, LLP ("Mellon Equity"), 500 Grant Street, Suite 4200, Pittsburgh, PA 15258. Mellon Equity is a wholly owned subsidiary of Mellon Financial Corporation ("Mellon"). Mellon has approximately $4.7 trillion in assets under management, administration or custody, including $781 billion under management. As of December 31, 2005, Mellon Equity managed approximately $21.3 billion in assets. The day-to-day portfolio management for some of the Accounts listed below is shared by two or more portfolio managers. In each such case, except where noted below, the portfolio managers operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio with no limitation on the authority of one portfolio manager in relation to another. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ MidCap Growth Adam T. Logan John O'Toole SmallCap Value Ronald P. Gala Peter D. Goslin
RONALD P. GALA, CFA . Mr. Gala is a portfolio manager of Dreyfus and a Senior Vice President and a principal of Mellon Equity. Mr. Gala has 20 years experience managing equity portfolios, and he is a past president of the Pittsburgh Society of Financial Analysts. Mr. Gala earned his MBA in Finance from the University of Pittsburgh and his BS in Business Administration from Duquesne University. He is a Chartered Financial Analyst. PETER D. GOSLIN, CFA . Mr. Goslin is a Vice President and Portfolio Manager with Mellon Equity. Before joining Mellon Equity in 1999, Mr. Goslin spent over four years with Merrill Lynch. During his tenure with Merrill, he worked as a NASDAQ market maker and an equity index options proprietary trader. Prior to that, he ran Merrill's S&P options desk at the Chicago Mercantile Exchange. Mr. Goslin earned his MBA in Finance at the University of Notre Dame Graduate School of Business following a BS in Finance from St. Vincent College. He has earned the right to use the Chartered Financial Analyst designation. ADAM T. LOGAN, CFA . Joining the company in 1998, Mr. Logan is a portfolio manager and Vice President of Mellon Equity. Previously, he performed duties as a financial analyst in Mellon Financial Corporation's corporate finance department. He is currently responsible for the management of client portfolios with a specific focus on mid and small capitalization securities. He earned a BA in Finance from Westminster College and an MBA from the Katz Graduate School of Business at the University of Pittsburgh. He has earned the right to use the Chartered Financial Analyst designation. JOHN O'TOOLE, CFA . Senior Vice President of Mellon Equity since 1990. Mr. O'Toole holds an MBA in Finance from the University of Chicago and a BA in Economics from the University of Pennsylvania. He is a member of the Association for Investment Management and Research, and the Pittsburgh Society of Financial Analysts. He is a Chartered Financial Analyst. 114 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 SUB-ADVISOR: Morgan Stanley Investment Management Inc. ("MSIM Inc."), doing business in certain instances (including its role as sub-advisor to the Asset Allocation Account) under the name "Van Kampen," is a registered investment adviser, located at 1221 Avenue of the Americas, New York, New York, 10020, and is a direct subsidiary of Morgan Stanley. As of December 31, 2005, Van Kampen, together with its affiliated asset management companies, had approximately $434.0 billion in asset under management. The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Asset Allocation Francine J. Bovich
FRANCINE J. BOVICH . Ms. Bovich is Managing Director of Morgan Stanley and Morgan Stanley & Co. Incorporated since 1997. Principal 1993-1996. Ms. Bovich holds a BA in Economics from Connecticut College, and an MBA in Finance from New York University. Ms. Bovich is co-head of Morgan Stanley's Global Tactical Asset Allocation Team. Ms. Bovich is responsible for the overall allocation of the Fund's assets among equities, bonds and money market instruments. SUB-ADVISOR: Neuberger Berman Management, Inc. ("Neuberger Berman") is an affiliate of Neuberger Berman, LLC. Neuberger Berman, LLC is located at 605 Third Avenue, 2nd Floor, New York, NY 10158-0180. Together with Neuberger Berman, the firms manage more than $105.9 billion in total assets (as of December 31, 2005) and continue an asset management history that began in 1939. Neuberger Berman Management, Inc. is an indirect, wholly owned subsidiary of Lehman Brothers Holdings, Inc. Lehman Brothers is located at 745 Seventh Avenue, New York, NY 10019. The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ MidCap Value S. Basu Mullick
S. BASU MULLICK . Mr. Mullick, Managing Director, Portfolio Manager, joined Neuberger Berman in 1998. He is manager of mid- to large-cap value Partners Fund and mid-cap value strategy totaling $5.4 billion in assets. Prior to joining the company, Mr. Mullick was a portfolio manager at Ark Asset Management. He earned a BA in Economics from the Presidency College, India. He also earned a MA in Economics and a Ph.D., ABD Finance from Rutgers University. SUB-ADVISOR: Principal Global Investors, LLC ("Principal") is an indirectly wholly-owned subsidiary of Principal Life Insurance Company and an affiliate of the Manager. Principal manages equity, fixed-income and real estate investments primarily for institutional investors, including Principal Life. As of December 31, 2005, Principal, together with its affiliated asset management companies, had approximately $159 billion in asset under management. Principal Global Investor's headquarters address is 801 Grand Avenue, Des Moines, Iowa 50392 and has other primary asset management offices in New York, London, Sydney and Singapore. PRINCIPAL VARIABLE CONTRACTS FUND 115 www.principal.com The day-to-day portfolio management for some of the Accounts listed below is shared by two or more portfolio managers. In each such case, except where noted below, the portfolio managers operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio with no limitation on the authority of one portfolio manager in relation to another. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Balanced Dirk Laschanzky Bond William C. Armstrong Timothy R. Warrick Capital Value John Pihlblad Diversified International Paul H. Blankenhagen Juliet Cohn Christopher Ibach Equity Income Dirk Laschanzky Government & High Quality Bond Brad Fredericks Lisa Stange International Emerging Markets Michael A. Marusiak Michael L. Reynal International SmallCap Brian W. Pattinson LargeCap Stock Index Dirk Laschanzky Mariateresa Monaco MidCap K. William Nolin Money Market Tracy Reeg Alice Robertson Principal LifeTime 2010 Dirk Laschanzky Principal LifeTime 2020 Dirk Laschanzky Principal LifeTime 2030 Dirk Laschanzky Principal LifeTime 2040 Dirk Laschanzky Principal LifeTime 2050 Dirk Laschanzky Principal LifeTime Strategic Income Dirk Laschanzky Short-Term Bond Zeid Ayer Craig Dawson Martin J. Schafer SmallCap Thomas Morabito
WILLIAM C. ARMSTRONG, CFA . Mr. Armstrong is a portfolio manager for Principal. He manages multi-sector portfolios that invest in corporate bonds, mortgage-backed securities, commercial mortgage-backed securities, asset-backed securities, sovereigns, and agencies. He jointed the firm in 1992. Previously he served as a commissioned bank examiner at Federal Deposit Insurance Commission. He earned a Master's degree from the University of Iowa and a Bachelor's degree from Kearney State College. He has earned the right to use the Chartered Financial Analyst designation. ZEID AYER, PH.D., CFA . Mr. Ayer is a portfolio manager at Principal. he is a co-manager of the ultra short and short-term bond portfolios. He is also head of the Structured Debt group that covers asset-backed securities (ABS) and non-- 116 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 agency mortgage-backed securities (MBS). He joined Principal in 2001 and is the primary analyst responsible for mortgage-related ABS and non-agency MBS investments. Previously, Mr. Ayer was an assistant vice president at PNC Financial Services Group. He earned a doctorate in Physics from the University of Notre Dame, a master's in Computational Finance from Carnegie Mellon University and a Bachelor's degree in Physics from St. Xavier's College, Bombay University. He has earned the right to use the Chartered Financial Analyst designation. PAUL H. BLANKENHAGEN, CFA . Mr. Blankenhagen joined the firm in 1992 and was named a portfolio manager in 2000. He is responsible for developing portfolio strategy and the ongoing management of core international equity portfolios. He earned a Master's degree from Drake University and a Bachelor's degree in Finance from Iowa State University. He has earned the right to use the Chartered Financial Analyst designation, and is a member of the Association for Investment Management and Research (AIMR) and the Iowa Society of Financial Analysts. JULIET COHN . Ms. Cohn is a portfolio manager at Principal. She co-manages the core international equity portfolios, with an emphasis on Europe and on the health care sector. Prior to joining the firm in 2003, she served as a director and senior portfolio manager at Allianz Dresdner Asset Management, managing both retail and institutional European accounts. Prior to that, she was a fund manager at London firms Capel Cure Myers and Robert Fleming. She earned a bachelor's degree in Mathematics from Trinity College, Cambridge England. CRAIG DAWSON, CFA . Mr. Dawson is a portfolio manager at Principal. He is co-manager of the ultra short and short term bond portfolios. He joined the firm in 1998 as a research associate, then moved into a portfolio analyst role before moving into a portfoio manager position in 2002. He earned an MBA and a Bachelor's degree in Finance from the University of Iowa. Mr. Dawson has earned the right to use the Chartered Financial Analyst designation. BRAD FREDERICKS. . Mr. Fredericks is a portfolio manager at Principal. He is responsible for co-managing the government securities accounts. His responsibilities include general portfolio overview and security analysis. He joined the firm in 1998 as a financial accountant and was named a portfolio manager in 2002. Previously, Mr. Fredericks was an assistant trader at Norwest Mortgage. He earned a Bachelor's degree in Finance from Iowa State University. Mr. Fredericks is a Fellow of the Life Management Institute (FLMI). CHRISTOPHER IBACH, CFA . Mr. Ibach is an associate portfolio manager and equity research analyst at Principal. He specializes primarily in the analysis of international technology companies, with a particular emphasis on semi-conductor research. Prior to joining Principal in 2000, he gained six years of related industry experience with Motorola, Inc. Mr. Ibach earned an MBA in Finance and a Bachelor's degree in Electrical Engineering from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. DIRK LASCHANZKY, CFA . Mr. Laschanzky is a portfolio manager for Principal, responsible for portfolio implementation strategies, asset allocation and managing the midcap value and index portfolios. Prior to joining Principal in 1997, he was a portfolio manager and analyst for over seven years at AMR Investment Services. He earned an MBA and BA, both in Finance, from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. Mr. Laschanzky shares responsibility for the day-to-day management of the LifeTime Accounts with Mr. Loeffler, a portfolio manager representing the Manager. On behalf of Principal, Mr. Laschanzky develops, implements and monitors the Accounts' strategic or long-term asset class targets and target ranges. On behalf of the Manager, Mr. Loeffler implements the strategic asset allocation Mr. Laschanzky sets. MICHAEL A. MARUSIAK . Mr. Marusiak is a portfolio manager for Principal. He specializes in the management of emerging markets portfolios, as well as regional Asian equity portfolios. Prior to joining Principal in 2000, he was an analyst at Trust Company of the West. He earned an MIA in International Finance from the Columbia University School of International and Public Affairs and a BA in Business Administration and Finance from Simon Fraser University of Burnaby, British Columbia. PRINCIPAL VARIABLE CONTRACTS FUND 117 www.principal.com MARIATERESA MONACO . Ms. Monaco is an portfolio manager at Principal. She serves as portfolio manager for the firm's small-cap growth and index portfiols and as a member of the firm's asset allocation policy group. Prior to joining Principal in 2005, she was a quantitative equity analyst at Fidelity Management and Research supporting a family of institutional equity funds. Ms. Monaco earned an MBA from the Sloan School of Management at the Massachusetts Institute of Technology and a Master's degree in Electrical Engineering from Northeastern University. She also earned a Master's degree in Electrical Engineering from Politecnico di Torino, Italy, and a diploma in Piano from the Conservatorio di Torino, Italy. THOMAS MORABITO, CFA . Mr. Morabito leads the small-cap portfolio management team for Principal and is the portfolio manager on the small-cap value portfolios. Prior to joining Principal in 2000, he managed the Structured Small Cap Fund for Invesco Management & Research. He earned an MBA in Finance from Northeastern University and his BA in Economics from State University of New York. He has earned the right to use the Chartered Financial Analyst designation. K. WILLIAM NOLIN, CFA . Mr. Nolin is a portfolio manager for Principal. He serves as the portfolio manager for the firm's international small-cap equity portfolios. He joined the firm in 1994. He earned an MBA from the Yale School of Management and a Bachelor's degree in Finance from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. BRIAN W. PATTINSON, CFA . Mr. Pattinson is a portfolio manager at Principal. He serves as the portfolio manager for the firm's international small-cap equity portfolios. He joined Principal in 1994. Mr. Pattinson earned an MBA and Bachelor's degree in Finance from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. JOHN PIHLBLAD, CFA . Mr. Pihlblad is a portfolio manager at Principal. He joined the firm in 2000 and led the development of Principal Global Investors' Global Research Platform. He has over 25 years experience in creating and managing quantitative investment systems. Prior to joining Principal, Mr. Pihlblad was a partner and co-founder of GlobeFlex Capital in San Diego where he was responsible for the development and implementation of the investment process for both domestic and international products. He earned a BA from Westminster College. He has earned the right to use the Chartered Financial Analyst designation. TRACY REEG. . Ms. Reeg is a portfolio manager at Principal. She is involved in the portfolio management of money market portfolios. She joined the firm in 1993 and began trading and portfolio management duties in 2000. Ms. Reeg earned a Bachelor's degree in Finance from the University of Northern Iowa. She is a member of the Life Office Management Association (LOMA) and is a Fellow of the Life Management Institute (FLMI). MICHAEL L. REYNAL . Mr. Reynal is a portfolio manager at Principal. He specializes in the management of emerging markets portfolios, as well as regional Asian equity portfolios. Prior to joining Principal in 2001, he was responsible for equity investments in Latin America, the Mediterranean and the Balkans while at Wafra Investment Advisory Group, Inc. in New York. Mr. Reynal earned an MBA from the Amos Tuck School at Dartmouth College, an MA in History from Christ's College at the University of Cambridge and a BA in History from Middlebury College. ALICE ROBERTSON . Ms. Robertson is a trader for Principal on the corporate fixed-income trading desk. She joined the Principal Financial Group in 1990 as a credit analyst and moved to her current position in 1993. Previously, Ms. Robertson was an assistant vice president/commercial paper analyst with Duff & Phelps Credit Company. Ms. Robertson earned her Master's degree in Finance and Marketing from DePaul University and her Bachelor's degree in Economics from Northwestern University. MARTIN J. SCHAFER . Mr. Schafer is a portfolio manager for Principal. He specializes in short-term and long duration portfolios, as well as the Inflation Protection Fund and stable value mandates. He also has experience in managing mortgage-backed securities. Mr. Schafer joined the firm in 1977 and in the early 1980s he developed the firm's secondary mortgage marketing operation. In 1984, he assumed portfolio management responsibility for its residential mortgage portfolio. He began managing mutual fund assets in 1985, institutional portfolios in 1992 and stable value portfolios in 2000. He has earned a Bachelor's degree in Accounting and Finance from the University of Iowa. 118 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 LISA A. STANGE, CFA . Ms. Stange is a portfolio manager and strategist for Principal. She is responsible for managing the government securities portfolios and the mortgage-backed securities (MBS) within the multi-sector portfolios. As a strategies, Ms. Stange is involved in the formulation of broad investment strategy, quantitative research and product development. Previously, she was co-portfolio manager for U.S. multi-sector portfolios. She joined the firm in 1989. Ms. Stange earned an MBA and a Bachelor's degree from the University of Iowa. She has earned the right to use the Chartered Financial Analyst designation. TIMOTHY R. WARRICK, CFA . Mr. Warrick is a portfolio manager at Principal with responsibility for the corporate and U.S. multi-sector portfolios. He also serves as portfolio management team leader with responsibility for overseeing portfolio management function for all total return fixed income products. Prior to his portfolio management responsibilities with the firm, Mr. Warrick was a fixed income credit analyst and extensively involved in product development He joined the firm in 1990. He received an MBA in Finance from Drake University and a Bachelor's degree in Accounting and Economics from Simpson College. He has earned the right to use the Chartered Financial Analyst designation. SUB-ADVISOR: Principal Real Estate Investors, LLC ("Principal - REI"), an indirect wholly-owned subsidiary of Principal Life and an affiliate of the Manager, was founded in 2000. It manages investments for institutional investors, including Principal Life. As of December 31, 2005, Principal - REI, together with its affiliated asset management companies, had approximately $32.0 billion in asset under management. Principal - REI's address is 801 Grand Avenue, Des Moines, Iowa 50392. The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Real Estate Securities Kelly D. Rush
KELLY D. RUSH, CFA . As portfolio manager, Mr. Rush directs the Real Estate Investment Trust (REIT) activity for Principal Real Estate Investors, the dedicated real estate group of Principal. He has been managing real estate stock portfolio since 1997. Previously, Mr. Rush participated in structuring commercial mortgage loans for public real estate companies and the analysis of real estate investment trust issued bonds. He has been with the real estate investment area of the firm since 1987. He earned an MBA in Business Administration and a Bachelor's degree in Finance from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. SUB-ADVISOR: T. Rowe Price Associates, Inc. ("T. Rowe Price"), a wholly-owned subsidiary of T. Rowe Price Group, Inc., a financial services holding company, has over 68 years of investment management experience. Together with its affiliates, T. Rowe Price had approximately $269.5 billion in assets under management as of December 31, 2005. T. Rowe Price is located at 100 East Pratt Street, Baltimore, MD 21202. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Equity Growth Robert W. Sharps LargeCap Blend William J. Stromberg Richard T. Whitney
PRINCIPAL VARIABLE CONTRACTS FUND 119 www.principal.com ROBERT W. SHARPS, CFA, CPA . Mr. Sharps is a Vice President of T. Rowe Price Group, Inc., and T. Rowe Price. He is also the lead Portfolio Manager with the Large-Cap Growth Strategy Team in the Equity Division. Prior to joining the firm in 1997, Mr. Sharps was a Senior Consultant at KPMG Peat Marwick. He earned a BS, summa cum laude, in Accounting from Towson University and an MBA in Finance from the Wharton School, University of Pennsylvania. He has also earned the Chartered Financial Analyst and Certified Public Accountant accreditations. WILLIAM J. STROMBERG, CFA . Mr. Stromberg is a Vice President of T. Rowe Price Group, Inc., and T. Rowe Price, Director of Global Equity Research, and Co-Director of Equities for T. Rowe Price. Prior to joining the firm in 1987, he was employed as a Systems Engineer for the Westinghouse Defense and Electronics Center. He earned a BA from Johns Hopkins University and an MBA from Tuck School of Business at Dartmouth College. He has earned the right to use the Chartered Financial Analyst designation. Mr. Stromberg serves as a portfolio coordinator for the Account. Instead of making stock selection decisions, he is responsible for ensuring adherence to portfolio constraints and risk controls, along with managing inter-analyst activity. As the lead portfolio coordinator, Mr. Stromberg has ultimate accountability for the Account. RICHARD T. WHITNEY, CFA . Mr. Whitney is a Vice President of T. Rowe Price Group, Inc. and T. Rowe Price, Director of the firm's Quantitative Equity Group and member of the Equity Steering Committee and Brokerage Control Committee. Prior to joining the firm in 1985, Mr. Whitney was employed by the Chicago Board of Trade and IBM. He earned a BS and an MEE in Electrical Engineering from Rice University and an MBA from the University of Chicago. He has earned the right to use the Chartered Financial Analyst designation. Mr. Whitney serves as a portfolio coordinator for the Fund. Instead of making stock selection decisions, he, along with Mr. Stromberg, is responsible for ensuring adherence to portfolio constraints and risk controls, as well as managing inter-analyst activity. SUB-ADVISOR: UBS Global Asset Management (Americas) Inc., a Delaware corporation located at One North Wacker, Chicago, IL 60606 ("UBS Global AM"), is a registered investment advisor. UBS Global AM, a subsidiary of UBS AG, is a member of the UBS Global Asset Management business group (the "Group") of UBS AG. As of December 31, 2005, UBS Global AM managed approximately $66.12 billion in assets and the Group managed approximately $581.49 billion in assets. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ SmallCap Growth Paul A. Graham, Jr. David N. Wabnik
PAUL A. GRAHAM, JR., CFA . Mr. Graham joined UBS Global AM in 1994 and has had portfolio management responsibilities since 1994. Mr. Graham is Managing Director, Head of Growth Investors and Co-Head of U.S. Small Cap Growth Equity. For eight years prior to joining the firm, he served as a small cap portfolio manager and research 120 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 analyst at Value Line Asset Management. Mr. Graham received his BA from Dartmouth College. He has earned the right to use the Chartered Financial Analyst designation and is a member of the New York Society of Security Analysts. DAVID N. WABNIK . Mr. Wabnik joined UBS Global AM in 1995 and has been a portfolio manager since 1995. Mr. Wabnik is Executive Director, Co-Head of U.S. SmallCap Growth Equity. For four years prior to joining the firm, he served as a small cap portfolio manager/senior research analyst at Value Line Asset Management. Mr. Wabnik received his BS from Binghamton University and his MBA from Columbia Business School. He has completed the Certified Financial Analyst Level I exam. THE SUB-SUB-ADVISORS Principal Global Investors, LLC ("Principal") has entered into sub-sub-advisory agreements for various Accounts. Under these agreements, each sub-sub-advisor has agreed to assume the obligations of Principal for a certain portion of the Account's assets. The sub-sub-advisor is paid a fee by Principal. Principal is the sub-advisor for the Bond Account. Day-to-day management decisions concerning a portion of the Bond Account's portfolio are made by Spectrum Asset Management, Inc. ("Spectrum"), and Post Advisory Group, LLC ("Post") each of which serves as sub-sub-advisor. Principal is the sub-advisor for the Equity Income Account. Day-to-day management decisions concerning a portion of the Equity Income Account's portfolio are made by Principal Real Estate Investors LLC ("Principal - REI"), and Spectrum each of which serves as sub-sub-advisor. See the discussion regarding Principal - REI provided in connection with the Real Estate Securities Account for a description of the firm and the individual who serves as portfolio manager. SUB-ADVISOR: Post Advisory Group, LLC ("Post") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. Post was founded in April 1992. Its address is 11755 Wilshire Boulevard, Los Angeles, CA 90025. As of December 31, 2005, Post had $8.1 billion in asset under management. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account. LAWRENCE A. POST . Mr. Post is a chief executive office and chief investment officer for Post, an affiliate of Principal. He has over 35 years experience in the investment business, including 25 years in the high yield bond market. Prior to founding Post Advisory Group in 1992, he founded the high yield bond department at Smith Barney, and subsequently served as director of high yield research at Salomon Brothers and co-director of research and senior trader at Drexel Burnham Lambert. He earned an MBA in business administration from the University of Pennsylvania's Wharton School of Business and a Bachelor's degree from Lehigh University. ALLAN SCHWEITZER . Mr. Schweitzer is a Managing Director at Post. Prior to joining Post in 2000, he was a senior high yield analyst at Trust Company of the West ("TCW"). Prior to TCW, he was a high yield research analyst at Putnam Investments. Mr. Schweitzer earned a Bachelor's degree in Business Administration from Washington University at St. Louis and a Master's in Business Administration from the University of Chicago with a concentration in analytical finance and international economics. SUB-ADVISOR: Spectrum Asset Management, Inc. ("Spectrum") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. Spectrum was founded in 1987. Its address is 4 High Ridge PRINCIPAL VARIABLE CONTRACTS FUND 121 www.principal.com Park, Stamford, CT 06905. As of December 31, 2005, Spectrum, together with its affiliated asset management companies, had approximately $13.2 billion in asset under management. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account. FERNANDO DIAZ. . Mr. Diaz is a vice president and assistant portfolio manager for Spectrum. Prior to joining Spectrum in 2000, Mr. Diaz was head of preferred trading at Spear, Leeds & Kellogg and Pershing, a division of DLJ, where he initiated preferred trading operations at both firms. Mr. Diaz has also worked at Goldman Sachs as an analyst in the Investment Banking division and in the Preferred Stock division as a trader and product analyst. L. PHILLIP JACOBY. . Mr. Jacoby is Sr. Vice President and Portfolio Manager for Spectrum and chairman of Spectrum's Investment Committee. Prior to joining Spectrum in 1995, he was a senior investment officer as USL Capital Corporation, a subsidiary of Ford Motor Corporate, and co-managed a $600 million preferred stock portfolio. He earned a earned a his BS in Finance from Boston University. BERNARD M. SUSSMAN. . Mr. Sussman is Chief Investment Officer of Spectrum and Chair of its Investment Committee. Prior to joining Spectrum in 1995, Mr. Sussman was a general partner and heard of the Preferred Stock area of Goldman Sachs & Co. He was responsible for sales, trading and underwriting for all preferred products and was instrumental in the development of the hybrid (MIPS) market. He earned both an MBA in Finance and a Bachelor's degree in Industrial Relations from Cornell University. JOSEPH J. URCIUOLI. . Mr. Urciuoli is a senior vice president and director of research for Spectrum and is responsible for all credit research supporting the client portfolios. He is also a portfolio manager. He joined Spectrum in 1998 from Presidential Life Insurance Company where he served as a fixed income analyst and assistant portfolio manager of a $2 billion portfolio. Mr. Urciuoli earned an MBA in Finance and a Bachelor's degree in finance from Long Island University. DUTIES OF THE MANAGER AND SUB-ADVISOR The Manager or Sub-Advisor provides the Directors of the Fund with a recommended investment program. The program must be consistent with the Account's investment objective and policies. Within the scope of the approved investment program, the Sub-Advisor advises the Account on its investment policy and determines which securities are bought or sold, and in what amounts. FEES PAID TO THE MANAGER The Manager is paid a fee by each Account for its services, which includes any fee paid to the Sub-Advisor. The fee paid by each Account (as a percentage of the average daily net assets) for the fiscal year ended December 31, 2005 was:
Asset Allocation 0.80% MidCap 0.57% Balanced 0.59% MidCap Growth 0.90% Bond 0.45% MidCap Value 1.05% Capital Value 0.60% Money Market 0.49% Diversified Principal LifeTime 2010 International 0.85% 0.12% Equity Growth 0.76% Principal LifeTime 2020 0.12% Equity Income 0.60% Principal LifeTime 2030 0.12% Government & High Principal LifeTime 2040 Quality Bond 0.44% 0.12% Growth 0.60% Principal LifeTime 2050 0.12% International Emerging Principal LifeTime Strategic Markets 1.25% Income 0.12% International SmallCap 1.19% Real Estate Securities 0.88% LargeCap Blend 0.75% Short-Term Bond 0.50% LargeCap Growth Equity 1.00% SmallCap 0.85% LargeCap Stock Index 0.35% SmallCap Growth 1.00% LargeCap Value 0.75% SmallCap Value 1.09%
122 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 FEES PAID TO THE SUB-ADVISOR The Sub-Advisor fee paid by each Account (as a percentage of the average daily net assets) for the fiscal year ended December 31, 2005 was:
Asset Allocation 0.36% MidCap 0.14% Balanced 0.10% MidCap Growth 0.36% Bond 0.10% MidCap Value 0.46% Capital Value 0.14% Money Market 0.07% Diversified Principal LifeTime 2010 International 0.10% 0.04% Equity Growth 0.34% Principal LifeTime 2020 0.04% Equity Income 0.17% Principal LifeTime 2030 0.04% Government & High Principal LifeTime 2040 Quality Bond 0.10% 0.04% Growth 0.13% Principal LifeTime 2050 0.04% International Emerging Principal LifeTime Strategic Markets 0.48% Income 0.04% International SmallCap 0.48% Real Estate Securities 0.54% LargeCap Blend 0.30% Short-Term Bond 0.10% LargeCap Growth Equity 0.38% SmallCap 0.19% LargeCap Stock Index 0.01% SmallCap Growth 0.54% LargeCap Value 0.21% SmallCap Value 0.49%
The Fund and the Manager, under an order received from the SEC, may enter into and materially amend agreements with Sub-Advisors, other than those affiliated with the Manager, without obtaining shareholder approval. For any Account that is relying on that order, the Manager may: . hire one or more Sub-Advisors; . change Sub-Advisors; and . reallocate management fees between itself and Sub-Advisors. The Manager will continue to have the ultimate responsibility for the investment performance of these Accounts due to its responsibility to oversee Sub-Advisors and recommend their hiring, termination and replacement. No Account will rely on the order until it receives approval from its shareholders or, in the case of a new Account, the Account's sole initial shareholder before the Account is available to the other purchasers, and the Account states in its prospectus that it intends to rely on the order. The Asset Allocation, Equity Growth, LargeCap Blend, LargeCap Growth Equity, LargeCap Value, MidCap Growth, MidCap Value, SmallCap Growth and SmallCap Value Accounts have received the necessary shareholder approval and intend to rely on the order. PRINCIPAL VARIABLE CONTRACTS FUND 123 www.principal.com GENERAL INFORMATION ABOUT AN ACCOUNT FREQUENT TRADING AND MARKET-TIMING (ABUSIVE TRADING PRACTICES) The Accounts of the Principal Variable Contracts Fund are not designed for frequent trading or market timing activity. The Fund has adopted fair valuation procedures to be used in the case of significant events, including broad market movements, occurring after the close of a foreign market in which securities are traded. The procedures will be followed if the Manager believes the events will impact the value of the foreign securities. These procedures are intended to discourage market timing transactions in shares of the Accounts. The Accounts do not knowingly accommodate frequent purchases and redemptions ("excessive trading") of Fund shares by investors. If you intend to trade frequently and/or use market timing investment strategies, do not purchase these Accounts. The Fund does not knowingly accommodate excessive trading. The Principal Variable Contracts Fund considers frequent trading and market timing activities to be abusive trading practices because they may: . Disrupt the management of the Accounts by; . forcing the Account to hold short-term (liquid) assets rather than investing for long term growth, which results in lost investment opportunities for the Account; and . causing unplanned portfolio turnover; . Hurt the portfolio performance of the Account; and . Increase expenses of the Account due to; . increased broker-dealer commissions; and . increased recordkeeping and related costs. If we are not able to identify such excessive trading practices, The Accounts may be negatively impacted and may cause investors to suffer the harms described. Certain Accounts may be at greater risk for abusive trading practices. For example, those Accounts that invest in foreign securities may appeal to investors attempting to take advantage of time-zone arbitrage. This risk is particularly relevant to the Diversified International, International Emerging Markets and International SmallCap Accounts but does apply to the purchase of foreign securities by any Account. As the Accounts of the Principal Variable Contracts Fund are only available through variable annuity or variable life contracts, the Principal Variable Contracts Fund must rely on Principal Life (as sponsor of the variable contract) to monitor customer trading activity to identify and take action against excessive trading. There can be no certainty that Principal Life will identify and prevent excessive trading in all instances. When Principal Life identifies excessive trading, Principal Life will act to curtail such trading in a fair and uniform manner. If Principal Life, or the Principal Variable Contracts Fund, deem excessive trading practices to be occurring, Principal Life will take action that may include, but is not limited to: . Rejecting exchange instructions from shareholder or other person authorized by the shareholder to direct exchanges; . Restricting submission of exchange requests by, for example, allowing exchange requests to be submitted by 1st class U.S. mail only and disallowing requests made via the internet, by facsimile, by overnight courier or by telephone; . Limiting the dollar amount of an exchange and/or the number of exchanges during a year; . Requiring a holding period of a minimum of 30 days before permitting exchanges among the Accounts where there is evidence of at least one round-trip exchange (exchange or redemption of shares that were purchased within 30 days of the exchange/redemption); and . Taking such other action as directed by the Principal Variable Contracts Fund. The Principal Variable Contracts Fund has reserved the right to accept or reject, without prior written notice, any exchange requests. In some instances, an exchange may be completed prior to a determination of abusive trading. In those instances, Principal Life will reverse an exchange (within three business days of the exchange) and return the account holdings to the positions held prior to the exchange. Principal Life will give you notice in writing in this instance. 124 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 ELIGIBLE PURCHASERS Only certain eligible purchasers may buy shares of the Accounts. Eligible purchasers are limited to 1) separate accounts of Principal Life or of other insurance companies, 2) Principal Life or any of its subsidiaries or affiliates, 3) trustees of other managers of any qualified profit sharing, incentive or bonus plan established by Principal Life or any of its subsidiaries or affiliates for employees of such company, subsidiary or affiliate. Such trustees or managers may buy Account shares only in their capacities as trustees or managers and not for their personal accounts. The Board of Directors of the Fund reserves the right to broaden or limit the designation of eligible purchaser. Each Account serves as the underlying investment vehicle for variable annuity contracts and variable life insurance policies that are funded through separate accounts established by Principal Life. It is possible that in the future, it may not be advantageous for variable life insurance separate accounts and variable annuity separate accounts to invest in the Accounts at the same time. Although neither Principal Life nor the Fund currently foresees any such disadvantage, the Fund's Board of Directors monitors events in order to identify any material conflicts between such policy owners and contract holders. Material conflict could result from, for example, 1) changes in state insurance laws, 2) changes in Federal income tax law, 3) changes in the investment management of an Account, or 4) differences in voting instructions between those given by policy owners and those given by contract holders. Should it be necessary, the Board would determine what action, if any, should be taken. Such action could include the sale of Account shares by one or more of the separate accounts which could have adverse consequences. SHAREHOLDER RIGHTS The following information applies to each Account of the Principal Variable Contracts Fund, Inc. Each Account share is eligible to vote, either in person or by proxy, at all shareholder meetings for that Account. This includes the right to vote on the election of directors, selection of independent auditors and other matters submitted to meetings of shareholders of the Account. Each share has equal rights with every other share of the Account as to dividends, earnings, voting, assets and redemption. Shares are fully paid, non-assessable and have no preemptive or conversion rights. Shares of an Account are issued as full or fractional shares. Each fractional share has proportionately the same rights including voting as are provided for a full share. Shareholders of the Fund may remove any director with or without cause by the vote of a majority of the votes entitled to be case at a meeting of all Account shareholders. The bylaws of the Fund provide that the Board of Directors of the Fund may increase or decrease the aggregate number of shares that the Fund has the authority to issue, without a shareholder vote. The bylaws of the Fund also provide that the Fund does not need to hold an annual meeting of shareholders unless one of the following is required to be acted upon by shareholders under the Investment Company Act of 1940: election of directors; approval of an investment advisory agreement; ratification of the selection of independent auditors; and approval of the distribution agreement. The Fund intends to hold shareholder meetings only when required by law and at such other times when the Board of Directors deems it to be appropriate. Shareholder inquiries should be directed to: Principal Variable Contracts Fund, Inc., Principal Financial Group, Des Moines, Iowa 50392-2080. NON-CUMULATIVE VOTING The Fund's shares have non-cumulative voting rights. This means that the holders of more than 50% of the shares voting for the election of directors of the Fund can elect 100% of the directors if they choose to do so. In such event, the holders of the remaining shares voting for the election of directors will not be able to elect any directors. Principal Life votes each Account's shares allocated to each of its separate accounts registered under the Investment Company Act of 1940 and attributable to variable annuity contracts or variable life insurance policies participating in the separate accounts. The shares are voted in accordance with instructions received from contract holders, policy owners, participants and annuitants. Other shares of each Account held by each separate account, including shares for which no timely voting instructions are received, are voted in proportion to the instructions that are received with respect to contracts or policies participating that separate account. Shares of each of the Accounts held in the general account of Principal Life or in the unregistered separate accounts are voted in proportion to the instructions that are received with respect to contracts and policies participating in its registered and unregistered separate accounts. If Principal Life determines, under applicable law, that an Account's shares held in one or more separate accounts or in PRINCIPAL VARIABLE CONTRACTS FUND 125 www.principal.com its general account need not be voted according to the instructions that are received, it may vote those Account shares in its own right. PURCHASE OF ACCOUNT SHARES Shares are purchased from Princor Financial Services Corporation, the Fund's principal underwriter. There are no sales charges on shares of the Accounts, however, your variable contract may impose a charge. There are no restrictions on amounts to be invested in shares of the Accounts. Shareholder accounts for each Account are maintained under an open account system. Under this system, an account is opened and maintained for each investor. Each investment is confirmed by sending the investor a statement of account showing the current purchase and the total number of shares owned. The statement of account is treated by each Account as evidence of ownership of Account shares. Share certificates are not issued. SALE OF ACCOUNT SHARES This section applies to eligible purchasers other than the separate accounts of Principal Life and its subsidiaries. Each Account sells its shares upon request. There is no charge for the sale. A shareholder sends a written request to the Account requesting the sale of any part or all of the shares. The letter must be signed exactly as the account is registered. If payment is to be made to the registered shareholder or joint shareholder, the Account does not require a signature guarantee. If payment is to be made to another party, the shareholder's signature(s) must be guaranteed by a commercial bank, trust company, credit union, savings and loan association, national securities exchange member or brokerage firm. Shares are redeemed at the net asset value per share next computed after the request is received by the Account in proper and complete form. Sales proceeds are generally sent within three business days after the request is received in proper form. However, the right to sell shares may be suspended during any period when 1) trading on the NYSE is restricted as determined by the SEC or when the NYSE is closed for other than weekends and holidays, or 2) an emergency exists, as determined by the SEC, as a result of which a) disposal by a fund of securities owned by it is not reasonably practicable, b) it is not reasonably practicable for a fund to fairly determine the value of its net assets, or c) the SEC permits suspension for the protection of security holders. If payments are delayed and the instruction is not canceled by the shareholder's written instruction, the amount of the transaction is determined as of the first valuation date following the expiration of the permitted delay. The transaction occurs within five days thereafter. In addition, payments on surrenders attributable to a premium payment made by check may be delayed up to 15 days. This permits payment to be collected on the check. RESTRICTED TRANSFERS Shares of each of the Accounts may be transferred to an eligible purchaser. However, if an Account is requested to transfer shares to other than an eligible purchaser, the Account has the right, at its election, to purchase the shares at the net asset value next calculated after the receipt of the transfer request. However, the Account must give written notification to the transferee(s) of the shares of the election to buy the shares within seven days of the request. Settlement for the shares shall be made within the seven-day period. FINANCIAL STATEMENTS You will receive an annual financial statement for the Fund, audited by the Fund's independent registered public accounting firm, Ernst & Young LLP. That report is a part of this prospectus. You will also receive a semiannual financial statement that is unaudited. FINANCIAL HIGHLIGHTS The following financial highlights tables are intended to help you understand the Fund's financial performance for the periods shown. Certain information reflects results for a single Fund share. The total returns in each table represent the 126 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 rate that an investor would have earned or lost each period on an investment in the Fund (assuming reinvestment of all distributions). The financial statements for the Fund were audited by Ernst & Young LLP, whose report, along with the financial statements, is included in the most recent annual report for the Fund. To receive a copy of the latest annual or semiannual report for the Fund, you may telephone 1-800-247-4123. FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- ASSET ALLOCATION ACCOUNT ------------------------ Net Asset Value, Beginning of Period.. $12.28 $11.70 $9.82 $11.28 $12.02 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.19 0.14 0.15 0.20 0.24 Net Realized and Unrealized Gain (Loss) on Investments......... 0.51 0.82 1.92 (1.66) (0.71) ---- ---- ---- ----- ----- Total From Investment Operations 0.70 0.96 2.07 (1.46) (0.47) Less Dividends and Distributions: Dividends from Net Investment Income... (0.20) (0.38) (0.19) -- (0.24) Distributions from Realized Gains...... -- -- -- -- (0.03) ---- ----- Total Dividends and Distributions (0.20) (0.38) (0.19) -- (0.27) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $12.78 $12.28 $11.70 $9.82 $11.28 ====== ====== ====== ===== ====== Total Return /(a)/ ... 5.79% 8.49% 21.61% (12.94)% (3.92)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $100,637 $103,131 $98,006 $82,409 $101,904 Ratio of Expenses to Average Net Assets.. 0.86% 0.84% 0.85% 0.84% 0.85% Ratio of Net Investment Income to Average Net Assets.. 1.53% 1.19% 1.49% 1.79% 2.23% Portfolio Turnover Rate................ 83.5% 127.0% 186.0% 255.3% 182.4% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- BALANCED ACCOUNT ---------------- Net Asset Value, Beginning of Period.. $14.34 $13.31 $11.56 $13.73 $15.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.31 0.31 0.27 0.34 0.40/(c)/ Net Realized and Unrealized Gain (Loss) on Investments......... 0.64 1.00 1.83 (2.11) (1.42)/(c)/ ---- ---- ---- ----- ----- Total From Investment Operations 0.95 1.31 2.10 (1.77) (1.02) Less Dividends and Distributions: Dividends from Net Investment Income... (0.36) (0.28) (0.35) (0.40) (0.47) Distributions from Realized Gains...... -- -- -- -- (0.21) ---- ----- Total Dividends and Distributions (0.36) (0.28) (0.35) (0.40) (0.68) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $14.93 $14.34 $13.31 $11.56 $13.73 ====== ====== ====== ====== ====== Total Return /(a)/ ... 6.79% 10.05% 18.82% (13.18)% (6.96)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $116,927 $126,548 $124,735 $110,545 $144,214 Ratio of Expenses to Average Net Assets.. 0.64% 0.63% 0.65% 0.61% 0.61% Ratio of Gross Expenses to Average Net Assets.......... -- 0.63%/(b)/ 0.65%/(b)/ 0.62%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 2.19% 2.32% 2.23% 2.52% 2.73%/(c)/ Portfolio Turnover Rate................ 115.3% 128.3% 114.3% 87.8% 114.3%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. /(c) /Effective January 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies. The effect of this change for the year ended December 31, 2001 was to decrease net investment income per share by $.01, increase net realized and unrealized gains/losses per share by $.01, and decrease the ratio of net investment income to average net assets by .08%. Financial highlights for prior periods have not been restated to reflect this change in presentation. 67 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- BOND ACCOUNT ------------ Net Asset Value, Beginning of Period.. $12.31 $12.31 $12.32 $11.84 $11.78 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.50 0.51 0.52 0.51 0.56/(c)/ Net Realized and Unrealized Gain (Loss) on Investments......... (0.20) 0.08 0.02 0.54 0.35/(c)/ ----- ---- ---- ---- ---- Total From Investment Operations 0.30 0.59 0.54 1.05 0.91 Less Dividends and Distributions: Dividends from Net Investment Income... (0.57) (0.59) (0.55) (0.57) (0.85) ----- ----- ----- ----- ----- Total Dividends and Distributions (0.57) (0.59) (0.55) (0.57) (0.85) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $12.04 $12.31 $12.31 $12.32 $11.84 ====== ====== ====== ====== ====== Total Return /(a)/ ... 2.50% 4.98% 4.59% 9.26% 8.12% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $338,044 $286,684 $263,435 $232,839 $166,658 Ratio of Expenses to Average Net Assets.. 0.47% 0.47% 0.47% 0.49% 0.50% Ratio of Net Investment Income to Average Net Assets.. 4.21% 4.23% 4.32% 5.02% 5.73%/(c)/ Portfolio Turnover Rate................ 176.2% 143.6% 82.1% 63.3% 146.1% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- CAPITAL VALUE ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $32.39 $29.23 $23.60 $27.78 $30.72 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.54 0.44 0.38 0.39 0.34 Net Realized and Unrealized Gain (Loss) on Investments......... 1.66 3.17 5.63 (4.18) (2.80) ---- ---- ---- ----- ----- Total From Investment Operations 2.20 3.61 6.01 (3.79) (2.46) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.45) (0.38) (0.39) (0.34) Distributions from Realized Gains...... -- -- -- -- (0.14) ----- ----- Total Dividends and Distributions -- (0.45) (0.38) (0.39) (0.48) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $34.59 $32.39 $29.23 $23.60 $27.78 ====== ====== ====== ====== ====== Total Return /(a)/ ... 6.80% 12.36% 25.49% (13.66)% (8.05)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $258,490 $265,580 $248,253 $206,541 $254,484 Ratio of Expenses to Average Net Assets.. 0.61% 0.60% 0.61% 0.61% 0.61% Ratio of Gross Expenses to Average Net Assets.......... -- 0.60%/(b)/ 0.61%/(b)/ 0.61%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.62% 1.47% 1.47% 1.45% 1.20% Portfolio Turnover Rate................ 120.9% 183.3% 125.7% 142.6% 91.7%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. /(c) /Effective January 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies. The effect of this change for the year ended December 31, 2001 was to decrease net investment income per share by $.01, increase net realized and unrealized gains/losses per share by $.01, and decrease the ratio of net investment income to average net assets by .08%. Financial highlights for prior periods have not been restated to reflect this change in presentation. 68 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- DIVERSIFIED INTERNATIONAL ACCOUNT --------------------------------- Net Asset Value, Beginning of Period /(a)/ ............... $13.75 $11.48 $8.78 $10.51 $13.90 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.18 0.17 0.13 0.10 0.09 Net Realized and Unrealized Gain (Loss) on Investments......... 3.05 2.22 2.67 (1.78) (3.46) ---- ---- ---- ----- ----- Total From Investment Operations 3.23 2.39 2.80 (1.68) (3.37) Less Dividends and Distributions: Dividends from Net Investment Income... (0.15) (0.12) (0.10) (0.05) (0.02) ----- ----- ----- ----- ----- Total Dividends and Distributions (0.15) (0.12) (0.10) (0.05) (0.02) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $16.83 $13.75 $11.48 $8.78 $10.51 ====== ====== ====== ===== ====== Total Return /(b)/ ... 23.79% 21.03% 32.33% (16.07)% (24.27)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $293,647 $226,753 $167,726 $119,222 $145,848 Ratio of Expenses to Average Net Assets.. 0.97% 0.96% 0.92% 0.92% 0.92% Ratio of Gross Expenses to Average Net Assets.......... 0.97%/(c)/ 0.97%/(d)/ 0.93%/(d)/ 0.93%/(d)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.27% 1.39% 1.33% 1.03% 0.78% Portfolio Turnover Rate................ 121.2% 170.1% 111.5% 82.2% 84.3% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- EQUITY GROWTH ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $16.02 $14.73 $11.74 $16.29 $20.37 Income from Investment Operations: Net Investment Income (Operating Loss).... -- 0.09 0.06 0.03 0.01 Net Realized and Unrealized Gain (Loss) on Investments......... 1.21 1.28 2.99 (4.54) (2.82) ---- ---- ---- ----- ----- Total From Investment Operations 1.21 1.37 3.05 (4.51) (2.81) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.08) (0.06) (0.04) (0.02) Distributions from Realized Gains...... -- -- -- -- (1.25) ---- ----- Total Dividends and Distributions -- (0.08) (0.06) (0.04) (1.27) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $17.23 $16.02 $14.73 $11.74 $16.29 ====== ====== ====== ====== ====== Total Return /(b)/ ... 7.55% 9.33% 25.95% (27.72)% (14.86)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $274,192 $280,700 $272,831 $219,044 $334,401 Ratio of Expenses to Average Net Assets.. 0.77% 0.72% 0.74% 0.77% 0.75% Ratio of Gross Expenses to Average Net Assets.......... -- 0.77%/(e)/ 0.77%/(e)/ -- -- Ratio of Net Investment Income to Average Net Assets.. 0.00% 0.59% 0.47% 0.19% 0.06% Portfolio Turnover Rate................ 51.6% 147.7% 130.9% 138.8% 88.8%
/(a) /Effective May 1, 2005, International Account changed its name to Diversified International Account. /(b) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(c) /Expense ratio without custodian credits. /(d) /Expense ratio without commission rebates and custodian credits. /(e) /Expense ratio without commission rebates. 69 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- EQUITY INCOME ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $9.01 $7.93 $7.26 $8.73 $12.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.37 0.34 0.34 0.37 0.25 Net Realized and Unrealized Gain (Loss) on Investments......... 0.41 1.05 0.66 (1.47) (3.70) ---- ---- ---- ----- ----- Total From Investment Operations 0.78 1.39 1.00 (1.10) (3.45) Less Dividends and Distributions: Dividends from Net Investment Income... (0.01) (0.31) (0.33) (0.37) (0.25) ---- Total Dividends and Distributions (0.01) (0.31) (0.33) (0.37) (0.25) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $9.78 $9.01 $7.93 $7.26 $8.73 ===== ===== ===== ===== ===== Total Return /(b)/ ... 8.67% 17.60% 13.83% (12.61)% (27.70)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $91,489 $44,572 $30,255 $25,079 $33,802 Ratio of Expenses to Average Net Assets.. 0.66% 0.62% 0.61% 0.62% 0.62% Ratio of Net Investment Income to Average Net Assets.. 3.93% 4.13% 4.54% 4.40% 2.22% Portfolio Turnover Rate................ 84.7% 137.2% 22.5% 66.4% 104.2% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- GOVERNMENT & HIGH QUALITY BOND ACCOUNT /(A)/ -------------------------------------- Net Asset Value, Beginning of Period.. $11.64 $11.77 $12.00 $11.58 $11.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.44 0.44 0.45 0.43 0.51 Net Realized and Unrealized Gain (Loss) on Investments......... (0.21) (0.04) (0.24) 0.55 0.32 ---- ----- ----- ---- ---- Total From Investment Operations 0.23 0.40 0.21 0.98 0.83 Less Dividends and Distributions: Dividends from Net Investment Income... (0.51) (0.53) (0.44) (0.52) (0.68) Distributions from Realized Gains...... -- -- -- (0.04) -- ---- ----- Total Dividends and Distributions (0.51) (0.53) (0.44) (0.56) (0.68) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $11.36 $11.64 $11.77 $12.00 $11.58 ====== ====== ====== ====== ====== Total Return /(b)/ ... 2.01% 3.56% 1.84% 8.80% 7.61% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $316,047 $334,034 $368,564 $342,001 $193,254 Ratio of Expenses to Average Net Assets.. 0.46% 0.44% 0.44% 0.47% 0.49% Ratio of Net Investment Income to Average Net Assets.. 3.88% 3.82% 3.83% 4.87% 5.63% Portfolio Turnover Rate................ 262.1% 67.2% 110.4% 33.8% 45.9%
/(a) /Effective November 19, 2005, Government Securities Account changed its name to Government & High Quality Bond Account. /(b) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. 70 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- GROWTH ACCOUNT -------------- Net Asset Value, Beginning of Period.. $11.94 $10.95 $8.68 $12.24 $16.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.03 0.07 0.03 0.02 -- Net Realized and Unrealized Gain (Loss) on Investments......... 1.40 0.95 2.26 (3.58) (4.19) ---- ---- ---- ----- ----- Total From Investment Operations 1.43 1.02 2.29 (3.56) (4.19) Less Dividends and Distributions: Dividends from Net Investment Income... (0.08) (0.03) (0.02) -- -- ---- Total Dividends and Distributions (0.08) (0.03) (0.02) -- -- ---- ----- ----- ----- Net Asset Value, End of Period............ $13.29 $11.94 $10.95 $8.68 $12.24 ====== ====== ====== ===== ====== Total Return /(b)/ ... 12.09% 9.38% 26.46% (29.07)% (25.50)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $124,254 $134,956 $141,107 $124,079 $209,879 Ratio of Expenses to Average Net Assets.. 0.62% 0.60% 0.61% 0.61% 0.61% Ratio of Gross Expenses to Average Net Assets.......... -- 0.60%/(f)/ 0.61%/(f)/ 0.61%/(f)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.26% 0.67% 0.35% 0.18% 0.02% Portfolio Turnover Rate................ 78.3% 122.4% 40.8% 27.3% 39.0% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- INTERNATIONAL EMERGING MARKETS ACCOUNT -------------------------------------- Net Asset Value, Beginning of Period.. $14.78 $12.86 $8.24 $8.93 $9.37 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.22 0.12 0.11 0.02 0.08 Net Realized and Unrealized Gain (Loss) on Investments......... 4.46 3.04 4.60 (0.70) (0.48) ---- ---- ---- ----- ----- Total From Investment Operations 4.68 3.16 4.71 (0.68) (0.40) Less Dividends and Distributions: Dividends from Net Investment Income... (0.17) (0.10) (0.08) -- (0.04) Distributions from Realized Gains...... (3.27) (1.14) -- -- -- Tax Return of Capital Distributions /(a)/. -- -- (0.01) (0.01) -- ----- ----- ----- Total Dividends and Distributions (3.44) (1.24) (0.09) (0.01) (0.04) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $16.02 $14.78 $12.86 $8.24 $8.93 ====== ====== ====== ===== ===== Total Return /(b)/ ... 34.29% 24.89% 57.20% (7.63)% (4.24)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $71,639 $43,502 $23,972 $10,835 $6,964 Ratio of Expenses to Average Net Assets.. 1.60% 1.53% 1.71% 1.60% 1.35% Ratio of Gross Expenses to Average Net Assets /(c)/ ... 1.60%/(d)/ 1.55%/(e)/ 1.84%/(e)/ 2.26%/(e)/ 2.33% Ratio of Net Investment Income to Average Net Assets.. 1.45% 0.87% 1.16% 0.39% 0.97% Portfolio Turnover Rate................ 169.6% 171.0% 112.4% 147.7% 137.4%
/(a) /See "Dividends and Distributions to Shareholders" in Notes to Financial Statements. /(b) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(c) /Expense ratio without the Manager's voluntary expense limit. The expense limit was increased on May 1, 2002, and May 1, 2003, and ceased on May 1, 2004. /(d) /Expense ratio without custodian credits. /(e) /Expense ratio without commission rebates and custodian credits. /(f) /Expense ratio without commission rebates. 72 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- INTERNATIONAL SMALLCAP ACCOUNT ------------------------------ Net Asset Value, Beginning of Period.. $17.72 $13.73 $9.06 $10.84 $13.87 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.12 0.11 0.10 0.08 0.04 Net Realized and Unrealized Gain (Loss) on Investments......... 4.96 4.00 4.72 (1.83) (3.07) ---- ---- ---- ----- ----- Total From Investment Operations 5.08 4.11 4.82 (1.75) (3.03) Less Dividends and Distributions: Dividends from Net Investment Income... (0.11) (0.12) (0.15) (0.03) -- Distributions from Realized Gains...... (0.19) -- -- -- -- ---- ----- Total Dividends and Distributions (0.30) (0.12) (0.15) (0.03) -- ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $22.50 $17.72 $13.73 $9.06 $10.84 ====== ====== ====== ===== ====== Total Return /(a)/ ... 29.12% 30.20% 54.15% (16.20)% (21.85)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $143,454 $99,833 $66,242 $38,912 $43,674 Ratio of Expenses to Average Net Assets.. 1.33% 1.30% 1.33% 1.31% 1.41% Ratio of Gross Expenses to Average Net Assets.......... 1.33%/(d)/ 1.31%/(e)/ 1.33%/(e)/ 1.32%/(e)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.63% 0.75% 1.00% 0.77% 0.32% Portfolio Turnover Rate................ 132.3% 140.6% 128.9% 73.6% 123.8% 2005 2004 2003 2002/(F)/ ---- ---- ---- ---- LARGECAP BLEND ACCOUNT ---------------------- Net Asset Value, Beginning of Period.. $10.73 $10.37 $8.43 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.10 0.13 0.10 0.02 Net Realized and Unrealized Gain (Loss) on Investments......... 0.40 0.92 1.90 (1.57) ---- ---- ---- ----- Total From Investment Operations 0.50 1.05 2.00 (1.55) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.11) (0.06) (0.02) Distributions from Realized Gains...... (0.04) (0.58) -- -- ---- ----- ----- Total Dividends and Distributions (0.04) (0.69) (0.06) (0.02) ----- ----- ----- ----- Net Asset Value, End of Period............ $11.19 $10.73 $10.37 $8.43 ====== ====== ====== ===== Total Return /(a)/ ... 4.74% 10.36% 23.76% (15.47)%/(g)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $135,072 $90,751 $54,632 $13,927 Ratio of Expenses to Average Net Assets.. 0.78% 0.76% 0.80% 1.00%/(h)/ Ratio of Gross Expenses to Average Net Assets /(b)/ ... -- 0.78%/(c)/ 0.83%/(c)/ 1.10%/(h)(c)/ Ratio of Net Investment Income to Average Net Assets.. 0.96% 1.23% 1.08% 0.86%/(h)/ Portfolio Turnover Rate................ 44.1% 75.6% 56.2% 49.1%/(h)/
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on May 1, 2004. /(c) /Expense ratio without commission rebates. /(d) /Expense ratio without custodian credits. /(e) /Expense ratio without commission rebates and custodian credits. /(f) /Period from May 1, 2002, date operations commenced, through December 31, 2002. /(g) /Total return amounts have not been annualized. /(h) /Computed on an annualized basis. 73 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- LARGECAP GROWTH EQUITY ACCOUNT ------------------------------ Net Asset Value, Beginning of Period.. $4.60 $4.47 $3.63 $5.44 $7.78 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.01 0.01 -- (0.02) (0.03) Net Realized and Unrealized Gain (Loss) on Investments......... 0.16 0.13 0.84 (1.79) (2.31) ---- ---- ---- ----- ----- Total From Investment Operations 0.17 0.14 0.84 (1.81) (2.34) Less Dividends and Distributions: Dividends from Net Investment Income... (0.01) (0.01) -- -- -- ----- ----- ----- Total Dividends and Distributions (0.01) (0.01) -- -- -- ----- ----- ----- Net Asset Value, End of Period............ $4.76 $4.60 $4.47 $3.63 $5.44 ===== ===== ===== ===== ===== Total Return /(a)/ ... 3.63% 3.16% 23.14% (33.27)% (30.08)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $36,912 $31,179 $24,677 $5,572 $5,172 Ratio of Expenses to Average Net Assets.. 1.09% 1.04% 1.16% 1.05% 1.10% Ratio of Gross Expenses to Average Net Assets /(b)/ ... -- 1.05%/(d)/ 1.19%/(d)/ 1.09%/(d)/ 1.11% Ratio of Net Investment Income to Average Net Assets.. 0.18% 0.28% (0.13)% (0.49)% (0.62)% Portfolio Turnover Rate................ 91.2% 141.8% 51.1% 183.8% 121.2% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- LARGECAP STOCK INDEX ACCOUNT ---------------------------- Net Asset Value, Beginning of Period.. $8.77 $8.06 $6.35 $8.29 $9.52 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.13 0.14 0.10 0.08 0.08 Net Realized and Unrealized Gain (Loss) on Investments......... 0.26 0.70 1.70 (1.94) (1.23) ---- ---- ---- ----- ----- Total From Investment Operations 0.39 0.84 1.80 (1.86) (1.15) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.13) (0.09) (0.08) (0.08) ----- Total Dividends and Distributions -- (0.13) (0.09) (0.08) (0.08) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $9.16 $8.77 $8.06 $6.35 $8.29 ===== ===== ===== ===== ===== Total Return /(a)/ ... 4.47% 10.39% 28.32% (22.44)% (12.10)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $179,143 $158,237 $118,638 $72,949 $73,881 Ratio of Expenses to Average Net Assets.. 0.38% 0.37% 0.39% 0.39% 0.40% Ratio of Gross Expenses to Average Net Assets /(c)/ ... 0.38% 0.37% 0.39% 0.39% 0.41% Ratio of Net Investment Income to Average Net Assets.. 1.52% 1.64% 1.42% 1.22% 1.05% Portfolio Turnover Rate................ 13.1% 20.5% 15.7% 15.1% 10.8%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on May 1, 2002. /(c) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on April 29, 2005. /(d) /Expense ratio without commission rebates. 73 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002/(C)/ ---- ---- ---- ---- LARGECAP VALUE ACCOUNT ---------------------- Net Asset Value, Beginning of Period.. $11.88 $10.80 $8.52 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.18 0.19 0.16 0.06 Net Realized and Unrealized Gain (Loss) on Investments......... 0.46 1.22 2.23 (1.48) ---- ---- ---- ----- Total From Investment Operations 0.64 1.41 2.39 (1.42) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.16) (0.11) (0.06) Distributions from Realized Gains...... (0.07) (0.17) -- -- ----- ----- ----- Total Dividends and Distributions (0.07) (0.33) (0.11) (0.06) ----- ----- ----- ----- Net Asset Value, End of Period............ $12.45 $11.88 $10.80 $8.52 ====== ====== ====== ===== Total Return /(a)/ ... 5.44% 13.09% 28.05% (14.24)%/(d)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $122,221 $80,721 $47,221 $13,186 Ratio of Expenses to Average Net Assets.. 0.77% 0.75% 0.74% 0.96%/(e)/ Ratio of Gross Expenses to Average Net Assets /(b)/ ... -- 0.76%/(f)/ 0.79%/(f)/ 1.00%/(e)(f)/ Ratio of Net Investment Income to Average Net Assets.. 1.52% 1.65% 1.77% 1.79%/(e)/ Portfolio Turnover Rate................ 19.7% 23.2% 17.1% 5.9%/(e)/ 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MIDCAP ACCOUNT -------------- Net Asset Value, Beginning of Period.. $39.63 $37.56 $28.54 $32.09 $34.47 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.45 0.39 0.35 0.30 0.24 Net Realized and Unrealized Gain (Loss) on Investments......... 3.12 6.05 9.01 (3.08) (1.50) ---- ---- ---- ----- ----- Total From Investment Operations 3.57 6.44 9.36 (2.78) (1.26) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.39) (0.34) (0.30) (0.24) Distributions from Realized Gains...... (0.66) (3.98) -- (0.47) (0.88) ---- ----- ----- ----- ----- Total Dividends and Distributions (0.66) (4.37) (0.34) (0.77) (1.12) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $42.54 $39.63 $37.56 $28.54 $32.09 ====== ====== ====== ====== ====== Total Return /(a)/ ... 9.21% 17.76% 32.81% (8.75)% (3.71)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $420,812 $395,304 $334,204 $248,986 $278,707 Ratio of Expenses to Average Net Assets.. 0.58% 0.59% 0.61% 0.62% 0.62% Ratio of Gross Expenses to Average Net Assets.......... -- 0.59%/(f)/ 0.61%/(f)/ 0.62%/(f)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.13% 1.02% 1.09% 0.98% 0.77% Portfolio Turnover Rate................ 49.9% 38.9% 44.9% 67.9% 73.6%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on May 1, 2004. /(c) /Period from May 1, 2002, date operations commenced, through December 31, 2002. /(d) /Total return amounts have not been annualized. /(e) /Computed on an annualized basis. /(f) /Expense ratio without commission rebates. 74 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MIDCAP GROWTH ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $9.84 $8.80 $6.26 $8.49 $10.46 Income from Investment Operations: Net Investment Income (Operating Loss).... (0.02) (0.03) (0.03) (0.04) (0.05) Net Realized and Unrealized Gain (Loss) on Investments......... 1.37 1.07 2.57 (2.19) (1.68) ---- ---- ---- ----- ----- Total From Investment Operations 1.35 1.04 2.54 (2.23) (1.73) Less Dividends and Distributions: Distributions from Realized Gains...... -- -- -- -- (0.24) ---- ----- Total Dividends and Distributions -- -- -- -- (0.24) ---- ----- Net Asset Value, End of Period............ $11.19 $9.84 $8.80 $6.26 $8.49 ====== ===== ===== ===== ===== Total Return /(a)/ ... 13.72% 11.82% 40.58% (26.27)% (16.92)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $68,471 $59,674 $54,288 $21,934 $27,838 Ratio of Expenses to Average Net Assets.. 0.92% 0.86% 0.91% 0.91% 0.97% Ratio of Gross Expenses to Average Net Assets.......... -- 0.92%/(b)/ 0.94%/(b)/ 0.92%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. (0.15)% (0.30)% (0.39)% (0.55)% (0.66)% Portfolio Turnover Rate................ 97.0% 47.7% 67.5% 43.1% 55.2% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MIDCAP VALUE ACCOUNT -------------------- Net Asset Value, Beginning of Period.. $15.38 $14.13 $10.48 $11.68 $12.57 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.05 0.02 0.01 -- 0.01 Net Realized and Unrealized Gain (Loss) on Investments......... 1.53 3.10 3.81 (1.16) (0.35) ---- ---- ---- ----- ----- Total From Investment Operations 1.58 3.12 3.82 (1.16) (0.34) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.01) (0.01) -- (0.01) Distributions from Realized Gains...... (0.39) (1.86) (0.16) (0.04) (0.54) ----- ----- ----- ----- ----- Total Dividends and Distributions (0.39) (1.87) (0.17) (0.04) (0.55) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $16.57 $15.38 $14.13 $10.48 $11.68 ====== ====== ====== ====== ====== Total Return /(a)/ ... 10.55% 22.67% 36.49% (9.96)% (2.58)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $112,437 $78,166 $52,054 $24,766 $11,778 Ratio of Expenses to Average Net Assets.. 1.07% 1.05% 1.05% 1.04% 1.36% Ratio of Gross Expenses to Average Net Assets.......... -- 1.08%/(b)/ 1.08%/(b)/ 1.10%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.32% 0.11% 0.11% 0.03% 0.12% Portfolio Turnover Rate................ 90.6% 59.2% 55.5% 75.3% 208.8%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. 75 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MONEY MARKET ACCOUNT -------------------- Net Asset Value, Beginning of Period.. $1.000 $1.000 $1.000 $1.000 $1.000 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.027 0.009 0.007 0.014 0.039 ----- ----- ----- ----- ----- Total From Investment Operations 0.027 0.009 0.007 0.014 0.039 Less Dividends and Distributions: Dividends from Net Investment Income... (0.027) (0.009) (0.007) (0.014) (0.039) ------ ------ ------ ------ ------ Total Dividends and Distributions (0.027) (0.009) (0.007) (0.014) (0.039) ------ ------ ------ ------ ------ Net Asset Value, End of Period............ $1.000 $1.000 $1.000 $1.000 $1.000 ====== ====== ====== ====== ====== Total Return /(a)/ ... 2.69% 0.92% 0.74% 1.42% 3.92% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $150,653 $140,553 $151,545 $201,455 $180,923 Ratio of Expenses to Average Net Assets.. 0.61% 0.49% 0.49% 0.49% 0.50% Ratio of Net Investment Income to Average Net Assets.. 2.66% 0.91% 0.74% 1.40% 3.70% 2005 2004/(D)/ ---- ---- PRINCIPAL LIFETIME 2010 ACCOUNT ------------------------------- Net Asset Value, Beginning of Period.. $10.84 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.02 0.11 Net Realized and Unrealized Gain (Loss) on Investments......... 0.59 0.82 ---- ---- Total From Investment Operations 0.61 0.93 Less Dividends and Distributions: Dividends from Net Investment Income... (0.01) (0.09) Distributions from Realized Gains...... (0.07) -- ---- ----- Total Dividends and Distributions (0.08) (0.09) ----- ----- Net Asset Value, End of Period............ $11.37 $10.84 ====== ====== Total Return /(a)/ ... 5.70% 9.31%/(e)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $12,930 $11 Ratio of Expenses to Average Net Assets /(b)/ .............. 0.16% 0.16%/(f)/ Ratio of Gross Expenses to Average Net Assets /(b)/ /(c)/ .............. 0.20% 10.02%/(f)/ Ratio of Net Investment Income to Average Net Assets.. 0.22% 3.21%/(f)/ Portfolio Turnover Rate................ 4.3% 3.0%/(f)/
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Does not include expenses of the investment companies in which the Account invests. /(c) /Expense ratio without the Manager's voluntary expense limit. The expense limit became a contractual limit on November 21, 2005. /(d) /Period from August 30, 2004, date operations commenced, through December 31, 2004. /(e) /Total return amounts have not been annualized. /(f) /Computed on an annualized basis. 77 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004/(D)/ ---- ---- PRINCIPAL LIFETIME 2020 ACCOUNT ------------------------------- Net Asset Value, Beginning of Period.. $10.97 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... (0.01) 0.13 Net Realized and Unrealized Gain (Loss) on Investments......... 0.75 0.93 ---- ---- Total From Investment Operations 0.74 1.06 Less Dividends and Distributions: Dividends from Net Investment Income... (0.02) (0.09) Distributions from Realized Gains...... (0.08) -- ---- ----- Total Dividends and Distributions (0.10) (0.09) ----- ----- Net Asset Value, End of Period............ $11.61 $10.97 ====== ====== Total Return /(a)/ ... 6.77% 10.62%/(e)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $26,753 $15 Ratio of Expenses to Average Net Assets /(b)/ .............. 0.13% 0.13%/(f)/ Ratio of Gross Expenses to Average Net Assets /(b)/ /(c)/ .............. 0.16% 8.72%/(f)/ Ratio of Net Investment Income to Average Net Assets.. (0.10)% 3.65%/(f)/ Portfolio Turnover Rate................ 3.1% 2.6%/(f)/ 2005 2004/(D)/ ---- ---- PRINCIPAL LIFETIME 2030 ACCOUNT ------------------------------- Net Asset Value, Beginning of Period.. $10.97 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.01 0.30 Net Realized and Unrealized Gain (Loss) on Investments......... 0.73 0.76 ---- ---- Total From Investment Operations 0.74 1.06 Less Dividends and Distributions: Dividends from Net Investment Income... (0.02) (0.09) Distributions from Realized Gains...... (0.06) -- ---- ----- Total Dividends and Distributions (0.08) (0.09) ----- ----- Net Asset Value, End of Period............ $11.63 $10.97 ====== ====== Total Return /(a)/ ... 6.76% 10.60%/(e)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $3,918 $151 Ratio of Expenses to Average Net Assets /(b)/ .............. 0.16% 0.16%/(f)/ Ratio of Gross Expenses to Average Net Assets /(b) (c)/ 0.38% 2.14%/(f)/ Ratio of Net Investment Income to Average Net Assets.. 0.08% 8.58%/(f)/ Portfolio Turnover Rate................ 11.5% 4.8%/(f)/
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Does not include expenses of the investment companies in which the Account invests. /(c) /Expense ratio without the Manager's voluntary expense limit. The expense limit became a contractual limit on November 21, 2005. /(d) /Period from August 30, 2004, date operations commenced, through December 31, 2004. /(e) /Total return amounts have not been annualized. /(f) /Computed on an annualized basis. 78 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004/(D)/ ---- ---- PRINCIPAL LIFETIME 2040 ACCOUNT ------------------------------- Net Asset Value, Beginning of Period.. $11.09 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.01 0.19 Net Realized and Unrealized Gain (Loss) on Investments......... 0.79 0.99 ---- ---- Total From Investment Operations 0.80 1.18 Less Dividends and Distributions: Dividends from Net Investment Income... (0.02) (0.09) Distributions from Realized Gains...... (0.05) -- ---- ----- Total Dividends and Distributions (0.07) (0.09) ----- ----- Net Asset Value, End of Period............ $11.82 $11.09 ====== ====== Total Return /(a)/ ... 7.27% 11.78%/(e)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $1,893 $147 Ratio of Expenses to Average Net Assets /(b)/ .............. 0.13% 0.14%/(f)/ Ratio of Gross Expenses to Average Net Assets /(b) (c)/ 0.56% 1.47%/(f)/ Ratio of Net Investment Income to Average Net Assets.. 0.12% 5.35%/(f)/ Portfolio Turnover Rate................ 18.2% 9.4%/(f)/ 2005 2004/(D)/ ---- ---- PRINCIPAL LIFETIME 2050 ACCOUNT ------------------------------- Net Asset Value, Beginning of Period.. $11.09 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.01 0.11 Net Realized and Unrealized Gain (Loss) on Investments......... 0.82 1.06 ---- ---- Total From Investment Operations 0.83 1.17 Less Dividends and Distributions: Dividends from Net Investment Income... (0.02) (0.08) Distributions from Realized Gains...... (0.05) -- ---- ----- Total Dividends and Distributions (0.07) (0.08) ----- ----- Net Asset Value, End of Period............ $11.85 $11.09 ====== ====== Total Return /(a)/ ... 7.56% 11.74%/(e)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $1,160 $88 Ratio of Expenses to Average Net Assets /(b)/ .............. 0.12% 0.13%/(f)/ Ratio of Gross Expenses to Average Net Assets /(b)/ /(c)/ .............. 1.11% 1.49%/(f)/ Ratio of Net Investment Income to Average Net Assets.. 0.11% 3.04%/(f)/ Portfolio Turnover Rate................ 4.2% 13.0%/(f)/
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Does not include expenses of the investment companies in which the Account invests. /(c) /Expense ratio without the Manager's voluntary expense limit. The expense limit was decreased on April 29, 2005, and became a contractual limit on November 21, 2005. /(d) /Period from August 30, 2004, date operations commenced, through December 31, 2004. /(e) /Total return amounts have not been annualized. /(f) /Computed on an annualized basis. 78 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004/(C)/ ---- ---- PRINCIPAL LIFETIME STRATEGIC INCOME ACCOUNT ------------------------------------------- Net Asset Value, Beginning of Period.. $10.68 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.06 0.12 Net Realized and Unrealized Gain (Loss) on Investments......... 0.46 0.65 ---- ---- Total From Investment Operations 0.52 0.77 Less Dividends and Distributions: Dividends from Net Investment Income... (0.03) (0.09) Distributions from Realized Gains...... (0.12) -- ---- ----- Total Dividends and Distributions (0.15) (0.09) ----- ----- Net Asset Value, End of Period............ $11.05 $10.68 ====== ====== Total Return /(a)/ ... 4.96% 7.66%/(d)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $5,463 $11 Ratio of Expenses to Average Net Assets /(b)/ .............. 0.14% 0.14%/(e)/ Ratio of Gross Expenses to Average Net Assets /(b)/ /(f)/ .............. 0.27% 10.09%/(e)/ Ratio of Net Investment Income to Average Net Assets.. 0.60% 3.30%/(e)/ Portfolio Turnover Rate................ 8.4% 2.9%/(e)/ 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- REAL ESTATE SECURITIES ACCOUNT ------------------------------ Net Asset Value, Beginning of Period.. $17.88 $14.90 $11.24 $10.77 $10.29 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.40 0.39 0.49 0.35 0.42 Net Realized and Unrealized Gain (Loss) on Investments......... 2.39 4.66 3.87 0.48 0.47 ---- ---- ---- ---- ---- Total From Investment Operations 2.79 5.05 4.36 0.83 0.89 Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.35) (0.42) (0.35) (0.41) Distributions from Realized Gains...... (0.16) (1.72) (0.28) (0.01) -- ---- ----- ----- ----- ----- Total Dividends and Distributions (0.16) (2.07) (0.70) (0.36) (0.41) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $20.51 $17.88 $14.90 $11.24 $10.77 ====== ====== ====== ====== ====== Total Return /(a)/ ... 15.85% 34.53% 38.91% 7.72% 8.75% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $178,922 $146,022 $93,018 $46,358 $22,457 Ratio of Expenses to Average Net Assets.. 0.89% 0.90% 0.91% 0.92% 0.92% Ratio of Gross Expenses to Average Net Assets ......... -- 0.90% 0.92% -- -- Ratio of Net Investment Income to Average Net Assets.. 2.16% 2.37% 3.83% 3.99% 4.55% Portfolio Turnover Rate................ 23.6% 58.8% 53.9% 54.4% 92.4%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Does not include expenses of the investment companies in which the Account invests. /(c) /Period from August 30, 2004, date operations commenced, through December 31, 2004. /(d) /Total return amounts have not been annualized. /(e) /Computed on an annualized basis. /(f) /Expense ratio without the Manager's voluntary expense limit. The expense limit became a contractual limit on November 21, 2005. 79 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003/(D)/ ---- ---- ---- SHORT-TERM BOND ACCOUNT ----------------------- Net Asset Value, Beginning of Period /(c)/ ............... $10.12 $9.99 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.33 0.25 0.13 Net Realized and Unrealized Gain (Loss) on Investments......... (0.15) (0.12) (0.05) ----- ----- ----- Total From Investment Operations 0.18 0.13 0.08 Less Dividends and Distributions: Dividends from Net Investment Income... (0.19) -- (0.09) ---- ----- ----- Total Dividends and Distributions (0.19) -- (0.09) ---- ----- ----- Net Asset Value, End of Period............ $10.11 $10.12 $9.99 ====== ====== ===== Total Return /(a)/ ... 1.80% 1.30% 0.78%/(e)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $83,822 $56,241 $20,552 Ratio of Expenses to Average Net Assets.. 0.57% 0.53% 0.57%/(f)/ Ratio of Gross Expenses to Average Net Assets/(b)/..... -- -- 0.57%/(f)/ Ratio of Net Investment Income to Average Net Assets.. 3.26% 2.53% 2.15%/(f)/ Portfolio Turnover Rate................ 74.3% 34.8% 5.0%/(f)/ 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- SMALLCAP ACCOUNT ---------------- Net Asset Value, Beginning of Period.. $9.55 $7.97 $5.83 $8.03 $7.83 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.02 -- 0.01 0.01 -- Net Realized and Unrealized Gain (Loss) on Investments......... 0.65 1.58 2.14 (2.20) 0.20 ---- ---- ---- ----- ---- Total From Investment Operations 0.67 1.58 2.15 (2.19) 0.20 Less Dividends and Distributions: Dividends from Net Investment Income... -- -- (0.01) (0.01) -- ---- ----- ----- Total Dividends and Distributions -- -- (0.01) (0.01) -- ---- ----- ----- Net Asset Value, End of Period............ $10.22 $9.55 $7.97 $5.83 $8.03 ====== ===== ===== ===== ===== Total Return /(a)/ ... 7.04% 19.82% 36.82% (27.33)% 2.55% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $94,476 $85,115 $65,285 $32,201 $36,493 Ratio of Expenses to Average Net Assets.. 0.88% 0.86% 0.95% 0.97% 1.00% Ratio of Gross Expenses to Average Net Assets.......... -- 0.86%/(g)/ 0.95%/(g)/ 0.97%/(g)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.17% 0.03% 0.09% 0.12% (0.06)% Portfolio Turnover Rate................ 125.8% 188.7% 162.9% 215.5% 154.5%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on May 1, 2004. /(c) /Effective November 19, 2005, Limited Term Bond Account changed its name to Short-Term Bond Account. /(d) /Period from May 1, 2003, date operations commenced, through December 31, 2003. /(e) /Total return amounts have not been annualized. /(f) /Computed on an annualized basis. /(g) /Expense ratio without commission rebates. 80 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- SMALLCAP GROWTH ACCOUNT ----------------------- Net Asset Value, Beginning of Period.. $9.30 $8.36 $5.74 $10.60 $15.59 Income from Investment Operations: Net Investment Income (Operating Loss).... (0.07) (0.06) (0.04) (0.05) (0.10) Net Realized and Unrealized Gain (Loss) on Investments......... 0.69 1.00 2.66 (4.81) (4.89) ---- ---- ---- ----- ----- Total From Investment Operations 0.62 0.94 2.62 (4.86) (4.99) ---- ---- ---- ----- ----- Net Asset Value, End of Period............ $9.92 $9.30 $8.36 $5.74 $10.60 ===== ===== ===== ===== ====== Total Return /(a)/ ... 6.67% 11.24% 45.64% (45.85)% (32.01)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $66,656 $63,453 $55,628 $32,754 $55,966 Ratio of Expenses to Average Net Assets.. 1.05% 0.99% 0.99% 0.95% 1.05% Ratio of Gross Expenses to Average Net Assets ......... -- 1.01%/(b)/ 1.02%/(b)/ 1.06%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. (0.77)% (0.70)% (0.64)% (0.68)% (0.92)% Portfolio Turnover Rate................ 68.2% 43.3% 54.1% 287.9% 152.2% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- SMALLCAP VALUE ACCOUNT ---------------------- Net Asset Value, Beginning of Period.. $16.83 $15.04 $10.30 $11.37 $11.26 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.07 0.03 0.06 0.06 0.09 Net Realized and Unrealized Gain (Loss) on Investments......... 0.96 3.37 5.14 (1.07) 0.60 ---- ---- ---- ----- ---- Total From Investment Operations 1.03 3.40 5.20 (1.01) 0.69 Less Dividends and Distributions: Dividends from Net Investment Income... (0.01) (0.03) (0.05) (0.06) (0.09) Distributions from Realized Gains...... (0.24) (1.58) (0.41) -- (0.49) ---- ----- ----- ----- ----- Total Dividends and Distributions (0.25) (1.61) (0.46) (0.06) (0.58) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $17.61 $16.83 $15.04 $10.30 $11.37 ====== ====== ====== ====== ====== Total Return /(a)/ ... 6.22% 23.08% 50.61% (8.86)% 6.25% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $132,035 $107,206 $82,135 $44,217 $30,888 Ratio of Expenses to Average Net Assets.. 1.13% 1.12% 1.16% 1.28% 1.24% Ratio of Gross Expenses to Average Net Assets.......... -- 1.13%/(b)/ 1.18%/(b)/ 1.29%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.38% 0.21% 0.50% 0.68% 0.95% Portfolio Turnover Rate................ 45.3% 38.0% 54.0% 77.4% 67.8%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. 82 ADDITIONAL INFORMATION Additional information about the Fund (including the Fund's policy regarding the disclosure of portfolio securities) is available in the Statement of Additional Information dated May 1, 2006 which is incorporated by reference into this prospectus. Additional information about the Funds' investments is available in the Fund's annual and semiannual reports to shareholders. In the Funds' annual report, you will find a discussion of the market conditions and investment strategies that significantly affected the Funds' performance during the last fiscal year. The Statement of Additional Information and the Fund's annual and semi-annual reports can be obtained free of charge by writing or telephoning Princor Financial Services Corporation, P.O. Box 10423, Des Moines, IA 50306. In addition, the Fund makes its Statement of Additional Information and annual and semi-annual reports available, free of charge, on http:// www.principal.com. To request this and other information about the Fund and to make shareholder inquiries, telephone 1-800-247-4123. Information about the Fund (including the Statement of Additional Information) can be reviewed and copied at the Commission's Public Reference Room in Washington, D.C. Information on the operation of the Public Reference Room may be obtained by calling the Commission at 1-202-942-8090. Reports and other information about the Fund are available on the EDGAR Database on the Commission's internet site at http://www.sec.gov. Copies of this information may be obtained, upon payment of a duplicating fee, by electronic request at the following E-mail address: publicinfo@sec.gov, or by writing the Commission's Public Reference Section, Washington, D.C. 20549-0102. The U.S. government does not insure or guarantee an investment in any of the Accounts. There can be no assurance that the Money Market Account will be able to maintain a stable share price of $1.00 per share. Shares of the Accounts are not deposits or obligations of, or guaranteed or endorsed by, any financial institution, nor are shares of the Accounts federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other agency. Principal Variable Contracts Fund, Inc. SEC File 811-01944 128 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 PRINCIPAL VARIABLE CONTRACTS FUND, INC.
ACCOUNTS OF THE FUND -------------------- ASSET ALLOCATION ACCOUNT MIDCAP ACCOUNT BOND ACCOUNT MIDCAP GROWTH ACCOUNT CAPITAL VALUE ACCOUNT MIDCAP VALUE ACCOUNT DIVERSIFIED INTERNATIONAL ACCOUNT MONEY MARKET ACCOUNT EQUITY GROWTH ACCOUNT PRINCIPAL LIFETIME 2010 ACCOUNT EQUITY INCOME ACCOUNT PRINCIPAL LIFETIME 2020 ACCOUNT EQUITY VALUE ACCOUNT PRINCIPAL LIFETIME 2030 ACCOUNT GOVERNMENT & HIGH QUALITY BOND ACCOUNT PRINCIPAL LIFETIME 2040 ACCOUNT (previously Government Securities PRINCIPAL LIFETIME 2050 ACCOUNT Account) GROWTH ACCOUNT PRINCIPAL LIFETIME STRATEGIC INCOME ACCOUNT INTERNATIONAL EMERGING MARKETS ACCOUNT REAL ESTATE SECURITIES ACCOUNT INTERNATIONAL SMALLCAP ACCOUNT SHORT-TERM BOND ACCOUNT LARGECAP BLEND ACCOUNT (previously Limited Term Bond Account) LARGECAP STOCK INDEX ACCOUNT SMALLCAP GROWTH ACCOUNT LARGECAP VALUE ACCOUNT SMALLCAP VALUE ACCOUNT
This Prospectus describes a mutual fund organized by Principal Life Insurance Company/(R)/ ("Principal Life"). The Fund provides a choice of investment objectives through the Accounts listed above. The date of this Prospectus is May 1, 2006. As with all mutual funds, neither the Securities and Exchange Commission ("SEC") nor any State Securities Commission has approved or disapproved of these securities or determined if this prospectus is accurate or complete. It is a criminal offense to represent otherwise. TABLE OF CONTENTS ACCOUNT DESCRIPTIONS....................................................3 Asset Allocation Account..............................................5 Bond Account..........................................................8 Capital Value Account.................................................12 Diversified International Account.....................................15 Equity Growth Account.................................................18 Equity Income Account .................................................21 Equity Value Account..................................................24 Government & High Quality Bond Account (f/k/a Government Securities Account)...................................27 Growth Account........................................................31 International Emerging Markets Account................................33 International SmallCap Account........................................36 LargeCap Blend Account................................................39 LargeCap Stock Index Account..........................................42 LargeCap Value Account................................................44 MidCap Account........................................................46 MidCap Growth Account.................................................49 MidCap Value Account..................................................52 Money Market Account..................................................55 Principal LifeTime 2010 Account .......................................58 Principal LifeTime 2020 Account.......................................61 Principal LifeTime 2030 Account.......................................64 Principal LifeTime 2040 Account.......................................67 Principal LifeTime 2050 Account.......................................71 Principal LifeTime Strategic Income Account...........................75 Real Estate Securities Account ........................................78 Short-Term Bond Account (f/k/a Limited Term Bond Account) .............81 SmallCap Growth Account...............................................84 SmallCap Value Account................................................87 CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.........................90 PRICING OF ACCOUNT SHARES...............................................96 DIVIDENDS AND DISTRIBUTIONS.............................................97 MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE..........................97 The Manager...........................................................97 The Sub-Advisors......................................................97 Duties of the Manager and Sub-Advisors................................110 Fees Paid to the Manager..............................................110 Fees Paid to the Sub-Advisor..........................................110 GENERAL INFORMATION ABOUT AN ACCOUNT....................................111 Frequent Trading and Market-Timing (Abusive Trading Practices)........111 Eligible Purchasers...................................................112 Shareholder Rights....................................................112 Non-Cumulative Voting.................................................113 Purchase of Account Shares............................................113 Sale of Account Shares................................................113 Restricted Transfers..................................................114 Financial Statements..................................................114 FINANCIAL HIGHLIGHTS....................................................114 ADDITIONAL INFORMATION..................................................129 2 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 ACCOUNT DESCRIPTIONS The Principal Variable Contracts Fund (the "Fund") is made up of Accounts. Each Account has its own investment objective. Principal Management Corporation*, the "Manager" of the Fund, has selected a Sub-Advisor for the Accounts based on the Sub-Advisor's experience with the investment strategy for which it was selected. The Manager seeks to provide a wide range of investment approaches through the Fund. The Sub-Advisors are: . AllianceBernstein L.P. ("AllianceBernstein") . American Century Investment Management, Inc. ("American Century") . Columbus Circle Investors ("CCI")* . Emerald Advisors, Inc. ("Emerald") . J.P. Morgan Investment Management Inc. ("Morgan") . Mellon Equity Associates, LLP ("Mellon Equity") . Morgan Stanley Investment Management Inc. ("MSIM Inc.") doing business as "Van Kampen" . Neuberger Berman Management Inc. ("Neuberger Berman") . Principal Global Investors, LLC ("Principal")* . Principal Real Estate Investors, LLC ("Principal - REI")* . T. Rowe Price Associates, Inc. ("T. Rowe Price") . UBS Global Asset Management (Americas) Inc. ("UBS Global AM") * CCI, Principal, Principal - REI, Principal Management Corporation and Princor Financial Services Corporation ("Princor") are affiliates of Principal Life Insurance Company and with it are subsidiaries of Principal Financial Group, Inc. and members of the Principal Financial Group/(R)/. In the description for each Account, there is important information about the Account's: MAIN STRATEGIES AND RISKS These sections describe each Account's investment objective and summarize how each Account intends to achieve its investment objective. The Board of Directors may change an Account's objective or the investment strategies without a shareholder vote if it determines such a change is in the best interests of the Account. If there is a material change to the Account's investment objective or investment strategies, you should consider whether the Account remains an appropriate investment for you. There is no guarantee that an Account will meet its objective. The sections also describe each Account's primary investment strategies (including the type or types of securities in which the Account invests), any policy of the Account to concentrate in securities of issuers in a particular industry or group of industries and the main risks associated with an investment in the Account. A fuller discussion of risks appears later in the Prospectus under the caption "Certain Investment Strategies and Related Risks." Each Account may invest up to 100% of its assets in cash and cash equivalents for temporary defensive purposes in response to adverse market, economic or political condition as more fully described under the caption "Certain Investment Strategies and Related Risks-Temporary Defensive Measures." Each Account is designed to be a portion of an investor's portfolio. None of the Accounts is intended to be a complete investment program. You should consider the risks of each Account before making an investment and be prepared to maintain the investment during periods of adverse market conditions. INVESTMENT RESULTS A bar chart and a table are included with each Account that has annual returns for a full calendar year. They show the Account's annual returns and its long-term performance. The chart shows how the Account's performance has varied from year-to-year. The table compares the Account's performance over time to that of: . a broad-based securities market index (An index measures the market price of a specific group of securities in a particular market or securities in a market sector. You cannot invest directly in an index. An index does not have an investment advisor and does not pay any commissions or expenses. If an index had expenses, its performance would be lower.); and PRINCIPAL VARIABLE CONTRACTS FUND 3 www.principal.com . an average of mutual funds with a similar investment objective and management style. The averages used are prepared by independent statistical services. An Account's past performance is not necessarily an indication of how the Account will perform in the future. Call the Principal Variable Contracts Fund at 1-800-247-4123 to get the current 7-day yield for the Money Market Account. FEES AND EXPENSES The annual operating expenses for each Account are deducted from that Account's assets. Each Account's operating expenses are shown with the description of the Account and are stated as a percentage of Account assets. A discussion of fees and expenses appears later in the Prospectus under the caption "The Costs of Investing." The fees and expenses shown do not include the effect of any separate account expenses or other contract level expenses. If such charges were included, overall expenses would be higher and would lower performance. The description of each Account includes examples of the costs associated with investing in the Account. The examples are intended to help you compare the cost of investing in a particular Account with the cost of investing in other mutual funds. The examples assume you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The examples also assume that your investment has a 5% total return each year and that the Account's operating expenses remain the same. Your actual costs of investing in a particular Account may be higher or lower than the costs assumed for purposes of the examples. NOTES: . No salesperson, dealer or other person is authorized to give information or make representations about an Account other than those contained in this Prospectus. Information or representations not contained in this Prospectus may not be relied upon as having been made by the Principal Variable Contracts Fund, an Account, the Manager, any Sub-Advisor or Princor. . Investments in these Accounts are not deposits of a bank and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. 4 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 ASSET ALLOCATION ACCOUNT The Account seeks to generate a total investment return consistent with preservation of capital. MAIN STRATEGIES The Account invests in a portfolio of securities that is broadly diversified by asset class, global region, country, economic sector, and currency. The Portfolio Manager makes the Account's broad asset allocation decisions and delegates responsibility for selection specific individual securities to the internal, active management teams of the Sub-Advisor, Van Kampen. In deciding how to allocate the Account's assets, Van Kampen assesses three sets of factors: . the relative value of the stock, bond and money markets in the various regions, countries and economic sectors; . the long-term dynamic forces that are driving economies, economic sectors, and companies; and . the short-term technical forces that are affecting market pricing. Factors evaluated include growth rates in gross domestic product, inflation and corporation earnings, labor market conditions, interest rate levels, sales growth, return on equity, dividend yields, price to book ratios and currency valuations. From time-to-time, Van Kampen changes the Account's allocation of assets in various ways, including by asset class, by global region, by country, by economic sector and by currency, in order to keep the portfolio in alignment with global investment outlook. Allocation among asset classes is designed to lessen overall investment risk by diversifying the Account's assets among different types of investments in different markets. Van Kampen reallocates among asset classes and eliminates asset classes for a period of time, when in its judgement the shift offers better prospects of achieving the investment objective of the Account. Under normal market conditions, abrupt reallocations among asset classes will not occur. Van Kampen does not allocate a specific percentage of the Account's assets to a class. Over time, it expects the asset mix to be within the following ranges: . 25% to 75% in equity securities; . 20% to 60% in fixed-income securities; and . 0% to 40% in money market instruments. The Account may invest up to 100% of its assets in foreign securities. Allowable instruments include individual securities (stocks (without regard to the market capitalization of the issuing company) and bonds), equity and interest rate futures, currency forward contracts, futures contracts, Exchange Traded Funds, fixed-income TRAINS and listed options. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. Van Kampen may utilize currency contracts, currency or index futures or other derivatives for hedging or other purposes, including modifying the Account's exposure to various currency, equity or fixed-income market. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. PRINCIPAL VARIABLE CONTRACTS FUND 5 www.principal.com CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.) FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. HEDGING STRATEGIES . Use of forward foreign currency exchange contracts, currency or index futures or other derivatives involves risks. The contracts may increase the Account's volatility and, thus, could involve a significant risk. If the Sub-Advisor's predictions are inaccurate, the adverse consequences to the Account (e.g., a reduction in the Account's net asset value) may leave the Account in a worse position than if these strategies were not used. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking a moderate risk approach towards long-term growth. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. 6 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Van Kampen has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"12.92 "1997"18.19 "1998"9.18 "1999"19.49 "2000"1.61 "2001"-3.92 "2002"-12.94 "2003"21.61 "2004"8.49 The Account's highest/lowest quarterly returns "2005"5.79 during this time period were: HIGHEST Q2 '03 12.11% LOWEST Q3 '02 -12.41% LOGO The year-to-date return as of March 31, 2006 is 3.34%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* ASSET ALLOCATION ACCOUNT .............. 5.79 3.14 7.52 8.25 S&P 500 Index ........ 4.91 0.54 9.07 11.02 Lehman Brothers Aggregate Bond Index . 2.43 5.87 6.17 6.92 MSCI EAFE (Europe, Australia, Far East) Index - ND ........... 13.54 4.56 5.84 6.03 Morningstar Moderate Allocation Category Average .............. 5.29 2.93 7.35 8.55 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (June 1, 1994).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM THE ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.80% Other Expenses................... 0.06 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.86%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 ASSET ALLOCATION ACCOUNT $88 $274 $477 $1,061
PRINCIPAL VARIABLE CONTRACTS FUND 7 www.principal.com BOND ACCOUNT The Account seeks to provide as high a level of income as is consistent with preservation of capital and prudent investment risk. MAIN STRATEGIES Under normal circumstances, the Account invests at least 80% of its assets in intermediate maturity fixed-income or debt securities rated BBB or higher by Standard & Poor's Rating Service ("S&P") or Baa or higher by Moody's Investors Service, Inc. ("Moody's"). The Account considers the term "bond" to mean any debt security. Under normal circumstances, the Account invests in: . securities issued or guaranteed by the U.S. government or its agencies or instrumentalities; . mortgage-backed securities representing an interest in a pool of mortgage loans; . debt securities and taxable municipal bonds rated, at the time of purchase, in one of the top four categories by S&P or Moody's or, if not rated, in the opinion of the Sub-Advisor, Principal, of comparable quality; and . securities issued or guaranteed by the governments of Canada (provincial or federal government) or the United Kingdom payable in U.S. dollars. The rest of the Account's assets may be invested in: . preferred and common stock that may be convertible (may be exchanged for a fixed number of shares of common stock of the same issuer) or may be non-convertible; or . securities rated less than the four highest grades of S&P or Moody's (i.e. less than investment grade (commonly known as "junk bonds")) but not lower than CCC- (S&P) or Caa (Moody's). The Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income. Under a reverse repurchase agreement, the Account sells securities and agrees to repurchase them at a specified date and price. The Account pays interest on this "secured financing" and attempts to make money on the difference between the financing rate and the interest it earns by investing the proceeds of the financing. While a reverse repurchase agreement is outstanding, the Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account may lend its portfolio securities to brokers, dealers and other financial institutions. In connection with such loans, the Account remains the owner of the loaned securities and continues to be entitled to payments in amounts equal to the interest, dividends or other distributions payable on the loaned securities. Loans of portfolio securities may not exceed 33 1/3% of the value of the Account's total assets (including the value of all assets received as collateral for loan). In connection with such loans the Account will receive collateral from the borrower equal to at least 100% of the value of the loaned securities. The Account may actively trade securities in an attempt to achieve its investment objective. During the fiscal year ended December 31, 2005, the average ratings of the Account's assets, based on market value at each month-end, were as follows (all ratings are by Moody's):
57.40% in securities 15.45% in securities 0.62% in securities rated rated Aaa rated Baa Caa 5.59% in securities 3.66% in securities rated 0.04% in securities rated rated Aa Ba Ca 13.12% in securities 4.11% in securities rated 0.01% in securities rated rated A B C
The above percentages for A&B rated securities include 0.08% and 0.06% respectively, of unrated securities which have been determined by the Manager to be of comparable quality. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: 8 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 MUNICIPAL SECURITIES . Principal and interest payments of municipal securities may not be guaranteed by the issuing body and may be payable only from monies derived from a particular source. If the source does not perform as expected, principal and income payments may not be made on time or at all. In addition, the market for municipal securities is often thin and may be temporarily affected by large purchases and sales, including those of the Account. General conditions in the financial markets and the size of a particular offering may also negatively affect the returns of a municipal security. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates. This may increase the volatility of the Account. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation maybe chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. REVERSE REPURCHASE AGREEMENTS. . This strategy involves the risk that interest costs on money borrowed may exceed the return on securities purchased with the borrowed money. In addition, reverse repurchase agreements may increase the volatility of the Fund. LENDING OF SECURITIES . If the Account lends its portfolio securities and the borrower of the securities fail financially, the Account may experience delays in recovering the loaned securities or exercising its rights in the collateral. Loans are made only to borrowers that are deemed by the Sub-Advisor to be of good financial standing. PORTFOLIO DURATION . The average portfolio duration of the Account normally varies within a three- to six-year time frame based on Sub-Advisor's forecast for interest rates. Duration is a measure of the expected life of a fixed-income security that is used to determine the sensitivity of a security's price to changes in interest rates. For example, if the portfolio duration of the Account is three years, a change of 1% in the market's yield results in a change of approximately 3% in the value of the Account's securities. The longer a security's duration, the more sensitive it is to changes in interest rates. An Account with a longer average portfolio duration will be more sensitive to changes in interest rates than an Account with a shorter average portfolio duration. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates. When interest rates rise, the value of fixed-income securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of fixed-income securities. Some fixed-income investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.) PRINCIPAL VARIABLE CONTRACTS FUND 9 www.principal.com DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. COMMODITY-LINKED DERIVATIVE INSTRUMENTS . The use of commodity-linked derivative instruments may subject the Account to greater volatility than investments in traditional securities. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 176.2%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking diversification by investing in a fixed-income mutual fund. 10 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"2.36 "1997"10.6 "1998"7.69 "1999"-2.59 "2000"8.17 "2001"8.12 "2002"9.26 "2003"4.59 "2004"4.98 The Account's highest/lowest quarterly returns "2005"2.5 during this time period were: HIGHEST Q3 '97 4.37% LOWEST Q1 '96-3.24% LOGO The year-to-date return as of March 31, 2006 is -0.55%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* BOND ACCOUNT ......... 2.50 5.86 5.50 7.69 Lehman Brothers Aggregate Bond Index . 2.43 5.87 6.17 7.78 Morningstar Intermediate-Term Bond Category Average...... 1.79 5.32 5.38 7.11 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (December 18, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.45% Other Expenses................... 0.02% ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.47%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 BOND ACCOUNT $48 $151 $263 $591
PRINCIPAL VARIABLE CONTRACTS FUND 11 www.principal.com CAPITAL VALUE ACCOUNT The Account seeks to provide long-term capital appreciation and secondarily growth of investment income. MAIN STRATEGIES The Account invests primarily in common stock and other equity securities of large capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with large market capitalizations (those with market capitalizations similar to companies in the Russell 1000/(R)// /Value Index (as of March 31, 2006 this range was between approximately $688 million and $387.4 billion) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Up to 25% of Account assets may be invested in foreign securities. The Account invests in stocks that, in the opinion of the Sub-Advisor, Principal, are undervalued in the marketplace at the time of purchase. Value stocks are often characterized by below average price/earnings ratios (P/E) and above average dividend yields relative to the overall market. Securities for the Account are selected by consideration of the quality and price of individual issuers rather than forecasting stock market trends. The selection process focuses on four key elements: . determination that a stock is selling below its fair market value; . early recognition of changes in a company's underlying fundamentals; . evaluation of the sustainability of fundamental changes; and . by monitoring a stock's behavior in the market, evaluation of the timeliness of the investment. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization value stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. 12 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 120.9%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks, but who prefer investing in companies that appear to be considered undervalued relative to similar companies. PRINCIPAL VARIABLE CONTRACTS FUND 13 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"23.5 "1997"28.53 "1998"13.58 "1999"-4.29 "2000"2.16 "2001"-8.05 "2002"-13.66 "2003"25.49 "2004"12.36 The Account's highest/lowest quarterly returns "2005"6.8 during this time period were: HIGHEST Q2 '03 15.52% LOWEST Q3 '02 -15.10% LOGO The year-to-date return as of March 31, 2006 is 6.07%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT CAPITAL VALUE ACCOUNT 6.80 3.64 7.74 11.92* Russell 1000 Value Index................. 7.05 5.28 10.94 14.32** Morningstar Large Value Category Average 5.88 3.96 8.85 13.21** Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 13, 1970). ** Lifetime results are measured from December 31, 1978 (earliest date for which information is available).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.60% Other Expenses................... 0.01% ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.61%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 CAPITAL VALUE ACCOUNT $62 $195 $340 $762
14 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 DIVERSIFIED INTERNATIONAL ACCOUNT The Account seeks long-term growth of capital by investing in a portfolio of equity securities of companies established outside of the U.S. MAIN STRATEGIES The Account invests in a portfolio of equity securities of companies domiciled in any of the nations of the world. The Account invests in securities of: . companies with their principal place of business or principal office outside the U.S.; . companies for which the principal securities trading market is outside the U.S.; and . companies, regardless of where their securities are traded, that derive 50% or more of their total revenue from goods or services produced or sales made outside the U.S. The Account has no limitation on the percentage of assets that are invested in any one country or denominated in any one currency. However, under normal market conditions, the Account intends to have at least 80% of its assets invested in companies in at least three different countries. One of those countries may be the U.S. though currently the Account does not intend to invest in equity securities of U.S. companies. Investments may be made anywhere in the world. Primary consideration is given to securities of corporations of Western Europe, North America and Australasia (Australia, Japan and Far East Asia). Changes in investments are made as prospects change for particular countries, industries or companies. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. The Account may actively trade securities in an attempt to achieve its investment objective. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as companies in more developed countries. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more PRINCIPAL VARIABLE CONTRACTS FUND 15 www.principal.com volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 121.2%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital in markets outside of the U.S. who are able to assume the increased risks of higher price volatility and currency fluctuations associated with investments in international stocks which trade in non-U.S. currencies. 16 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"25.09 "1997"12.24 "1998"9.98 "1999"25.93 "2000"-8.34 "2001"-24.27 "2002"-16.07 "2003"32.33 "2004"21.03 The Account's highest/lowest quarterly returns "2005"23.79 during this time period were: HIGHEST Q2 '03 17.25% LOWEST Q3 '02 -18.68% LOGO The year-to-date return as of March 31, 2006 is 11.97%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS DIVERSIFIED INTERNATIONAL ACCOUNT. 23.79 4.73 8.43 Citigroup BMI Global ex-US Index/(1)/...... 19.59 8.09 7.79 MSCI EAFE (Europe, Australia, Far East) Index - ND ........... 13.54 4.56 5.84 Morningstar Foreign Large Blend Category Average .............. 14.55 2.93 6.47 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 2, 1994). ** Lifetime results are measured from the Index inception date (December 31, 1994). ///(1)/ This index is now the benchmark against which the Account measures its performance. The Manager and the portfolio manager believe it better represents the universe of investment choices open to the Account under its investment philosophy. The index formerly used is also shown. LIFE OF ACCOUNT* DIVERSIFIED 8.09 INTERNATIONAL ACCOUNT. Citigroup BMI Global 8.02** ex-US Index/(1)/...... MSCI EAFE (Europe, 5.94 Australia, Far East) Index - ND ........... Morningstar Foreign 6.27 Large Blend Category Average .............. Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured f the date the Account was first sold (May 2, 1994). ** Lifetime results are measured the Index inception date (December 31, 1994). ///(1)/ This index is now the benchmark against which the Account measures its performance. The Manager and the portfolio manager believe it better represents the universe of investment choices open to the Account under its investment philosophy. The index formerly used is also shown.
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES
Management Fees.................... 0.85% Other Expenses..................... 0.12 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.97%
(EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005 EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate PRINCIPAL VARIABLE CONTRACTS FUND 17 www.principal.com account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES -------------------------------------------------------------------------------------------- 1 3 5 10 DIVERSIFIED INTERNATIONAL ACCOUNT $99 $309 $536 $1,190
18 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 EQUITY GROWTH ACCOUNT The Account seeks to provide long-term capital appreciation by investing primarily in equity securities. MAIN STRATEGIES The Account seeks to maximize long-term capital appreciation by investing primarily in growth-oriented equity securities of U.S. and, to a limited extent, foreign companies that exhibit strong growth and free cash flow potential. These companies are generally characterized as "growth" companies. Under normal market conditions, the Account invests at least 80% of its net assets in equity securities of companies with market capitalizations within the range of companies in the Russell 1000/(R)// /Growth Index (as of March 31, 2006, this range was between approximately $952 million and $368.9 billion) at the time of purchase. The Account's investments in foreign companies will be limited to 25% of its total assets. The Account may also purchase futures and options, in keeping with Account objectives. The Sub-Advisor, T. Rowe Price, generally looks for companies with an above-average rate of earnings and cash flow growth and a lucrative niche in the economy that gives them the ability to sustain earnings momentum even during times of slow economic growth. As a growth investor, T. Rowe Price believes that when a company increases its earnings faster than both inflation and the overall economy, the market will eventually reward it with a higher stock price. In pursuing its investment objective, the Sub-Advisor has the discretion to purchase some securities that do not meet its normal investment criteria, as described above, when it perceives an unusual opportunity for gain. These special situations might arise when the Sub-Advisor believes a security could increase in value for a variety of reasons, including a change in management, an extraordinary corporate event, or a temporary imbalance in the supply of or demand for the securities. The Account may sell securities for a variety of reasons, such as to secure gains, limit losses, or redeploy assets into more promising opportunities. The Account may actively trade securities in an attempt to achieve its investment objective. Futures and options contracts may be bought or sold for any number of reasons, including: to manage exposure to changes in interest rates and foreign currencies; as an efficient means of increasing or decreasing fund overall exposure to a specific part or broad segment of the U.S. or a foreign market; in an effort to enhance income; to protect the value of portfolio securities; and to serve as a cash management tool. Call or put options may be purchased or sold on securities, financial indices, and foreign currencies. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization growth-oriented stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation, making returns more dependent on market increases and decreases. Growth stocks may therefore be more vulnerable than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's PRINCIPAL VARIABLE CONTRACTS FUND 19 www.principal.com portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed an Account's initial investment in such contracts. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 51.6%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks that may have greater risks than stocks of companies with lower potential for earnings growth. 20 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 T. Rowe Price became the Sub-Advisor to the Account on August 24, 2004. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"28.05 "1997"30.86 "1998"18.95 "1999"39.5 "2000"-11.71 "2001"-14.86 "2002"-27.72 "2003"25.95 "2004"9.33 The Account's highest/lowest quarterly returns "2005"7.55 during this time period were: HIGHESTQ4 '9822.68% LOWEST Q1 '01-18.25% LOGO The year-to-date return as of March 31, 2006 is 1.57%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* EQUITY GROWTH ACCOUNT 7.55 -1.84 8.39 10.89 Russell 1000 Growth Index................. 5.26 -3.58 6.73 9.20 Morningstar Large Growth Category Average .............. 6.46 -3.36 6.95 9.09 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (June 1, 1994).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.76% Other Expenses................... 0.01 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.77%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 EQUITY GROWTH ACCOUNT $79 $246 $428 $954
PRINCIPAL VARIABLE CONTRACTS FUND 21 www.principal.com EQUITY INCOME ACCOUNT The Account seeks to achieve high current income and long-term growth of income and capital. MAIN STRATEGIES The Account seeks to achieve its objective by investing primarily in equity securities (such as common stocks), preferred securities, shares of real estate investment trusts (REITs) and convertible securities. In selecting securities, the Sub-Advisor, Principal, places an emphasis on securities with potentially high dividend yields. Under normal market conditions, the Account invests at least 80% of its assets in equity securities. The Account may invest up to 25% of its assets in securities of foreign companies. When determining how to invest the Account's assets in equity securities, Principal seeks stocks that it believes are undervalued in the marketplace at the time of purchase. Securities for the Account are selected by consideration of the quality and price of individual issuers rather than forecasting stock market trends. The selection process focuses on: . the determination that a stock is selling below its fair market value; . an early recognition of changes in a company's underlying fundamentals; . an evaluation of the sustainability of fundamental changes; and . monitoring a stock's behavior in the market. In selecting preferred securities for the Account, Principal focuses on the financial services industry (i.e., banking, insurance and commercial finance). For a security to be considered for the Account, Principal will assess the credit risk within the context of the yield available on the preferred security. The Sub-Advisor also may consider whether the companies' securities have a favorable income-paying history and whether income payments are expected to continue to increase. REITs are corporations or business trusts that are permitted to eliminate corporate level federal income taxes by meeting certain requirements of the Internal Revenue Code. In selecting REITs for the Account, Principal focuses on equity REITs which primarily own property and generate revenue from rental income. Principal seeks to diversify the Account's REIT holdings by property types (e.g. apartment REITs, mall REITs, office and industrial REITs). MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. VALUE STOCKS . The Account's potential investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. INTEREST RATE CHANGES . Changes in interest rates may adversely affect the value of an investor's securities. When interest rates rise, the value of preferred securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of preferred securities. Some investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. PREPAYMENT OR CALL RISK . Some investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the 22 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. EQUITY REITS . Equity REITs are affected by the changes in the value of the properties owned by the trust. In addition, they: . may not be diversified with regard to the types of tenants (thus subject to business developments of the tenant(s)); . may not be diversified with regard to the geographic locations of the properties (thus subject to regional economic developments); and . are subject to cash flow dependency of its tenants. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. INVESTOR PROFILE The Account may be an appropriate investment for investors who seek dividends to generate income or to be reinvested for growth and accept fluctuations in the value of investments. PRINCIPAL VARIABLE CONTRACTS FUND 23 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999"2.29 "2000"19.18 "2001"-27.7 "2002"-12.61 "2003"13.83 "2004"17.6 The Account's highest/lowest quarterly returns "2005"8.67 during this time period were: HIGHESTQ3 '0018.18% LOWEST Q3 '01-16.65% LOGO The year-to-date return as of March 31, 2006 is 7.04%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* EQUITY INCOME ACCOUNT ........ 8.67 -1.67 3.40 Russell 1000 Value Index ..... 7.05 5.28 5.69 Morningstar Moderate Allocation Category Average .. 5.29 2.93 4.29 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.60% Other Expenses............................. 0.06 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.66%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 EQUITY INCOME ACCOUNT $67 $211 $368 $822
24 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 EQUITY VALUE ACCOUNT The Account seeks long-term growth of capital. MAIN STRATEGIES The Account invests primarily in common stocks and other equity securities of large capitalization companies. Under normal market conditions, the Account invests at least 80% of its net assets in securities of companies with market capitalizations similar to companies in the Russell 1000/(R) /Value Index (as of March 31, 2006, this range was between approximately $688 million and $387.4 billion) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. The Account may invest up to 25% of its assets in securities of foreign companies. The Sub-Advisor, American Century/(R)/, uses a value investment strategy that looks for companies that are temporarily out of favor in the market. The Sub-Advisor attempts to purchase the stocks of these undervalued companies and hold the stocks until they have returned to favor in the market and their price has increased to, or is higher than, a level the Sub-Advisor believes more accurately reflects the irfair value. American Century may sell stocks from the Account's portfolio if it believes a stock no longer meets its valuation criteria. Companies may be undervalued due to market declines, poor economic conditions, actual or anticipated bad news regarding the issuer or its industry, or because they have been overlooked by the market. To identify these companies, the Sub-Advisor looks for companies with earnings, cash flows and/or assets that may not be reflected accurately in the companies' stock prices or may be outside the companies' historical ranges. The Sub-Advisor also may consider whether the companies' securities have a favorable income-paying history and whether income payments are expected to continue or increase. American Century/(R)/ does not attempt to time the market. Instead, under normal market conditions, it intends to keep at least 80% of the Account's assets in U.S. equity securities. Equity securities include common stock, preferred stock, and equity-equivalent securities (such as securities convertible into common stock) stock futures contracts or stock index futures contracts. Futures contracts, a type of derivative security, can help the Account's cash assets remain liquid while performing more like stocks. The Sub-Advisor has a policy governing futures contracts and similar derivative securities to help manage the risk of these types of investments. When the Sub-Advisor believes it is prudent, the Account may invest a portion of its assets in foreign securities, debt securities of companies, debt obligations of governments and their agencies and other similar securities. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. The Account may actively trade securities in an attempt to achieve its investment objective. In the event of exceptional market or economic conditions, the Account may as a temporary defensive measure, invest all or a substantial portion of its assets in cash, cash-equivalent securities or short-term debt securities. To the extent the Account assumes a defensive position, it will not be pursuing its objective of capital growth. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. VALUE STOCKS . The Account's potential investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. PRINCIPAL VARIABLE CONTRACTS FUND 25 www.principal.com INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. HEDGING STRATEGIES . Use of forward foreign currency exchange contracts, currency or index futures or other derivatives involves risks. The contracts may increase the Account's volatility and, thus, could involve a significant risk. If the Sub-Advisor's predictions are inaccurate, the adverse consequences to the Account (e.g., a reduction in the Account's net asset value) may leave the Account in a worse position than if these strategies were not used. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A high turnover rate may increase the Account's trading costs and may have an adverse impact on the Account's performance. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs and may have an adverse impact on the Account's performance. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 26.7%. TEMPORARY DEFENSIVE STRATEGIES . To the extent the Account assumes a defensive position, the Account may succeed in avoiding losses but it will not be pursuing its objective of capital growth and may fail to achieve its investment objective. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks but prefer investing in companies that appear to be considered undervalued relative to similar companies. 26 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 American Century has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2005"3.78 LOGO The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q3 '05 2.73% LOWEST Q1 '05 -1.07% The year-to-date return as of March 31, 2006 is 3.75%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF FUND* EQUITY VALUE ACCOUNT ................. 3.78 11.46 Russell 1000 Value Index ............. 7.05 14.65 Morningstar Large Value Category Average .............................. 5.88 12.75 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (August 30, 2004).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees....... 0.85% Other Expenses........ 0.29 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.14% Fee Reduction and/or Expense Reimbursement. 0.09 ---- NET EXPENSES 1.05% The Manager has contractually agreed to reimburse operating expenses so that the total Account operating expenses will not be greater than 1.05% through April 30, 2007. The Manager may not continue this arrangement after April 30, 2007.
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate PRINCIPAL VARIABLE CONTRACTS FUND 27 www.principal.com account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES --------------------------------------------------------------------------------------------- 1 3 5 10 EQUITY VALUE ACCOUNT $107 $350 $616 $1,375
28 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 GOVERNMENT & HIGH QUALITY BOND ACCOUNT F/K/A GOVERNMENT SECURITIES ACCOUNT The Account seeks a high level of current income, liquidity and safety of principal. MAIN STRATEGIES The Account seeks to achieve its investment objective by investing primarily (at least 80% of its assets) in securities that are issued by the U.S. Government, its agencies or instrumentalities. The Account may invest in mortgage-backed securities representing an interest in a pool of mortgage loans. These securities are rated AAA by Standard & Poor's Corporation or Aaa by Moody's Investor Services, Inc. or, if unrated, determined by the Sub-Advisor, Principal, to be of equivalent quality. The Account relies on the professional judgment of Principal to make decisions about the Account's portfolio securities. The basic investment philosophy of Principal is to seek undervalued securities that represent good long-term investment opportunities. Securities may be sold when Principal believes they no longer represent good long-term value. The Account may also hold cash and cash equivalents. The size of the Account's cash position depends on various factors, including market conditions and purchases and redemptions of Account shares. A large cash position could impact the ability of the Account to achieve its objective but it also would reduce the Account's exposure in the event of a market downturn and provide liquidity to make additional investments or to meet redemptions. The Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income. Under a reverse repurchase agreement, the Account sells securities and agrees to repurchase them at a specified date and price. The Account pays interest on this "secured financing" and attempts to make money on the difference between the financing rate and the interest it earns by investing the proceeds of the financing. While a reverse repurchase agreement is outstanding, the Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account may lend its portfolio securities to brokers, dealers and other financial institutions. In connection with such loans, the Account remains the owner of the loaned securities and continues to be entitled to payments in amounts equal to the interest, dividends or other distributions payable on the loaned securities. Loans of portfolio securities may not exceed 33 1/3% of the value of the Account's total assets (including the value of all assets received as collateral for loan). In connection with such loans the Account will receive collateral from the borrower equal to at least 100% of the value of the loaned securities. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: U.S. GOVERNMENT SECURITIES . U.S. Government securities do not involve the degree of credit risk associated with investments in lower quality fixed-income securities. As a result, the yields available from U.S. Government securities are generally lower than the yields available from many other fixed-income securities. Like other fixed-income securities, the values of U.S. Government securities change as interest rates fluctuate. Fluctuations in the value of the Account's securities do not affect interest income on securities already held by the Account, but are reflected in the Account's price per share. Since the magnitude of these fluctuations generally is greater at times when the Account's average maturity is longer, under certain market conditions the Account may invest in short-term investments yielding lower current income rather than investing in higher yielding longer term securities. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates. When interest rates rise, the value of fixed-income securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of fixed-income securities. Some fixed-income investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. PRINCIPAL VARIABLE CONTRACTS FUND 29 www.principal.com CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. U.S. GOVERNMENT SPONSORED SECURITIES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. Prepayments, unscheduled principal payments, may result from voluntary prepayment, refinancing or foreclosure of the underlying mortgage. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates and potentially increasing the volatility of the Account. In addition, prepayments may cause losses on securities purchased at a premium (dollar amount by which the price of the bond exceeds its face value). At times, mortgage-backed securities may have higher than market interest rates and are purchased at a premium. Unscheduled prepayments are made at par and cause the Account to experience a loss of some or all of the premium. DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. REVERSE REPURCHASE AGREEMENTS. . This strategy involves the risk that interest costs on money borrowed may exceed the return on securities purchased with the borrowed money. In addition, reverse repurchase agreements may increase the volatility of the Fund. LENDING OF SECURITIES . If the Account lends its portfolio securities and the borrower of the securities fail financially, the Account may experience delays in recovering the loaned securities or exercising its rights in the collateral. The Account lends its securities only to borrowers that the Sub-Advisor determines are creditworthy. PORTFOLIO DURATION . The average portfolio duration of the Account normally varies within a three- to six-year time frame based on Sub-Advisor's forecast for interest rates. Duration is a measure of the expected life of a fixed-income security that is used to determine the sensitivity of a security's price to changes in interest rates. For example, if the portfolio duration of the Account is three years, a change of 1% in the market's yield results in a change of approximately 3% in the value of the Account's securities. The longer a security's duration, the more sensitive it is to changes in interest rates. An Account with a longer average portfolio duration will be more sensitive to changes in interest rates than an Account with a shorter average portfolio duration. 30 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading cost which may have an adverse impact on the Account's performance. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 262.1%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking diversification by investing in a fixed-income mutual fund. PRINCIPAL VARIABLE CONTRACTS FUND 31 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"3.35 "1997"10.39 "1998"8.27 "1999"-0.29 "2000"11.4 "2001"7.61 "2002"8.8 "2003"1.84 "2004"3.56 The Account's highest/lowest quarterly returns "2005"2.01 during this time period were: HIGHEST Q2 '97 4.52% LOWEST Q1 '96 -1.90% LOGO The year-to-date return as of March 31, 2006 is -0.45%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* GOVERNMENT & HIGH QUALITY BOND ACCOUNT . 2.01 4.72 5.62 7.30 Lehman Brothers Government/Mortgage Index................. 2.63 5.40 6.01 7.56 Morningstar Intermediate Government Category Average .............. 1.90 4.62 5.12 6.67 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (April 9, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.44% Other Expenses................... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.46%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 GOVERNMENT & HIGH QUALITY BOND ACCOUNT $47 $148 $258 $579
32 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 GROWTH ACCOUNT The Account seeks long-term growth of capital through the purchase primarily of common stocks, but the Account may invest in other securities. MAIN STRATEGIES The Account invests primarily in common stocks and other equity securities of large capitalization companies with strong earnings growth potential. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with large market capitalizations (those with market capitalizations similar to companies in the Russell 1000/(R)/ Growth Index (as of March 31, 2006 this range was between approximately $952 million and $368.9 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. The Sub-Advisor, CCI, uses a bottom-up approach (focusing on individual stock selection rather than forecasting stock market trends) in its selection of individual securities that it believes have an above average potential for earnings growth. Selection is based on the premise that companies doing better than expected will have rising securities prices, while companies producing less than expected results will not. CCI refers to its discipline as positive momentum and positive surprise. Through in-depth analysis of company fundamentals in the context of the prevailing economic environment, CCI seeks to select companies that meet the criteria of positive momentum and positive surprise in reported results. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization growth-oriented stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks that may have greater risks than stocks of companies with lower potential for earnings growth. PRINCIPAL VARIABLE CONTRACTS FUND 33 www.principal.com CCI became the Sub-Advisor to the Account on January 5, 2005. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"12.51 "1997"26.96 "1998"21.36 "1999"16.44 "2000"-10.15 "2001"-25.5 "2002"-29.07 "2003"26.46 "2004"9.38 The Account's highest/lowest quarterly returns "2005"12.09 during this time period were: HIGHESTQ4 '9821.35% LOWEST Q1 '01-23.55% LOGO The year-to-date return as of March 31, 2006 is 4.86%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* GROWTH ACCOUNT ....... 12.09 -3.91 4.04 5.97 Russell 1000 Growth Index................. 5.26 -3.58 6.73 9.27 Morningstar Large Growth Category Average .............. 6.46 -3.36 6.95 9.05 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (May 2, 1994).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.60% Other Expenses................... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.62%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 GROWTH ACCOUNT $63 $199 $346 $774
34 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 INTERNATIONAL EMERGING MARKETS ACCOUNT The Account seeks long-term growth of capital by investing primarily in equity securities of issuers in emerging market countries. MAIN STRATEGIES The Account seeks to achieve its objective by investing in common stocks of companies in emerging market countries. For this Account, the term "emerging market country" means any country which is considered to be an emerging country by the international financial community (including the International Bank for Reconstruction and Development (also known as the World Bank) and the International Financial Corporation). These countries generally include every nation in the world except the United States, Canada, Japan, Australia, New Zealand and most nations located in Western Europe. Investing in many emerging market countries is not feasible or may involve unacceptable political risk. Principal, the Sub-Advisor, focuses on those emerging market countries that it believes have strongly developing economies and markets which are becoming more sophisticated. Under normal conditions, at least 80% of the Account's assets are invested in emerging market country equity securities. The Account invests in securities of: . companies with their principal place of business or principal office in emerging market countries; . companies for which the principal securities trading market is an emerging market country; or . companies, regardless of where their securities are traded, that derive 50% or more of their total revenue from either goods or services produced in emerging market countries or sales made in emerging market countries. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. EMERGING MARKET COUNTRIES . Investments in emerging market countries involve special risks. Certain emerging market countries have historically experienced, and may continue to experience, certain economic problems. These may include: high rates of inflation, high interest rates, exchange rate fluctuations, large amounts of debt, balance of payments and trade difficulties, and extreme poverty and unemployment. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect PRINCIPAL VARIABLE CONTRACTS FUND 35 www.principal.com against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading cost which may have an adverse impact on the Account's performance. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 169.6%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital in securities of emerging market countries who are able to assume the increased risks of higher price volatility and currency fluctuations associated with investments in international stocks which trade in non-U.S. currencies. 36 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2001"-4.24 "2002"-7.63 "2003"57.2 "2004"24.89 The Account's highest/lowest quarterly returns "2005"34.29 during this time period were: HIGHESTQ4 '0126.63% LOWEST Q3 '01-23.90% LOGO The year-to-date return as of March 31, 2006 is 15.59%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* INTERNATIONAL EMERGING MARKETS ACCOUNT...... 34.29 18.45 16.31 MSCI Emerging Markets Free Index - NDTR/(1)/ 34.00 19.08 18.64 MSCI Emerging Markets Free Index - ID ...... 30.31 16.23 14.18 Morningstar Diversified Emerging Markets Category Average .............. 31.64 18.59 16.26 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (October 24, 2000). ///(1)/ This index is now the benchmark against which the Account measures its performance. The Manager and portfolio manager believe it better represents the universe of investment choices open to the Account under its investment philosophy. The index formerly used is also shown.
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.25% Other Expenses............................. 0.35 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.60%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate PRINCIPAL VARIABLE CONTRACTS FUND 37 www.principal.com account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------- 1 3 5 10 INTERNATIONAL EMERGING MARKETS ACCOUNT $163 $505 $871 $1,900
38 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 INTERNATIONAL SMALLCAP ACCOUNT The Account seeks long-term growth of capital by investing in a portfolio of equity securities of companies established outside of the U.S. MAIN STRATEGIES The Account invests primarily in equity securities of non-U.S. companies with comparatively smaller market capitalizations. Under normal market conditions, the Account invests at least 80% of its assets in securities of companies similar in size to companies included in the Citigroup Extended Market Index (EMI) World ex US (as of March 31, 2006 this range was between approximately $3.3 million and $26.1 billion). Market capitalization is defined as total current market value of a company's outstanding common stock. The Account invests in securities of: . companies with their principal place of business or principal office outside the U.S.; . companies for which the principal securities trading market is outside the U.S.; and . companies, regardless of where their securities are traded, that derive 50% or more of their total revenue from goods or services produced or sales made outside the U.S. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller PRINCIPAL VARIABLE CONTRACTS FUND 39 www.principal.com capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 132.3%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital in smaller companies outside of the U.S. who are able to assume the increased risks of higher price volatility and currency fluctuations associated with investments in international stocks which trade in non-U.S. currencies. 40 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999"93.81 "2000"-11.5 "2001"-21.85 "2002"-16.2 "2003"54.15 "2004"30.2 The Account's highest/lowest quarterly returns "2005"29.12 during this time period were: HIGHESTQ4 '9936.59% LOWEST Q3 '01-21.49% LOGO The year-to-date return as of March 31, 2006 is 15.21%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* INTERNATIONAL SMALLCAP ACCOUNT ........................... 29.12 11.16 13.32 Citigroup Extended Market Index (EMI) World ex US ...... 11.70 4.32 9.36 Morningstar Foreign Small/Mid Growth Category Average ...... 24.79 8.46 12.37 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.19% Other Expenses............................. 0.14 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.33%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 INTERNATIONAL SMALLCAP ACCOUNT $135 $421 $729 $1,601
PRINCIPAL VARIABLE CONTRACTS FUND 41 www.principal.com LARGECAP BLEND ACCOUNT The Account seeks long-term growth of capital. MAIN STRATEGIES The Account pursues its investment objective by investing primarily in equity securities of U.S. companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with large market capitalizations (those with market capitalizations within the range of companies in the Standard & Poor's 500 Stock Index ("S&P 500 Index") (as of March 31, 2006 this range was between approximately $579 million and $371.6 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. The market capitalization of companies in the Account's portfolio and the S&P 500 Index will change over time, and the Account will not automatically sell or cease to purchase a stock of a company it already owns just because the company's market capitalization grows or falls outside of the index range. In addition, the Account has the ability to purchase stocks whose market capitalization falls below the range of companies in the S&P 500 Index. The Account's Sub-Advisor, T. Rowe Price, uses a disciplined portfolio construction process whereby it weights each sector approximately the same as the S&P 500 Index. Individual holdings within each sector, and their weights within the portfolio, can vary substantially from the S&P 500 Index. A team of T. Rowe Price equity analysts is directly responsible for selecting stocks for the Account. Analysts select stocks from the industries they cover based on rigorous fundamental analysis that assesses the quality of the business franchise, earnings growth potential for the company, and stock valuation. The Account seeks to take full advantage of the analysts' focused expertise in their industries. A team of portfolio managers supervises the analysts and has the responsibility for the overall structure of the Account and coordinating Account investments. They also oversee the quantitative analysis that helps the analysts manage their industry-specific portfolios. In pursuing its investment objective, the Account's management has the discretion to purchase some securities that do not meet its normal investment criteria, as described above, when it perceives an unusual opportunity for gain. These special situations might arise when T. Rowe Price believes a security could increase in value for a variety of reasons, including a change in management, an extraordinary corporate event, or a temporary imbalance in the supply of or demand for the securities. The Account will generally remain fully invested (less than 5% cash reserves) and will be sector neutral when compared to the S&P 500 Index. While the majority of assets will be invested in large-capitalization U.S. common stocks, small- and mid-capitalization stocks and foreign stocks (up to 25% of total assets) may also be purchased in keeping with Account objectives. Securities may be sold for a variety of reasons, such as to secure gains, limit losses, or redeploy assets into more promising opportunities. Futures and options contracts may be bought or sold for any number of reasons, including: to manage exposure to changes in interest rates and foreign currencies; as an efficient means of increasing or decreasing fund overall exposure to a specific part or broad segment of the U.S. or a foreign market; in an effort to enhance income; to protect the value of portfolio securities; and to serve as a cash management tool. Call or put options may be purchased or sold on securities, financial indices, and foreign currencies. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's equity securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: 42 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 STOCK MARKET VOLATILITY . The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation, making returns more dependent on market increases and decreases. Growth stocks may therefore be more vulnerable than non-growth stocks to market changes. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. SECTOR RISK . The Sub-Advisor may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As the Sub-Advisor allocates more of the Account's portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in an aggressively managed portfolio of common stocks, but who prefer investing in larger, established companies. PRINCIPAL VARIABLE CONTRACTS FUND 43 www.principal.com T. Rowe Price became the Sub-Advisor to the Account effective March 9, 2004. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2003"23.76 "2004"10.36 "2005"4.74 The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q2 '03 14.07% LOGO LOWEST Q1 '03 -3.91% The year-to-date return as of March 31, 2006 is 4.21%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF ACCOUNT* LARGECAP BLEND ACCOUNT..................... 4.74 5.31 S&P 500 Index .............................. 4.91 5.99 Morningstar Large Blend Category Average ... 5.77 5.57 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 2002).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees...................................... 0.75% Other Expenses....................................... 0.03 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.78%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. This Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 LARGECAP BLEND ACCOUNT $80 $249 $433 $966
44 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 LARGECAP STOCK INDEX ACCOUNT The Account seeks long-term growth of capital. MAIN STRATEGIES Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies that compose the Standard & Poor's ("S&P") 500 Index. The Sub-Advisor, Principal, attempts to mirror the investment performance of the Index by allocating the Account's assets in approximately the same weightings as the S&P 500. The S&P 500 is an unmanaged index of 500 common stocks chosen to reflect the industries of the U.S. economy and is often considered a proxy for the stock market in general. Each stock is weighted by its market capitalization which means larger companies have greater representation in the Index than smaller ones. As of March 31, 2006, the market capitalization range of the Index was between approximately $579 million and $371.6 billion. Over the long-term, Principal seeks a very close correlation between performance of the Account, before expenses, and that of the S&P 500. It is unlikely that a perfect correlation of 1.00 will be achieved. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. Because of the difficulty and expense of executing relatively small stock trades, the Account may not always be invested in the less heavily weighted S&P 500 stocks. At times, the Account's portfolio may be weighted differently from the S&P 500, particularly if the Account has a small level of assets to invest. In addition, the Account's ability to match the performance of the S&P 500 is affected to some degree by the size and timing of cash flows into and out of the Account. The Account is managed to attempt to minimize such effects. Principal reserves the right to omit or remove any of the S&P 500 stocks from the Account if it determines that the stock is not sufficiently liquid. In addition, a stock might be excluded or removed from the Account if extraordinary events or financial conditions lead Principal to believe that it should not be a part of the Account's assets. Principal may also elect to omit any S&P 500 stocks from the Account if such stocks are issued by an affiliated company. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's equity securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth stocks typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. PRINCIPAL VARIABLE CONTRACTS FUND 45 www.principal.com INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital, willing to accept the potential for volatile fluctuations in the value of investments and preferring a passive, rather than active, management style. NOTE: "Standard & Poor's 500" and "S&P 500/(R)/" are trademarks of The McGraw-Hill Companies, Inc. and have been licensed by the Manager. The Account is not sponsored, endorsed, sold or promoted by Standard and Poor's and Standard & Poor's makes no representation regarding the advisability of investing in the Account. 46 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2000"-9.67 "2001"-12.1 "2002"-22.44 "2003"28.32 "2004"10.39 The Account's highest/lowest quarterly returns "2005"4.47 during this time period were: HIGHEST Q2 '03 15.28% LOWEST Q3 '02 -17.27% LOGO The year-to-date return as of March 31, 2006 is 4.17%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* LARGECAP STOCK INDEX ACCOUNT . 4.47 0.18 -0.11 S&P 500 Index ................ 4.91 0.54 0.54 Morningstar Large Blend Category Average.............. 5.77 0.50 1.55 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 3, 1999).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.25%* Other Expenses............................. 0.03 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.28% *Effective January 1, 2006.
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 LARGECAP STOCK INDEX ACCOUNT $29 $90 $157 $356
PRINCIPAL VARIABLE CONTRACTS FUND 47 www.principal.com LARGECAP VALUE ACCOUNT The Account seeks long-term growth of capital. MAIN STRATEGIES The Account invests primarily in undervalued equity securities of companies among the 750 largest by market capitalization that the Sub-Advisor, AllianceBernstein, believes offer above-average potential for growth in future earnings. Under normal market conditions, the Account generally invests at least 80% of its assets in companies with large market capitalizations (those with market capitalizations similar to companies in the Russell 1000/(R)/ Value Index (as of March 31, 2006, this range was between approximately $688 million and $387.4 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. The Account may invest up to 25% of its assets in securities of foreign companies. AllianceBernstein employs an investment strategy, generally described as "value" investing, that involves seeking securities that: . exhibit low financial ratios (particularly stock price-to-book value (liquidation value), but also stock price-to-earnings and stock price-to-cash flow); . can be acquired for less than what AllianceBernstein believes is the issuer's intrinsic value; or . whose price appears attractive relative to the value of the dividends expected to be paid by the issuer in the future. Value oriented investing entails a strong "sell discipline" in that it generally requires the sale of securities that have reached their intrinsic value or a target financial ratio. Value oriented investments may include securities of companies in cyclical industries during periods when such securities appear to AllianceBernstein to have strong potential for capital appreciation or securities of "special situation" companies. A special situation company is one that AllianceBernstein believes has potential for significant future earnings growth but has not performed well in the recent past. These situations include companies with management changes, corporate or asset restructuring or significantly undervalued assets. For AllianceBernstein, identifying special situation companies and establishing an issuer's intrinsic value involves fundamental research about such companies and issuers. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization value stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks but who prefer investing in companies that appear to be considered undervalued relative to similar companies. 48 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 AllianceBernstein has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2003"28.05 "2004"13.09 "2005"5.44 The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q2 '03 16.19% LOGO LOWEST Q1 '03 -5.04% The year-to-date return as of March 31, 2006 is 5.20%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF ACCOUNT* LARGECAP VALUE ACCOUNT...................... 5.44 7.63 Russell 1000 Value Index ................... 7.05 8.81 Morningstar Large Value Category Average ... 5.88 6.76 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 2002).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees...................................... 0.75% Other Expenses....................................... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.77%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 LARGECAP VALUE ACCOUNT $79 $246 $428 $954
PRINCIPAL VARIABLE CONTRACTS FUND 49 www.principal.com MIDCAP ACCOUNT The Account seeks to achieve capital appreciation by investing primarily in securities of emerging and other growth-oriented companies. MAIN STRATEGIES The Account invests primarily in common stocks and other equity securities of medium capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with medium market capitalizations (those with market capitalizations similar to companies in the Russell MidCap/(R)/ Index (as of March 31, 2006, this range was between approximately $688 million and $22.1 billion) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Up to 25% of Account assets may be invested in foreign securities. In selecting securities for investment, the Sub-Advisor, Principal, looks at stocks with value and/or growth characteristics and constructs an investment portfolio that has a "blend" of stocks with these characteristics. In managing the assets of the Account, Principal does not have a policy of preferring one of these categories to the other. The value orientation emphasizes buying stocks at less than their inherent value and avoiding stocks whose price has been artificially built up. The growth orientation emphasizes buying stocks of companies whose potential for growth of capital and earnings is expected to be above average. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. MAIN RISKS The Account is subject to the risk that its principal market segment, medium capitalization stocks, may underperform compared to other market segments or to the equity markets as a whole. Because different types of stocks tend to shift in and out of favor depending on market and economic conditions, the Account's performance may sometimes be lower or higher than that of other types of funds. The value of the Account's equity securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. 50 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 MEDIUM CAPITALIZATIONS . Companies with medium capitalizations may have a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the potential for short-term fluctuations in the value of investments. PRINCIPAL VARIABLE CONTRACTS FUND 51 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"21.11 "1997"22.75 "1998"3.69 "1999"13.04 "2000"14.59 "2001"-3.71 "2002"-8.75 "2003"32.81 "2004"17.76 The Account's highest/lowest quarterly returns "2005"9.21 during this time period were: HIGHESTQ4 '9923.31% LOWEST Q3 '98-20.01% LOGO The year-to-date return as of March 31, 2006 is 4.55%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* MIDCAP ACCOUNT ....... 9.21 8.46 11.60 14.11 Russell Midcap Index . 12.65 8.45 12.49 14.57 Morningstar Mid-Cap Blend Category Average 9.21 8.14 11.74 14.12 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (December 18, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.57% Other Expenses................... 0.01 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.58%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MIDCAP ACCOUNT $59 $186 $324 $726
52 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 MIDCAP GROWTH ACCOUNT The Account seeks long-term growth of capital. MAIN STRATEGIES Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with medium market capitalization (those with market capitalizations similar to companies in the Russell Midcap/(R)/ Growth Index (as of March 31, 2006, this range was between approximately $952 million and $21.9 billion)) at the time of purchase. In the view of the Sub-Advisor, Mellon Equity, many medium-sized companies: . are in fast growing industries; . offer superior earnings growth potential; and . are characterized by strong balance sheets and high returns on equity. The Account may also hold investments in large and small capitalization companies, including emerging and cyclical growth companies. The Account may invest up to 25% of its net assets in securities of foreign companies, including securities of issuers in emerging countries and securities quoted in foreign currencies. Mellon Equity uses valuation models designed to identify common stocks of companies that have demonstrated consistent earnings momentum and delivered superior results relative to market analyst expectations. Other considerations include profit margins, growth in cash flow and other standard balance sheet measures. The securities held are generally characterized by strong earnings momentum measures and higher expected earnings per share growth. The valuation model incorporates information about the relevant criteria as of the most recent period for which data are available. Once ranked, the securities are categorized under the headings "buy," "sell" or "hold." The decision to buy, sell or hold is made by Mellon Equity based primarily on output of the valuation model. However, that decision may be modified due to subsequently available or other specific relevant information about the security. In addition, Mellon Equity manages risk by diversifying across companies and industries, limiting the potential adverse impact from any one stock or industry. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. MEDIUM CAPITALIZATIONS . Companies with medium capitalizations may have a limited operating history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency PRINCIPAL VARIABLE CONTRACTS FUND 53 www.principal.com exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. EMERGING MARKET COUNTRIES . Investments in emerging market countries involve special risks. Certain emerging market countries have historically experienced, and may continue to experience, certain economic problems. These may include: high rates of inflation, high interest rates, exchange rate fluctuations, large amounts of debt, balance of payments and trade difficulties, and extreme poverty and unemployment. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth and willing to accept the potential for short-term fluctuations in the value of their investments. 54 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Mellon Equity has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999"10.67 "2000"8.1 "2001"-16.92 "2002"-26.27 "2003"40.58 "2004"11.82 The Account's highest/lowest quarterly returns "2005"13.72 during this time period were: HIGHESTQ4 '0124.12% LOWEST Q3 '01-25.25% LOGO The year-to-date return as of March 31, 2006 is 7.08%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* MIDCAP GROWTH ACCOUNT ........ 13.72 1.83 3.12 Russell Midcap Growth Index .. 12.10 1.38 5.30 Morningstar Mid-Cap Growth Category Average.............. 9.70 0.01 6.65 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.90% Other Expenses............................. 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.92%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MIDCAP GROWTH ACCOUNT $94 $293 $509 $1,131
PRINCIPAL VARIABLE CONTRACTS FUND 55 www.principal.com MIDCAP VALUE ACCOUNT The Account seeks long-term growth of capital by investing primarily in equity securities of companies with value characteristics and market capitalizations. MAIN STRATEGIES The Account invests primarily in common stocks of medium capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with a medium market capitalization (those with market capitalizations similar to companies in the Russell Midcap/(R)/ Value Index (as of March 31, 2006, this range was between approximately $688 million and $22.1 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Companies may range from the well-established and well known to the new and unseasoned. The Account may invest up to 25% of its assets in securities of foreign companies. The stocks are selected using a value oriented investment approach by Neuberger Berman, the Sub-Advisor. Neuberger Berman identifies value stocks in several ways. Factors it considers in identifying value stocks may include: . strong fundamentals, such as a company's financial, operational and competitive positions; . consistent cash flow; and . a sound earnings record through all phases of the market cycle. Neuberger Berman may also look for other characteristics in a company, such as a strong position relative to competitors, a high level of stock ownership among management, and a recent sharp decline in stock price that appears to be the result of a short-term market overreaction to negative news. Neuberger Berman believes that, over time, securities that are undervalued are more likely to appreciate in price and are subject to less risk of price decline than securities whose market prices have already reached their perceived economic value. This approach also involves selling portfolio securities when Neuberger Berman believes they have reached their potential, when the securities fail to perform as expected or when other opportunities appear more attractive. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. MEDIUM CAPITALIZATIONS . Companies with medium capitalizations may have a limited operating history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency 56 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth and willing to accept short-term fluctuations in the value of investments. PRINCIPAL VARIABLE CONTRACTS FUND 57 www.principal.com Neuberger Berman has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2000"31.03 "2001"-2.58 "2002"-9.96 "2003"36.49 "2004"22.67 The Account's highest/lowest quarterly returns "2005"10.55 during this time period were: HIGHEST Q2 '03 14.93% LOWEST Q3 '02 -14.54% LOGO The year-to-date return as of March 31, 2006 is 4.70%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* MIDCAP VALUE ACCOUNT ......... 10.55 10.18 13.65 Russell Midcap Value Index ... 12.65 12.21 10.93 Morningstar Mid-Cap Value Category Average.............. 8.41 9.36 10.54 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 3, 1999).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.05% Other Expenses............................. 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.07%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MIDCAP VALUE ACCOUNT $109 $340 $590 $1,306
58 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 MONEY MARKET ACCOUNT The Account has an investment objective of as high a level of current income available from investments in short-term securities as is consistent with preservation of principal and maintenance of liquidity. MAIN STRATEGIES The Account invests its assets in a portfolio of high quality, short-term money market instruments. The investments are U.S. dollar denominated securities which the Sub-Advisor, Principal, believes present minimal credit risks. At the time the Account purchases each security, it is an "eligible security" as defined in the regulations issued under the Investment Company Act of 1940, as amended. The Account maintains a dollar weighted average portfolio maturity of 90 days or less. It intends to hold its investments until maturity. However, the Account may sell a security before it matures: . to take advantage of market variations; . to generate cash to cover sales of Account shares by its shareholders; or . upon revised credit opinions of the security's issuer. The sale of a security by the Account before maturity may not be in the best interest of the Account. The sale of portfolio securities is usually a taxable event. The Account does have an ability to borrow money to cover the redemption of Account shares. It is the policy of the Account to be as fully invested as possible to maximize current income. Securities in which the Account invests include: . securities issued or guaranteed by the U.S. government, including treasury bills, notes and bonds; . securities issued or guaranteed by agencies or instrumentalities of the U.S. government. These are backed either by the full faith and credit of the U.S. government or by the credit of the particular agency or instrumentality; . bank obligations including: . certificates of deposit which generally are negotiable certificates against funds deposited in a commercial bank; or . bankers acceptances which are time drafts drawn on a commercial bank, usually in connection with international commercial transactions. . commercial paper which is short-term promissory notes issued by U.S. or foreign corporations primarily to finance short-term credit needs; . corporate debt consisting of notes, bonds or debentures which at the time of purchase by the Account has 397 days or less remaining to maturity; . repurchase agreements under which securities are purchased with an agreement by the seller to repurchase the security at the same price plus interest at a specified rate. Generally these have a short maturity (less than a week) but may also have a longer maturity; and . taxable municipal obligations which are short-term obligations issued or guaranteed by state and municipal issuers which generate taxable income. Among the certificates of deposit typically held by the Account are Eurodollar and Yankee obligations which are issued in U.S. dollars by foreign banks and foreign branches of U.S. banks. Before the Sub-Advisor selects a Eurodollar or Yankee obligation, however, the foreign issuer undergoes the same credit-quality analysis and tests of financial strength as an issuer of domestic securities. MAIN RISKS As with all mutual funds, the value of the Account's assets may rise or fall. Although the Account seeks to preserve the value of an investment at $1.00 per share, it is possible to lose money by investing in the Account. An investment in the Account is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. As with any security, the securities in which the Account invests have associated risks. These include risks of: CREDIT RISK . Credit risk pertains to the issuer's ability to make scheduled principal or interest payments. This may reduce the Account's stream of income and decrease the Account's yield. PRINCIPAL VARIABLE CONTRACTS FUND 59 www.principal.com INTEREST RATE RISK . The value of the Account's shares is directly impacted by trends in interest rates. If interest rates rise, the value of debt securities generally will fall. REPURCHASE AGREEMENTS . The Account may invest in repurchase agreements with commercial banks, brokers and dealers considered by the Sub-Advisor to be creditworthy. Default or insolvency of the other party is a potential risk to the Account. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in securities issued by government-sponsored enterprises. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. EURODOLLAR AND YANKEE OBLIGATIONS . Eurodollar and Yankee obligations have risks similar to U.S. money market instruments, such as income risk and credit risk. Other risks of Eurodollar and Yankee obligations include the possibilities that: a foreign government will not let U.S. dollar-denominated assets leave the country; the banks that issue Eurodollar obligations may not be subject to the same regulations as U.S. banks; and adverse political or economic developments will affect investments in a foreign country. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking monthly dividends without incurring much principal risk. 60 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"5.07 "1997"5.04 "1998"5.2 "1999"4.84 "2000"6.07 "2001"3.92 "2002"1.42 "2003"0.74 "2004"0.92 "2005"2.69 TO OBTAIN THE ACCOUNT'S CURRENT YIELD INFORMATION, PLEASE CALL 1-800-247-4123 LOGO The year-to-date return as of March 31, 2006 is 1.00%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* Money Market Account . 2.69 1.93 3.60 3.15 *Lifetime results are measured from the date the Account was first sold (March 18, 1983).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.49% Other Expenses................... 0.12 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.61%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MONEY MARKET ACCOUNT $62 $195 $340 $762
PRINCIPAL VARIABLE CONTRACTS FUND 61 www.principal.com PRINCIPAL LIFETIME 2010 ACCOUNT The Account seeks a total return consisting of long-term growth of capital and current income. MAIN STRATEGIES To pursue its goal, the Account invests in shares of other Principal Variable Contracts Fund Accounts (the "underlying funds"). The underlying funds are intended to give the Account broad exposure to the domestic and foreign equity and fixed-income markets. The Manager and the Sub-Advisor, Principal, both provide investment advisory services to the Account. The Manager has hired Principal to develop, implement, and monitor the strategic or long-term asset class targets and target ranges for the Account. In deciding how to allocate the Account's assets among several asset classes, Principal considers long-term asset class returns, volatility assumptions and the Account's target time horizon. Principal is also responsible for employing an active rebalancing strategy that, within the target ranges, directs cash flows or Account assets towards or away from asset classes that Principal determines to be attractive or unattractive over shorter time periods, so long as the target asset class ranges are not violated. The Manager is responsible for implementing the strategic asset allocation set by Principal. In this role, the Manager selects the underlying funds and their respective weights. The Manager is also responsible for monitoring the Sub-Advisor of each underlying fund and may, at any time, add or substitute underlying funds in which the Account invests. Over time, shifts in the asset class targets and underlying funds will be designed to accommodate investors progressing from asset accumulation years to income-generation years; shifts in the asset class targets or underlying funds may also occur when market forces or Account circumstances change allocations. In allocating Account assets among the underlying funds, the Manager relies on a combination of quantitative measures, such as past performance and style consistency, and qualitative factors. Qualitative factors that the Manager considers include the fund advisor's organizational stability, investment experience, consistency of investment process, risk management processes, and information, trading and compliance systems. There are no minimum or maximum percentages in which the Account must invest in a specific asset class or underlying fund. Principal intends to gradually shift the Account's asset allocation so that within five to ten years after the year 2010, the Account's asset allocation matches that of the Principal LifeTime Strategic Income Account. At that time, the Account may be combined with the Principal LifeTime Strategic Income Account if the Board of Directors determines that the combination is in the best interests of Account shareholders. MAIN RISKS The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The Account's investments are concentrated in the underlying funds and, as a result, the Account's performance is directly related to their performance. The Account's ability to meet its investment objective depends on the ability of the underlying funds to achieve their investment objectives. Consequently, the Account is subject to the particular risks of the underlying funds in the proportions in which the Account invests in them. The Account's broad diversification is designed to cushion severe losses in any one investment sector and moderate the Account's overall price swings. However, the Account's share prices will fluctuate as the prices of the underlying funds rise or fall with changing market conditions. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the underlying funds invest have associated risks. These include risks of: INTEREST RATE CHANGES . The value of fixed-income securities held by an underlying fund may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by an underlying fund may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. 62 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 U.S. GOVERNMENT SPONSORED ENTERPRISES . An underlying fund may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. STOCK MARKET VOLATILITY . The prices of equity securities held by an underlying fund may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. FOREIGN INVESTING . The underlying funds may invest in foreign securities. Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. SMALL AND MEDIUM CAPITALIZATIONS . The underlying funds may invest in small and medium capitalization companies. Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. HEDGING STRATEGIES . The underlying funds may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The underlying funds may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the underlying funds and, therefore, the Account. However, the Account's performance could be worse than if the underlying funds had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; use of them by the underlying funds could lower Account total return; and the potential loss from the use of futures can exceed an underlying fund's initial investment in such contracts. INITIAL PUBLIC OFFERINGS ("IPOS") . An underlying fund's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors expecting to retire around the year 2010. UNDERLYING FUND ALLOCATION As of December 31, 2005, the Account's assets were allocated among the underlying funds as follows:
Bond 38.8 LargeCap Stock Index 10.1 Capital Value 3.0 LargeCap Value 5.1 Diversified International 5.6 Money Market 10.7 Equity Income 6.1 Real Estate Securities 8.5 LargeCap Growth Equity 8.1 SmallCap 4.0
Based on this allocation, the weighted average of the total account operating expenses of the underlying funds is 0.64%. The combined total expenses for the Account may be higher or lower depending on the allocation of its assets among the underlying funds. PRINCIPAL VARIABLE CONTRACTS FUND 63 www.principal.com The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2005"5.7 LOGO The Account's highest/lowest quarterly returns during this time period were: HIGHESTQ2 '053.59% LOWEST Q1 '05-1.64% The year-to-date return as of March 31, 2006 is 3.76%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF FUND* PRINCIPAL LIFETIME 2010 ACCOUNT ...... 5.70 11.41 S&P 500 Index ........................ 4.91 11.66 Lehman Brothers Aggregate Bond Index . 2.43 2.75 Morningstar Conservative Allocation Category Average...................... 3.05 5.88 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (August 30, 2004).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES
Management Fees....... 0.12% Other Expenses........ 0.08 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.20% Fee Reduction and/or Expense Reimbursement. 0.04 ---- NET EXPENSES 0.16% The Manager has contractually agreed to reimburse operating expenses so that the total Account operating expenses will not be greater than 0.16% through April 30, 2007. The Manager may choose not to continue this arrangement after April 30, 2007. As a shareholder in the underlying funds, the Account indirectly bears its pro rata share of the operating expenses incurred by each underlying fund. As of December 31, 2005, the operating expenses of the underlying funds ranged from 0.38% to 1.09%. The Account's investment return is net of the underlying funds' operating expenses.
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If the 64 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 operating expenses of the underlying funds, separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 PRINCIPAL LIFETIME 2010 ACCOUNT $16 $59 $107 $250
PRINCIPAL VARIABLE CONTRACTS FUND 65 www.principal.com PRINCIPAL LIFETIME 2020 ACCOUNT The Account seeks a total return consisting of long-term growth of capital and current income. MAIN STRATEGIES To pursue its goal, the Account invests in shares of other Principal Variable Contracts Fund Accounts (the "underlying funds"). The underlying funds are intended to give the Account broad exposure to the domestic and foreign equity and fixed-income markets. The Manager and the Sub-Advisor, Principal, both provide investment advisory services to the Account. The Manager has hired Principal to develop, implement, and monitor the strategic or long-term asset class targets and target ranges for the Account. In deciding how to allocate the Account's assets among several asset classes, Principal considers long-term asset class returns, volatility assumptions and the Account's target time horizon. Principal is also responsible for employing an active rebalancing strategy that, within the target ranges, directs cash flows or Account assets towards or away from asset classes that Principal determines to be attractive or unattractive over shorter time periods, so long as the target asset class ranges are not violated. The Manager is responsible for implementing the strategic asset allocation set by Principal. In this role, the Manager selects the underlying funds and their respective weights. The Manager is also responsible for monitoring the Sub-Advisor of each underlying fund and may, at any time, add or substitute underlying funds in which the Account invests. Over time, shifts in the asset class targets and underlying funds will be designed to accommodate investors progressing from asset accumulation years to income-generation years; shifts in the asset class targets or underlying funds may also occur when market forces or Account circumstances change allocations. In allocating Account assets among the underlying funds, the Manager relies on a combination of quantitative measures, such as past performance and style consistency, and qualitative factors. Qualitative factors that the Manager considers include the fund advisor's organizational stability, investment experience, consistency of investment process, risk management processes, and information, trading and compliance systems. There are no minimum or maximum percentages in which the Account must invest in a specific asset class or underlying fund. Principal intends to gradually shift the Account's asset allocation so that within five to ten years after the year 2020, the Account's asset allocation matches that of the Principal LifeTime Strategic Income Account. At that time, the Account may be combined with the Principal LifeTime Strategic Income Account if the Board of Directors determines that the combination is in the best interests of Account shareholders. MAIN RISKS The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The Account's investments are concentrated in the underlying funds and, as a result, the Account's performance is directly related to their performance. The Account's ability to meet its investment objective depends on the ability of the underlying funds to achieve their investment objectives. Consequently, the Account is subject to the particular risks of the underlying funds in the proportions in which the Account invests in them. The Account's broad diversification is designed to cushion severe losses in any one investment sector and moderate the Account's overall price swings. However, the Account's share prices will fluctuate as the prices of the underlying funds rise or fall with changing market conditions. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the underlying funds invest have associated risks. These include risks of: STOCK MARKET VOLATILITY . The prices of equity securities held by an underlying fund may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL AND MEDIUM CAPITALIZATIONS . The underlying funds may invest in small and medium capitalization companies. Companies with small or medium capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such 66 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. SECTOR RISK . The underlying funds may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As the Sub-Advisor allocates more of the Account's portfolio holdings to an underlying fund that allocates more of its portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . The underlying funds may invest in foreign securities. Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. HEDGING STRATEGIES . The underlying funds may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The underlying funds may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the underlying funds and, therefore, the Account. However, the Account's performance could be worse than if the underlying funds had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; use of them by the underlying funds could lower Account total return; and the potential loss from the use of futures can exceed an underlying fund's initial investment in such contracts. INITIAL PUBLIC OFFERINGS ("IPOS") . An underlying fund's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INTEREST RATE CHANGES . The value of fixed-income securities held by an underlying fund may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by an underlying fund may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. U.S. GOVERNMENT SPONSORED ENTERPRISES . An underlying fund may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. INVESTOR PROFILE The Fund may be an appropriate investment for investors expecting to retire around the year 2020 or fund a cashflow need in the year 2020. UNDERLYING FUND ALLOCATION As of December 31, 2005, the Account's assets were allocated among the underlying funds as follows:
Bond 34.5 LargeCap Value 5.6 Capital Value 7.3 Real Estate Securities 8.8 Diversified International 9.9 SmallCap 2.0 Equity Income 6.1 SmallCap Growth 1.5 LargeCap Growth Equity 5.9 SmallCap Value 1.5 LargeCap Stock Index 16.9
PRINCIPAL VARIABLE CONTRACTS FUND 67 www.principal.com Based on this allocation, the weighted average of the total account operating expenses of the underlying funds is 0.64%. The combined total expenses for the Account may be higher or lower depending on the allocation of its assets among the underlying funds. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2005"6.77 LOGO The Account's highest/lowest quarterly returns during this time period were: HIGHESTQ2 '053.27% LOWEST Q1 '05 -1.60% The year-to-date return as of March 31, 2006 is 5.00%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF FUND* PRINCIPAL LIFETIME 2020 ACCOUNT ...... 6.77 13.26 S&P 500 Index ........................ 4.91 11.66 Lehman Brothers Aggregate Bond Index . 2.43 2.75 Morningstar Moderate Allocation Category Average...................... 5.29 10.47 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (August 30, 2004).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees....... 0.12% Other Expenses........ 0.04 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.16% Fee Reduction and/or Expense Reimbursement. 0.03 ---- NET EXPENSES 0.13% The Manager has contractually agreed to reimburse operating expenses so that the total Account operating expenses will not be greater than 0.13% through April 30, 2007. The Manager may choose not to continue this arrangement after April 30, 2007. As a shareholder in the underlying funds, the Account indirectly bears its pro rata share of the operating expenses incurred by each underlying fund. As of December 31, 2005, the operating expenses of the underlying funds ranged from 0.38% to 1.13%. The Account's investment return is net of the underlying funds' operating expenses.
68 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If the operating expenses of the underlying funds, separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ------------------------------------------------------------------------------------------------- 1 3 5 10 PRINCIPAL LIFETIME 2020 ACCOUNT $13 $47 $86 $201
PRINCIPAL VARIABLE CONTRACTS FUND 69 www.principal.com PRINCIPAL LIFETIME 2030 ACCOUNT The Account seeks a total return consisting of long-term growth of capital and current income. MAIN STRATEGIES To pursue its goal, the Account invests in shares of other Principal Variable Contracts Fund Accounts (the "underlying funds"). The underlying funds are intended to give the Account broad exposure to the domestic and foreign equity and fixed-income markets. The Manager and the Sub-Advisor, Principal, both provide investment advisory services to the Account. The Manager has hired Principal to develop, implement, and monitor the strategic or long-term asset class targets and target ranges for the Account. In deciding how to allocate the Account's assets among several asset classes, Principal considers long-term asset class returns, volatility assumptions and the Account's target time horizon. Principal is also responsible for employing an active rebalancing strategy that, within the target ranges, directs cash flows or Account assets towards or away from asset classes that Principal determines to be attractive or unattractive over shorter time periods, so long as the target asset class ranges are not violated. The Manager is responsible for implementing the strategic asset allocation set by Principal. In this role, the Manager selects the underlying funds and their respective weights. The Manager is also responsible for monitoring the Sub-Advisor of each underlying fund and may, at any time, add or substitute underlying funds in which the Account invests. Over time, shifts in the asset class targets and underlying funds will be designed to accommodate investors progressing from asset accumulation years to income-generation years; shifts in the asset class targets or underlying funds may also occur when market forces or Account circumstances change allocations. In allocating Account assets among the underlying funds, the Manager relies on a combination of quantitative measures, such as past performance and style consistency, and qualitative factors. Qualitative factors that the Manager considers include the fund advisor's organizational stability, investment experience, consistency of investment process, risk management processes, and information, trading and compliance systems. There are no minimum or maximum percentages in which the Account must invest in a specific asset class or underlying fund. Principal intends to gradually shift the Account's asset allocation so that within five to ten years after the year 2030, the Account's asset allocation matches that of the Principal LifeTime Strategic Income Account. At that time, the Account may be combined with the Principal LifeTime Strategic Income Account if the Board of Directors determines that the combination is in the best interests of Account shareholders. MAIN RISKS The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The Account's investments are concentrated in the underlying funds and, as a result, the Account's performance is directly related to their performance. The Account's ability to meet its investment objective depends on the ability of the underlying funds to achieve their investment objectives. Consequently, the Account is subject to the particular risks of the underlying funds in the proportions in which the Account invests in them. The Account's broad diversification is designed to cushion severe losses in any one investment sector and moderate the Account's overall price swings. However, the Account's share prices will fluctuate as the prices of the underlying funds rise or fall with changing market conditions. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the underlying funds invest have associated risks. These include risks of: STOCK MARKET VOLATILITY . The prices of equity securities held by an underlying fund may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL AND MEDIUM CAPITALIZATIONS . The underlying funds may invest in small and medium capitalization companies. Companies with small or medium capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such 70 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. SECTOR RISK . The underlying funds may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As the Sub-Advisor allocates more of the Account's portfolio holdings to an underlying fund that allocates more of its portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . An underlying fund may invest in foreign securities. Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. HEDGING STRATEGIES . The underlying funds may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The underlying funds may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the underlying funds and, therefore, the Account. However, the Account's performance could be worse than if the underlying funds had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; use of them by the underlying funds could lower Account total return; and the potential loss from the use of futures can exceed an underlying fund's initial investment in such contracts. INITIAL PUBLIC OFFERINGS ("IPOS") . An underlying fund's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INTEREST RATE CHANGES . The value of fixed-income securities held by an underlying fund may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by an underlying fund may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. U.S. GOVERNMENT SPONSORED ENTERPRISES . An underlying fund may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. INVESTOR PROFILE The Fund may be an appropriate investment for investors expecting to retire around the year 2030 or fund a cashflow need in the year 2030. UNDERLYING FUND ALLOCATION As of December 31, 2005, the Account's assets were allocated among the underlying funds as follows:
Bond 24.8 LargeCap Value 9.0 Capital Value 5.0 Real Estate Securities 7.2 Diversified International 10.2 SmallCap 2.0 Equity Income 5.0 SmallCap Growth 2.0 LargeCap Growth Equity 14.4 SmallCap Value 2.0 LargeCap Stock Index 18.4
PRINCIPAL VARIABLE CONTRACTS FUND 71 www.principal.com Based on this allocation, the weighted average of the total account operating expenses of the underlying funds is 0.70%. The combined total expenses for the Account may be higher or lower depending on the allocation of its assets among the underlying funds. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2005"6.76 LOGO The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q3 '05 3.35% LOWEST Q1 '05 -1.59% The year-to-date return as of March 31, 2006 is 5.02%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF FUND* PRINCIPAL LIFETIME 2030 ACCOUNT ...... 6.76 13.23 S&P 500 Index ........................ 4.91 11.66 Lehman Brothers Aggregate Bond Index . 2.43 2.75 Morningstar Moderate Allocation Category Average...................... 5.29 10.47 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (August 30, 2004).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees....... 0.12% Other Expenses........ 0.26 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.38% Fee Reduction and/or Expense Reimbursement. 0.22 ---- NET EXPENSES 0.16% The Manager has contractually agreed to reimburse operating expenses so that the total Account operating expenses will not be greater than 0.16% through April 30, 2007. The Manager may choose not to continue this arrangement after April 30, 2007. As a shareholder in the underlying funds, the Account indirectly bears its pro rata share of the operating expenses incurred by each underlying fund. As of December 31, 2005, the operating expenses of the underlying funds ranged from 0.38% to 1.13%. The Account's investment return is net of the underlying funds' operating expenses.
72 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If the operating expenses of the underlying funds, separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ------------------------------------------------------------------------------------------------- 1 3 5 10 PRINCIPAL LIFETIME 2030 ACCOUNT $16 $92 $183 $451
PRINCIPAL VARIABLE CONTRACTS FUND 73 www.principal.com PRINCIPAL LIFETIME 2040 ACCOUNT The Account seeks a total return consisting of long-term growth of capital and current income. MAIN STRATEGIES To pursue its goal, the Account invests in shares of other Principal Variable Contracts Fund Accounts (the "underlying funds"). The underlying funds are intended to give the Account broad exposure to the domestic and foreign equity and fixed-income markets. The Manager and the Sub-Advisor, Principal, both provide investment advisory services to the Account. The Manager has hired Principal to develop, implement, and monitor the strategic or long-term asset class targets and target ranges for the Account. In deciding how to allocate the Account's assets among several asset classes, Principal considers long-term asset class returns, volatility assumptions and the Account's target time horizon. Principal is also responsible for employing an active rebalancing strategy that, within the target ranges, directs cash flows or Account assets towards or away from asset classes that Principal determines to be attractive or unattractive over shorter time periods, so long as the target asset class ranges are not violated. The Manager is responsible for implementing the strategic asset allocation set by Principal. In this role, the Manager selects the underlying funds and their respective weights. The Manager is also responsible for monitoring the Sub-Advisor of each underlying fund and may, at any time, add or substitute underlying funds in which the Account invests. Over time, shifts in the asset class targets and underlying funds will be designed to accommodate investors progressing from asset accumulation years to income-generation years; shifts in the asset class targets or underlying funds may also occur when market forces or Account circumstances change allocations. In allocating Account assets among the underlying funds, the Manager relies on a combination of quantitative measures, such as past performance and style consistency, and qualitative factors. Qualitative factors that the Manager considers include the fund advisor's organizational stability, investment experience, consistency of investment process, risk management processes, and information, trading and compliance systems. There are no minimum or maximum percentages in which the Account must invest in a specific asset class or underlying fund. Principal intends to gradually shift the Account's asset allocation so that within five to ten years after the year 2040, the Account's asset allocation matches that of the Principal LifeTime Strategic Income Account. At that time, the Account may be combined with the Principal LifeTime Strategic Income Account if the Board of Directors determines that the combination is in the best interests of Account shareholders. MAIN RISKS The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The Account's investments are concentrated in the underlying funds and, as a result, the Account's performance is directly related to their performance. The Account's ability to meet its investment objective depends on the ability of the underlying funds to achieve their investment objectives. Consequently, the Account is subject to the particular risks of the underlying funds in the proportions in which the Account invests in them. The Account's broad diversification is designed to cushion severe losses in any one investment sector and moderate the Account's overall price swings. However, the Account's share prices will fluctuate as the prices of the underlying funds rise or fall with changing market conditions. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the underlying funds invest have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of an underlying fund's shares is affected by changes in the value of the securities it owns. The prices of equity securities held by the underlying fund may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL AND MEDIUM CAPITALIZATIONS . An underlying fund may invest in small and medium capitalization companies. Companies with small or medium capitalizations are often companies with a limited operation history. Such companies 74 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. SECTOR RISK . The underlying funds may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As the Sub-Advisor allocates more of the Account's portfolio holdings to an underlying fund that allocates more of its portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . The underlying funds may invest in foreign securities. Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. HEDGING STRATEGIES . The underlying funds may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The underlying funds may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the underlying funds and, therefore, the Account. However, the Account's performance could be worse than if the underlying funds had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; use of them by the underlying funds could lower Account total return; and the potential loss from the use of futures can exceed an underlying fund's initial investment in such contracts. INITIAL PUBLIC OFFERINGS ("IPOS") . An underlying fund's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. FIXED-INCOME RISKS . Interest rate changes. The value of fixed-income securities held by an underlying fund may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. . Credit risk. Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by an underlying fund may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. . High yield securities. Fixed-income securities in which an underlying fund may invest that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.). . U.S. Government Sponsored Enterprises. An underlying fund may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. PRINCIPAL VARIABLE CONTRACTS FUND 75 www.principal.com INVESTOR PROFILE The Fund may be an appropriate investment for investors expecting to retire around the year 2040 or fund a cashflow need in the year 2040. UNDERLYING FUND ALLOCATION As of December 31, 2005, the Account's assets were allocated among the underlying funds as follows:
Bond 16.6 LargeCap Value 10.9 Capital Value 5.9 Real Estate Securities 4.8 Diversified International 13.1 SmallCap 3.5 Equity Income 2.7 SmallCap Growth 2.5 LargeCap Growth Equity 16.0 SmallCap Value 2.5 LargeCap Stock Index 21.5
Based on this allocation, the weighted average of the total account operating expenses of the underlying funds is 0.73%. The combined total expenses for the Account may be higher or lower depending on the allocation of its assets among the underlying funds. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2005"7.27 LOGO The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q3 '05 3.95% LOWEST Q1 '05-1.44% The year-to-date return as of March 31, 2006 is 5.40%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF FUND* PRINCIPAL LIFETIME 2040 ACCOUNT ...... 7.27 14.55 S&P 500 Index ........................ 4.91 11.66 Lehman Brothers Aggregate Bond Index . 2.43 2.75 Morningstar Moderate Allocation Category Average...................... 5.29 10.47 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (August 30, 2004).
76 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees....... 0.12% Other Expenses........ 0.44 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.56% Fee Reduction and/or Expense Reimbursement. 0.43 ---- NET EXPENSES 0.13% The Manager has contractually agreed to reimburse operating expenses so that the total Account operating expenses will not be greater than 0.13% through April 30, 2007. The Manager may choose not to continue this arrangement after April 30, 2007. As a shareholder in the underlying funds, the Account indirectly bears its pro rata share of the operating expenses incurred by each underlying fund. As of December 31, 2005, the operating expenses of the underlying funds ranged from 0.38% to 1.13%. The Account's investment return is net of the underlying funds' operating expenses.
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If the operating expenses of the underlying funds, separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ------------------------------------------------------------------------------------------------- 1 3 5 10 PRINCIPAL LIFETIME 2040 ACCOUNT $13 $121 $255 $646
PRINCIPAL VARIABLE CONTRACTS FUND 77 www.principal.com PRINCIPAL LIFETIME 2050 ACCOUNT The Account seeks a total return consisting of long-term growth of capital and current income. MAIN STRATEGIES To pursue its goal, the Account invests in shares of other Principal Variable Contracts Fund Accounts (the "underlying funds"). The underlying funds are intended to give the Account broad exposure to the domestic and foreign equity and fixed-income markets. The Manager and the Sub-Advisor, Principal, both provide investment advisory services to the Account. The Manager has hired Principal to develop, implement, and monitor the strategic or long-term asset class targets and target ranges for the Account. In deciding how to allocate the Account's assets among several asset classes, Principal considers long-term asset class returns, volatility assumptions and the Account's target time horizon. Principal is also responsible for employing an active rebalancing strategy that, within the target ranges, directs cash flows or Account assets towards or away from asset classes that Principal determines to be attractive or unattractive over shorter time periods, so long as the target asset class ranges are not violated. The Manager is responsible for implementing the strategic asset allocation set by Principal. In this role, the Manager selects the underlying funds and their respective weights. The Manager is also responsible for monitoring the Sub-Advisor of each underlying fund and may, at any time, add or substitute underlying funds in which the Account invests. Over time, shifts in the asset class targets and underlying funds will be designed to accommodate investors progressing from asset accumulation years to income-generation years; shifts in the asset class targets or underlying funds may also occur when market forces or Account circumstances change allocations. In allocating Account assets among the underlying funds, the Manager relies on a combination of quantitative measures, such as past performance and style consistency, and qualitative factors. Qualitative factors that the Manager considers include the fund advisor's organizational stability, investment experience, consistency of investment process, risk management processes, and information, trading and compliance systems. There are no minimum or maximum percentages in which the Account must invest in a specific asset class or underlying fund. Principal intends to gradually shift the Account's asset allocation so that within five to ten years after the year 2050, the Account's asset allocation matches that of the Principal LifeTime Strategic Income Account. At that time, the Account may be combined with the Principal LifeTime Strategic Income Account if the Board of Directors determines that the combination is in the best interests of Account shareholders. MAIN RISKS The Account's investments are concentrated in the underlying funds and, as a result, the Account's performance is directly related to their performance. The Account's ability to meet its investment objective depends on the ability of the underlying funds to achieve their investment objectives. Consequently, the Account is subject to the particular risks of the underlying funds in the proportions in which the Account invests in them. The Account's broad diversification is designed to cushion severe losses in any one investment sector and moderate the Account's overall price swings. However, the Account's share prices will fluctuate as the prices of the underlying funds rise or fall with changing market conditions. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the underlying funds invest have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of an underlying fund's shares is affected by changes in the value of the securities it owns. The prices of equity securities held by the underlying fund may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL AND MEDIUM CAPITALIZATIONS . The underlying funds may invest in small and medium capitalization companies. Companies with small or medium capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such 78 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. SECTOR RISK . The underlying funds may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As the Sub-Advisor allocates more of the Account's portfolio holdings to an underlying fund that allocates more of its portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . The underlying funds may invest in foreign securities. Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. HEDGING STRATEGIES . The underlying funds may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The underlying funds may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the underlying funds and, therefore, the Account. However, the Account's performance could be worse than if the underlying funds had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; use of them by the underlying funds could lower Account total return; and the potential loss from the use of futures can exceed an underlying fund's initial investment in such contracts. INITIAL PUBLIC OFFERINGS ("IPOS") . The underlying fund's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. FIXED-INCOME RISKS . Interest rate changes. The value of fixed-income securities held by an underlying fund may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. . Credit risk. Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by an underlying fund may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. . High yield securities. Fixed-income securities in which an underlying fund may invest that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.). . U.S. Government Sponsored Enterprises. An underlying fund may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. INVESTOR PROFILE The Fund may be an appropriate investment for investors expecting to retire around the year 2050 or fund a cashflow need in the year 2050. PRINCIPAL VARIABLE CONTRACTS FUND 79 www.principal.com UNDERLYING FUND ALLOCATION As of December 31, 2005, the Account's assets were allocated among the underlying funds as follows:
Bond 8.7 LargeCap Value 12.4 Capital Value 6.5 Real Estate Securities 2.1 Diversified International 14.8 SmallCap 4.0 Equity Income 2.0 SmallCap Growth 3.0 LargeCap Growth Equity 18.8 SmallCap Value 3.0 LargeCap Stock Index 24.7
Based on this allocation, the weighted average of the total account operating expenses of the underlying funds is 0.75%. The combined total expenses for the Account may be higher or lower depending on the allocation of its assets among the underlying funds. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2005"7.56 LOGO The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q3 '05 4.41% LOWEST Q1 '05-1.33% The year-to-date return as of March 31, 2006 is 5.69%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF FUND* PRINCIPAL LIFETIME 2050 ACCOUNT ...... 7.56 14.75 S&P 500 Index ........................ 4.91 11.66 Lehman Brothers Aggregate Bond Index . 2.43 2.75 Morningstar Large Blend Category Average .............................. 5.77 12.85 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (August 30, 2004).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) 80 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees....... 0.12% Other Expenses........ 0.99 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.11% Fee Reduction and/or Expense Reimbursement. 0.99 ---- NET EXPENSES 0.12% The Manager has contractually agreed to reimburse operating expenses so that the total Account operating expenses will not be greater than 0.12% through April 30, 2007. The Manager may choose not to continue this arrangement after April 30, 2007. As a shareholder in the underlying funds, the Account indirectly bears its pro rata share of the operating expenses incurred by each underlying fund. As of December 31, 2005, the operating expenses of the underlying funds ranged from 0.38% to 1.13%. The Account's investment return is net of the underlying funds' operating expenses.
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If the operating expenses of the underlying funds, separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES --------------------------------------------------------------------------------------------------- 1 3 5 10 PRINCIPAL LIFETIME 2050 ACCOUNT $12 $220 $482 $1,232
PRINCIPAL VARIABLE CONTRACTS FUND 81 www.principal.com PRINCIPAL LIFETIME STRATEGIC INCOME ACCOUNT The Account seeks current income. MAIN STRATEGIES To pursue its goal, the Account invests in shares of other Principal Variable Contracts Fund Accounts (the "underlying funds"). The underlying funds are intended to give the Account broad exposure to the domestic and foreign equity and fixed-income markets. The Manager and the Sub-Advisor, Principal, both provide investment advisory services to the Account. The Manager has hired Principal to develop, implement, and monitor the strategic or long-term asset class targets and target ranges for the Account. In deciding how to allocate the Account's assets among several asset classes, Principal considers long-term asset class returns, volatility assumptions and the Account's target time horizon. Principal is also responsible for employing an active rebalancing strategy that, within the target ranges, directs cash flows or Account assets towards or away from asset classes that Principal determines to be attractive or unattractive over shorter time periods, so long as the target asset class ranges are not violated. The Manager is responsible for implementing the strategic asset allocation set by Principal. In this role, the Manager selects the underlying funds and their respective weights. The Manager is also responsible for monitoring the Sub-Advisor of each underlying fund and may, at any time, add or substitute underlying funds in which the Account invests. In allocating Account assets among the underlying funds, the Manager relies on a combination of quantitative measures, such as past performance and style consistency, and qualitative factors. Qualitative factors that the Manager considers include the fund advisor's organizational stability, investment experience, consistency of investment process, risk management processes, and information, trading and compliance systems. MAIN RISKS The Account's investments are concentrated in the underlying funds and, as a result, the Account's performance is directly related to their performance. The Account's ability to meet its investment objective depends on the ability of the underlying funds to achieve their investment objectives. Consequently, the Account is subject to the particular risks of the underlying funds in the proportions in which the Account invests in them. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the underlying funds invest have associated risks. These include risks of: INTEREST RATE CHANGES . The value of fixed-income securities held by an underlying fund may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by an underlying fund may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. U.S. GOVERNMENT SPONSORED ENTERPRISES . An underlying fund may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. EQUITY SECURITY RISKS . Stock market volatility. The net asset value of the underlying fund shares is affected by change in the value of the securities it owns. The net asset value of the underlying fund shares is effected by changes in the value of the securities it owns. The prices of equity securities held by an underlying fund may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. 82 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 . Foreign investing. The underlying funds may invest in foreign securities. Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries may negatively impact the portfolios of underlying funds. An underlying fund may make investments in instruments denominated in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. . Small and Medium Capitalizations. The underlying funds may invest in small and medium capitalization companies. Companies with small capitalizations are often companies with a limited operation history. Smaller capitalization companies securities may be more volatile in price than larger company securities, especially over the short-term. . Hedging strategies. Use of forward foreign currency exchange contracts, currency or index futures or other derivatives involves risks. . Initial Public Offerings ("IPOs"). An underlying fund's purchase of shares issued in IPOs exposes an underlying fund to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. INVESTOR PROFILE The Fund may be an appropriate investment for investors in retirement. UNDERLYING FUND ALLOCATION As of December 31, 2005, the Account's assets were allocated among the underlying funds as follows:
Bond 41.7 LargeCap Stock Index 5.5 Capital Value 1.5 LargeCap Value 3.0 Diversified International 3.4 Money Market 23.4 Equity Income 6.2 Real Estate Securities 9.3 LargeCap Growth Equity 4.0 SmallCap 2.0
Based on this allocation, the weighted average of the total account operating expenses of the underlying funds is 0.61%. The combined total expenses for the Account may be higher or lower depending on the allocation of its assets among the underlying funds. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2005"4.96 LOGO The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q2 '05 3.87% LOWEST Q1 '05-1.78% The year-to-date return as of March 31, 2006 is 3.00%.
PRINCIPAL VARIABLE CONTRACTS FUND 83 www.principal.com AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF FUND* PRINCIPAL LIFETIME STRATEGIC INCOME ACCOUNT .............................. 4.96 9.57 S&P 500 Index ........................ 4.91 11.66 Lehman Brothers Aggregate Bond Index . 2.43 2.75 Morningstar Conservative Allocation Category Average...................... 3.05 5.88 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (August 30, 2004).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES
Management Fees....... 0.12% Other Expenses........ 0.15 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.27% Fee Reduction and/or Expense Reimbursement. 0.13 ---- NET EXPENSES 0.14% The Manager has contractually agreed to reimburse operating expenses so that the total Account operating expenses will not be greater than 0.14% through April 30, 2007. The Manager may choose not to continue this arrangement after April 30, 2007. As a shareholder in the underlying funds, the Account indirectly bears its pro rata share of the operating expenses incurred by each underlying fund. As of December 31, 2005, the operating expenses of the underlying funds ranged from 0.38% to 1.09%. The Account's investment return is net of the underlying funds' operating expenses.
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If the operating expenses of the underlying funds, separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES --------------------------------------------------------------------------------------------- 1 3 5 10 PRINCIPAL LIFETIME STRATEGIC INCOME ACCOUNT $14 $69 $134 $326
84 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 REAL ESTATE SECURITIES ACCOUNT The Account seeks to generate a total return by investing primarily in equity securities of companies principally engaged in the real estate industry. MAIN STRATEGIES Under normal market conditions, the Account invests at least 80% of its net assets in equity securities of companies principally engaged in the real estate industry. For purposes of the Account's investment policies, a real estate company has at least 50% of its assets, income or profits derived from products or services related to the real estate industry. Real estate companies include real estate investment trusts and companies with substantial real estate holdings such as paper, lumber, hotel and entertainment companies. Companies whose products and services relate to the real estate industry include building supply manufacturers, mortgage lenders and mortgage servicing companies. Real estate investment trusts ("REITs") are corporations or business trusts that are permitted to eliminate corporate level federal income taxes by meeting certain requirements of the Internal Revenue Code. REITs are characterized as: . equity REITs, which primarily own property and generate revenue from rental income; . mortgage REITs, which invest in real estate mortgages; and . hybrid REITs, which combine the characteristics of both equity and mortgage REITs. In selecting securities for the Account, the Sub-Advisor focuses on equity REITs. The Account may invest up to 25% of its assets in securities of foreign real estate companies. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SECTOR RISK . Because the Account invests at least 80% of its net assets in securities of companies principally engaged in the real estate industry, the Account is also subject to sector risk; that is, the possibility that the real estate sector may underperform other sectors or the market as a whole. As more of the Account's portfolio holdings to the real estate sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. The share price of the Account may fluctuate more widely than the value of shares of a fund that invests in a broader range of industries. Securities of real estate companies are subject to securities market risks as well as risks similar to those of direct ownership of real estate. These include: . declines in the value of real estate . risks related to general and local economic conditions . dependency on management skills . heavy cash flow dependency . possible lack of available mortgage funds . overbuilding . extended vacancies in properties . increases in property taxes and operating expenses . changes in zoning laws . expenses incurred in the cleanup of environmental problems . casualty or condemnation losses . changes in interest rates PRINCIPAL VARIABLE CONTRACTS FUND 85 www.principal.com In addition to the risks listed above, equity REITs are affected by the changes in the value of the properties owned by the trust. Mortgage REITs are affected by the quality of the credit extended. Both equity and mortgage REITs: . may not be diversified with regard to the types of tenants (thus subject to business developments of the tenant(s)); . may not be diversified with regard to the geographic locations of the properties (thus subject to regional economic developments); and . are subject to cash flow dependency of its tenants. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. INVESTOR PROFILE The Account may be an appropriate investment for investors who seek a total return, want to invest in companies engaged in the real estate industry and accept the potential for volatile fluctuations in the value of investments. 86 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Principal REI has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999"-4.48 "2000"30.97 "2001"8.75 "2002"7.72 "2003"38.91 "2004"34.53 The Account's highest/lowest quarterly returns "2005"15.85 during this time period were: HIGHEST Q4 '04 17.84% LOWEST Q3 '99-8.40% LOGO The year-to-date return as of March 31, 2006 is 16.34%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* REAL ESTATE SECURITIES ACCOUNT 15.85 20.46 15.23 MSCI US REIT Index ........... 12.52 18.80 12.60 Morningstar Specialty - Real Estate Category Average ...... 11.59 18.58 12.68 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.88% Other Expenses............................. 0.01 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.89%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ------------------------------------------------------------------------------------------ 1 3 5 10 REAL ESTATE SECURITIES ACCOUNT $91 $284 $493 $1,096
PRINCIPAL VARIABLE CONTRACTS FUND 87 www.principal.com SHORT-TERM BOND ACCOUNT F/K/A LIMITED TERM BOND ACCOUNT The Account seeks to provide current income. MAIN STRATEGIES The Account invests primarily in short-term fixed-income securities. Under normal circumstances, the Account maintains a dollar-weighted effective maturity of not more than three years. In determining the average effective maturity of the Fund's assets, the maturity date of a callable security or prepayable securities may be adjusted to reflect the judgment of Principal, the Sub-Advisor, regarding the likelihood of the security being called or prepaid. The Account considers the term "bond" to mean any debt security. Under normal circumstances, it invests at least 80% of its assets in: . securities issued or guaranteed by the U.S. government or its agencies or instrumentalities; . debt securities of U.S. issuers rated in the three highest grades by Standard & Poor's Rating Service or Moody's Investors Service, Inc. or, if unrated, in the opinion of the Sub-Advisor, Principal, of comparable quality; and . mortgage-backed securities representing an interest in a pool of mortgage loans. The rest of the Account's assets may be invested in a variety of financial instruments, including securities in the fourth highest rating category or their equivalent. Securities in the fourth highest category are "investment grade." While they are considered to have adequate capacity to pay interest and repay principal, they do have speculative characteristics. Changes in economic and other conditions are more likely to affect the ability of the issuer to make principal and interest payments than is the case with issuers of higher rated securities. The Account may invest up to 15% of its assets in below-investment-grade fixed-income securities. Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (please see "High Yield Securities" in the section of the prospectus entitled "Certain Investment Strategies and Related Risks) The Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income. Under a reverse repurchase agreement, the Account sells securities and agrees to repurchase them at a specified date and price. The Account pays interest on this "secured financing" and attempts to make money on the difference between the financing rate and the interest it earns by investing the proceeds of the financing. While a reverse repurchase agreement is outstanding, the Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account may lend its portfolio securities to brokers, dealers and other financial institutions. In connection with such loans, the Account remains the owner of the loaned securities and continues to be entitled to payments in amounts equal to the interest, dividends or other distributions payable on the loaned securities. Loans of portfolio securities may not exceed 33 1/3% of the value of the Account's total assets (including the value of all assets received as collateral for loan). In connection with such loans the Account will receive collateral from the borrower equal to at least 100% of the value of the loaned securities. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates. When interest rates rise, the value of fixed-income securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of fixed-income securities. Some fixed-income investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. 88 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. PORTFOLIO DURATION. . The average portfolio duration of the Account normally is less than three years and is based on Principal's forecast for interest rates. Duration is a measure of the expected life of a fixed-income security that is used to determine the sensitivity of a security's price to changes in interest rates. For example, if the portfolio duration of the Account is three years, a change of 1% in the market's yield results in a change of approximately 3% in the value of the Account's securities. The longer a security's duration, the more sensitive it is to changes in interest rates. An Account with a longer average portfolio duration will be more sensitive to changes in interest rates than an Account with a shorter average portfolio duration. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates. This may increase the volatility of the Account. REVERSE REPURCHASE AGREEMENTS. . This strategy involves the risk that interest costs on money borrowed may exceed the return on securities purchased with the borrowed money. In addition, reverse repurchase agreements may increase the volatility of the Fund. LENDING OF SECURITIES . If the Account lends its portfolio securities and the borrower of the securities fail financially, the Account may experience delays in recovering the loaned securities or exercising its rights in the collateral. Loans are made only to borrowers that are deemed by the Sub-Advisor to be of good financial standing. HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.) DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. COMMODITY-LINKED DERIVATIVE INSTRUMENTS . The use of commodity-linked derivative instruments may subject the Account to greater volatility than investments in traditional securities. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-- PRINCIPAL VARIABLE CONTRACTS FUND 89 www.principal.com Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking diversification by investing in a fixed-income mutual fund. 90 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2004"1.3 "2005"1.8 The Account's highest/lowest quarterly returns LOGO during this time period were: HIGHEST Q1 '04 1.50% LOWEST Q2 '04 -1.58% The year-to-date return as of March 31, 2006 is 0.28%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF ACCOUNT* SHORT-TERM BOND ACCOUNT .................... 1.80 1.46 Lehman Brothers Mutual Fund 1-5 Gov't/Credit Index ...................................... 1.44 1.87 Morningstar Short-Term Bond Category Average 1.43 1.64 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 2003).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees...................................... 0.50% Other Expenses....................................... 0.07 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.57%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SHORT-TERM BOND ACCOUNT $58 $183 $318 $714
PRINCIPAL VARIABLE CONTRACTS FUND 91 www.principal.com SMALLCAP GROWTH ACCOUNT The Account seeks long-term growth of capital. The Manager has selected UBS Global AM and Emerald as Sub-Advisors to the Account. MAIN STRATEGIES The Account pursues its investment objective by investing primarily in equity securities. Under normal market conditions, the Account invests at least 80% of its assets in equity securities of companies with small market capitalizations (those with market capitalizations equal to or smaller than the greater of 1) $2.5 billion or 2) the highest market capitalization of the companies in the Russell 2000/(R)/ Growth Index at the time of purchase (as of March 31, 2005, this range was between approximately $23 million and $5.4 billion)). Market capitalization is defined as total current market value of a company's outstanding common stock. The Account may invest up to 25% of its assets in securities of foreign companies. UBS Global AM seeks to invest in companies that possess dominant market positions or franchises, a major technical edge, or a unique competitive advantage. To this end, UBS Global AM considers earnings revision trends, positive stock price momentum and strong fundamentals when selecting securities. The Account may also invest in securities of emerging growth companies which are companies that UBS Global AM expects to experience above average earnings or cash flow growth or meaningful changes in underlying asset values. Investments in equity securities may include common stock and preferred stock. Utilizing fundamental analysis, Emerald seeks to invest in the common stock of companies with distinct competitive advantages, strong management teams, leadership positions, high revenue and earnings growth rates versus peers, differentiated growth drivers and limited sell-side research. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. The Manager may, from time-to-time, reallocate Account assets among the Sub-Advisors. The decision to do so may be based on a variety of factors, including but not limited to: the investment capacity of each Sub-Advisor, portfolio diversification, volume of net cash flows, fund liquidity, investment performance, investment strategies, changes in each Sub-Advisor's firm or investment professionals, or changes in the number of Sub-Advisors. Ordinarily, reallocations of Account assets among Sub-Advisors will occur as a Sub-Advisor liquidates assets in the normal course of portfolio management and with net new cash flows; however, at times reallocations may occur by transferring assets in cash or in kind among Sub-Advisors. MAIN RISKS The Account's share price may fluctuate more than that of funds primarily invested in stocks of mid-sized and large companies and may underperform as compared to the securities of larger companies. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. 92 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 SECTOR RISK . UBS Global AM may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As UBS Global AM allocates more of the Account's portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries . INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks that may have greater risks than stocks of companies with lower potential for earnings growth. PRINCIPAL VARIABLE CONTRACTS FUND 93 www.principal.com UBS Global AM became the Sub-Advisor to the Account on October 1, 2002. On August 24, 2004, Emerald also became Sub-Advisor to the Account. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999 "95.69 "2000"-13.91 "2001"-32.01 "2002"-45.85 "2003 "45.64 The Account's highest/lowest quarterly returns "2004"11.24 during this time period were: HIGHESTQ4 '9959.52% LOWEST Q3 '01-37.66% LOGO The year-to-date return as of March 31, 2006 is 13.41%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* SMALLCAP GROWTH ACCOUNT ...... 6.67 -8.64 1.29 Russell 2000 Growth Index .... 4.15 2.28 1.46 Morningstar Small Growth Category Average.............. 5.74 2.17 6.26 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.00% Other Expenses............................. 0.05 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.05%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SMALLCAP GROWTH ACCOUNT $107 $334 $579 $1,283
94 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 SMALLCAP VALUE ACCOUNT The Account seeks long-term growth of capital. The Manager has selected Mellon Equity and Morgan as Sub-Advisors to the Account. MAIN STRATEGIES The Account invests primarily in a diversified group of equity securities of U.S. companies with small market capitalizations (those with market capitalizations similar to companies in the Russell 2000/(R)/ Value Index (as of March 31, 2006, this range was between approximately $29 million and $4.2 billion)) at the time of purchase. Under normal market conditions, the Account invests at least 80% of its assets in equity securities of such companies. Emphasis is given to those companies that exhibit value characteristics. Value securities generally have above average dividend yield and below average price to earnings (P/E) ratios. Up to 25% of the Account's assets may be invested in foreign securities. The Sub-Advisor, Morgan, uses quantitative and fundamental research, systematic stock valuation and a disciplined portfolio construction process. It seeks to enhance returns and reduce the volatility in the value of the Account relative to that of the U.S. small company value universe, represented by the Russell 2000/(R)/ Value Index. Morgan continuously screens the small company universe to identify for further analysis those companies that exhibit favorable factor rankings. Such factors include various valuation and momentum measures. Morgan ranks these companies within economic sectors according to their relative attractiveness. Morgan then selects for purchase the companies it feels to be most attractive within each economic sector. Under normal market conditions, the portion of the Account sub-advised by Morgan will have sector weightings comparable to that of the U.S. small company value universe though it may under or over-weight selected economic sectors. In addition, as a company moves out of the market capitalization range of the small company universe, it generally becomes a candidate for sale. Morgan may also purchase securities issued as part of, or a short period after, companies' initial public offerings ("IPOs"), and may at times dispose of those shares shortly after their acquisition. In selecting investments for the Account, the Sub-Advisor, Mellon Equity, uses a disciplined investment process that combines fundamental analysis and risk management with a multi-factor model that searches for undervalued stocks. Undervalued stocks are those selling at a low price relative to their profits and prospective earnings growth. The stock evaluation process uses several different characteristics, including changes in earnings estimates and change in price-to-earnings ratios, in an attempt to identify value among individual stocks. Rather than using broad economic or market trends, Mellon Equity selects stocks on a company-by-company basis. To ensure ample diversification, the portion of the Account's assets managed by Mellon Equity are allocated among industries and economic sectors in similar proportions to those of the Index. The portfolio is generally kept broadly diversified in an attempt to capture opportunities that may be realized quickly during periods of above-average market volatility. By maintaining such a diversified stance, stock selection drives performance. Since the Account has a long-term investment perspective, Mellon Equity does not intend to respond to short-term market fluctuations or to acquire securities for the purpose of short-term trading. The Manager may, from time-to-time, reallocate Account assets among the Sub-Advisors. The decision to do so may be based on a variety of factors, including but not limited to: the investment capacity of each Sub-Advisor, portfolio diversification, volume of net cash flows, fund liquidity, investment performance, investment strategies, changes in each Sub-Advisor's firm or investment professionals, or changes in the number of Sub-Advisors. Ordinarily, reallocations of Account assets among Sub-Advisors will occur as a Sub-Advisor liquidates assets in the normal course of portfolio management and with net new cash flows; however, at times reallocations may occur by transferring assets in cash or in kind among Sub-Advisors. PRINCIPAL VARIABLE CONTRACTS FUND 95 www.principal.com MAIN RISKS The Account's share price may fluctuate more than that of funds primarily invested in stocks of mid-sized and large companies and may underperform as compared to the securities of larger companies. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operational history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities that may be more volatile in price than larger company securities, especially over the short-term. VALUE STOCKS . The Account's investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Companies doing business in emerging markets may not have the same range of opportunities as companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, neither Sub-Advisor can guarantee continued access to IPO offerings and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth and willing to accept volatile fluctuations in the value of their investment. The Account is not designed for investors seeking income or conservation of capital. 96 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Morgan has been the Account's Sub-Advisor since its inception. On August 8, 2005, Mellon Equity also became Sub-Advisor to the Account. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999 "21.45 "2000 "23.87 "2001"6.25 "2002"-8.86 "2003 "50.61 "2004 "23.08 The Account's highest/lowest quarterly returns "2005"6.22 during this time period were: HIGHEST Q2 '03 23.76% LOWEST Q3 '02 -17.74% LOGO The year-to-date return as of March 31, 2006 is 13.36%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* SMALLCAP VALUE ACCOUNT ....... 6.22 13.78 12.31 Russell 2000 Value Index ..... 4.71 13.55 9.19 Morningstar Small Value Category Average.............. 6.13 13.50 9.60 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.09% Other Expenses............................. 0.04 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.13%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SMALLCAP VALUE ACCOUNT $115 $359 $622 $1,375
PRINCIPAL VARIABLE CONTRACTS FUND 97 www.principal.com CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS The information in this section does not directly apply to the Principal LifeTime Accounts. It does apply to the underlying funds in which the LifeTime Accounts invest.The Statement of Additional Information (SAI) contains additional information about investment strategies and their related risks. SECURITIES AND INVESTMENT PRACTICES MARKET VOLATILITY . Equity securities include common stocks, preferred stocks, convertible securities, depositary receipts, rights and warrants. Common stocks, the most familiar type, represent an equity (ownership) interest in a corporation. The value of a company's stock may fall as a result of factors directly relating to that company, such as decisions made by its management or lower demand for the company's products or services. A stock's value may also fall because of factors affecting not just the company, but also companies in the same industry or in a number of different industries, such as increases in production costs. The value of a company's stock may also be affected by changes in financial markets that are relatively unrelated to the company or its industry, such as changes in interest rates or currency exchange rates. In addition, a company's stock generally pays dividends only after the company invests in its own business and makes required payments to holders of its bonds and other debt. For this reason, the value of a company's stock will usually react more strongly than its bonds and other debt to actual or perceived changes in the company's financial condition or prospects. Stocks of smaller companies may be more vulnerable to adverse developments than those of larger companies. Fixed-income securities include bonds and other debt instruments that are used by issuers to borrow money from investors. The issuer generally pays the investor a fixed, variable or floating rate of interest. The amount borrowed must be repaid at maturity. Some debt securities, such as zero coupon bonds, do not pay current interest, but are sold at a discount from their face values. INTEREST RATE CHANGES . Fixed-income securities are sensitive to changes in interest rates. In general, fixed-income security prices rise when interest rates fall and fall when interest rates rise. Longer term bonds and zero coupon bonds are generally more sensitive to interest rate changes. CREDIT RISK . Fixed-income security prices are also affected by the credit quality of the issuer. Investment grade debt securities are medium and high quality securities. Some bonds, such as lower grade or "junk" bonds, may have speculative characteristics and may be particularly sensitive to economic conditions and the financial condition of the issuers. REPURCHASE AGREEMENTS AND LOANED SECURITIES Although not a principal investment strategy, each of the Accounts may invest a portion of its assets in repurchase agreements. Repurchase agreements typically involve the purchase of debt securities from a financial institution such as a bank, savings and loan association or broker-dealer. A repurchase agreement provides that the Account sells back to the seller and that the seller repurchases the underlying securities at a specified price on a specific date. Repurchase agreements may be viewed as loans by an Account collateralized by the underlying securities. This arrangement results in a fixed rate of return that is not subject to market fluctuation while the Account holds the security. In the event of a default or bankruptcy by a selling financial institution, the affected Account bears a risk of loss. To minimize such risks, the Account enters into repurchase agreements only with large, well-capitalized and well-established financial institutions. In addition, the value of the securities collateralizing the repurchase agreement is, and during the entire term of the repurchase agreement remains, at least equal to the repurchase price, including accrued interest. Each of the Accounts may lend its portfolio securities to unaffiliated broker-dealers and other unaffiliated qualified financial institutions. REVERSE REPURCHASE AGREEMENTS An Account may use reverse repurchase agreements to obtain cash to satisfy unusually heavy redemption requests or for other temporary or emergency purposes without the necessity of selling portfolio securities, or to earn additional income on portfolio securities, such as Treasury bills or notes. In a reverse repurchase agreement, an Account sells a portfolio security to another party, such as a bank or broker-dealer, in return for cash and agrees to repurchase the 98 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 instrument at a particular price and time. While a reverse repurchase agreement is outstanding, an Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account will enter into reverse repurchase agreements only with parties that the Sub-Advisor deems creditworthy. Using reverse repurchase agreements to earn additional income involves the risk that the interest earned on the invested proceeds is less than the expense of the reverse repurchase agreement transaction. This technique may also have a leveraging effect on the Account, although the Account's intent to segregate assets in the amount of the repurchase agreement minimizes this effect. CURRENCY CONTRACTS The Accounts may enter into currency contracts, currency futures contracts and options, and options on currencies for hedging and other purposes. A forward currency contract involves a privately negotiated obligation to purchase or sell a specific currency at a future date at a price set in the contract. An Account will not hedge currency exposure to an extent greater than the aggregate market value of the securities held or to be purchased by the Account (denominated or generally quoted or currently convertible into the currency). Hedging is a technique used in an attempt to reduce risk. If an Account's Sub-Advisor hedges market conditions incorrectly or employs a strategy that does not correlate well with the Account's investment, these techniques could result in a loss. These techniques may increase the volatility of an Account and may involve a small investment of cash relative to the magnitude of the risk assumed. In addition, these techniques could result in a loss if the other party to the transaction does not perform as promised. There is also a risk of government action through exchange controls that would restrict the ability of the Account to deliver or receive currency. FORWARD COMMITMENTS Although not a principal investment strategy, each of the Accounts may enter into forward commitment agreements. These agreements call for the Account to purchase or sell a security on a future date at a fixed price. Each of the Accounts may also enter into contracts to sell its investments either on demand or at a specific interval. WARRANTS Each of the Accounts may invest in warrants though none of the Accounts use such investments as a principal investment strategy. A warrant is a certificate granting its owner the right to purchase securities from the issuer at a specified price, normally higher than the current market price. HIGH YIELD SECURITIES The Asset Allocation, Bond, MidCap Value and Short-Term Bond Accounts may invest in debt securities rated lower than BBB by S&P or Baa by Moody's or, if not rated, determined to be of equivalent quality by the Manager or the Sub-Advisor. Such securities are sometimes referred to as high yield or "junk bonds" and are considered speculative. Investment in high yield bonds involves special risks in addition to the risks associated with investment in highly rated debt securities. High yield bonds may be regarded as predominantly speculative with respect to the issuer's continuing ability to meet principal and interest payments. Moreover, such securities may, under certain circumstances, be less liquid than higher rated debt securities. Analysis of the creditworthiness of issuers of high yield securities may be more complex than for issuers of higher quality debt securities. The ability of an Account to achieve its investment objective may, to the extent of its investment in high yield bonds, be more dependent on such credit analysis than would be the case if the Account were investing in higher quality bonds. High yield bonds may be more susceptible to real or perceived adverse economic and competitive industry conditions than higher-grade bonds. The prices of high yield bonds have been found to be less sensitive to interest rate changes than more highly rated investments, but more sensitive to adverse economic downturns or individual corporate developments. If the issuer of high yield bonds defaults, an Account may incur additional expenses to seek recovery. The secondary market on which high yield bonds are traded may be less liquid than the market for higher-grade bonds. Less liquidity in the secondary trading market could adversely affect the price at which an Account could sell a high PRINCIPAL VARIABLE CONTRACTS FUND 99 www.principal.com yield bond and could adversely affect and cause large fluctuations in the daily price of the Account's shares. Adverse publicity and investor perceptions, whether or not based on fundamental analysis, may decrease the value and liquidity of high yield bonds, especially in a thinly traded market. The use of credit ratings for evaluating high yield bonds also involves certain risks. For example, credit ratings evaluate the safety of principal and interest payments, not the market value risk of high yield bonds. Also, credit rating agencies may fail to change credit ratings in a timely manner to reflect subsequent events. If a credit rating agency changes the rating of a portfolio security held by an Account, the Account may retain the security if the Manager or Sub-Advisor thinks it is in the best interest of shareholders. INITIAL PUBLIC OFFERINGS ("IPOS") Certain of the Accounts may invest in IPOs. An IPO is a company's first offering of stock to the public. IPO risk is that the market value of IPO shares will fluctuate considerably due to factors such as the absence of a prior public market, unseasoned trading, the small number of shares available for trading and limited information about the issuer. The purchase of IPO shares may involve high transaction costs. IPO shares are subject to market risk and liquidity risk. In addition, the market for IPO shares can be speculative and/or inactive for extended periods of time. The limited number of shares available for trading in some IPOs may make it more difficult for an Account to buy or sell significant amounts of shares without an unfavorable impact on prevailing prices. Investors in IPO shares can be affected by substantial dilution in the value of their shares by sales of additional shares and by concentration of control in existing management and principal shareholders. When an Account's asset base is small, a significant portion of the Account's performance could be attributable to investments in IPOs because such investments would have a magnified impact on the Account. As the Account's assets grow, the effect of the Account's investments in IPOs on the Account's performance probably will decline, which could reduce the Account's performance. Because of the price volatility of IPO shares, an Account may choose to hold IPO shares for a very short period of time. This may increase the turnover of the Account's portfolio and lead to increased expenses to the Account, such as commissions and transaction costs. By selling IPO shares, the Account may realize taxable gains it will subsequently distribute to shareholders. DERIVATIVES To the extent permitted by its investment objectives and policies, each of the Accounts (except Money Market) may invest in securities that are commonly referred to as derivative securities. Generally, a derivative is a financial arrangement, the value of which is derived from, or based on, a traditional security, asset, or market index. Certain derivative securities are described more accurately as index/structured securities. Index/structured securities are derivative securities whose value or performance is linked to other equity securities (such as depositary receipts), currencies, interest rates, indices or other financial indicators (reference indices). Some derivatives, such as mortgage-related and other asset-backed securities, are in many respects like any other investment, although they may be more volatile or less liquid than more traditional debt securities. There are many different types of derivatives and many different ways to use them. Futures and options are commonly used for traditional hedging purposes to attempt to protect an Account from exposure to changing interest rates, securities prices, or currency exchange rates and for cash management purposes as a low-cost method of gaining exposure to a particular securities market without investing directly in those securities. The Accounts may enter into put or call options, future contracts, options on futures contracts and over-the-counter swap contracts (e.g., interest rate swaps, total return swaps and credit default swaps) for both hedging and non-hedging purposes. Generally, no Account may invest in a derivative security unless the reference index or the instrument to which it relates is an eligible investment for the Account. The return on a derivative security may increase or decrease, depending upon changes in the reference index or instrument to which it relates. The risks associated with derivative investments include: . the risk that the underlying security, interest rate, market index or other financial asset will not move in the direction the Manager or Sub-Advisor anticipated; . the possibility that there may be no liquid secondary market which may make it difficult or impossible to close out a position when desired; 100 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 . the risk that adverse price movements in an instrument can result in a loss substantially greater than an Account's initial investment; and . the counterparty may fail to perform its obligations. EXCHANGE TRADED FUNDS (ETFS) These are a type of index fund bought and sold on a securities exchange. An ETF trades like common stock and represents a fixed portfolio of securities designed to track a particular market index. The Accounts could purchase shares issued by an ETF to temporarily gain exposure to a portion of the U.S. or a foreign market while awaiting purchase of underlying securities. The risks of owning an ETF generally reflect the risks of owning the underlying securities they are designed to track, although ETFs have management fees that increase their costs. CONVERTIBLE SECURITIES Convertible securities are fixed-income securities that an Account has the right to exchange for equity securities at a specified conversion price. The option allows the Account to realize additional returns if the market price of the equity securities exceeds the conversion price. For example, the Account may hold fixed-income securities that are convertible into shares of common stock at a conversion price of $10 per share. If the market value of the shares of common stock reached $12, the Account could realize an additional $2 per share by converting its fixed-income securities. Convertible securities have lower yields than comparable fixed-income securities. In addition, at the time a convertible security is issued the conversion price exceeds the market value of the underlying equity securities. Thus, convertible securities may provide lower returns than non-convertible fixed-income securities or equity securities depending upon changes in the price of the underlying equity securities. However, convertible securities permit the Account to realize some of the potential appreciation of the underlying equity securities with less risk of losing its initial investment. The Accounts treat convertible securities as both fixed-income and equity securities for purposes of investment policies and limitations because of their unique characteristics. The Accounts may invest in convertible securities without regard to their ratings. FOREIGN INVESTING As a principal investment strategy, the Asset Allocation, Diversified International, International Emerging Markets and International SmallCap Accounts may invest Account assets in securities of foreign companies. The other Accounts (except Government & High Quality Bond) may invest in securities of foreign companies but not as a principal investment strategy. For the purpose of this restriction, foreign companies are: . companies with their principal place of business or principal office outside the U.S.; and . companies for which the principal securities trading market is outside the U.S. Foreign companies may not be subject to the same uniform accounting, auditing and financial reporting practices as are required of U.S. companies. In addition, there may be less publicly available information about a foreign company than about a U.S. company. Securities of many foreign companies are less liquid and more volatile than securities of comparable U.S. companies. Commissions on foreign securities exchanges may be generally higher than those on U.S. exchanges, although each Account seeks the most favorable net results on its portfolio transactions. Foreign markets also have different clearance and settlement procedures than those in U.S. markets. In certain markets there have been times when settlements have been unable to keep pace with the volume of securities transactions, making it difficult to conduct these transactions. Delays in settlement could result in temporary periods when a portion of Account assets is not invested and earning no return. If an Account is unable to make intended security purchases due to settlement problems, the Account may miss attractive investment opportunities. In addition, an Account may incur a loss as a result of a decline in the value of its portfolio if it is unable to sell a security. With respect to certain foreign countries, there is the possibility of expropriation or confiscatory taxation, political or social instability, or diplomatic developments that could affect an Account's investments in those countries. In addition, an Account may also suffer losses due to nationalization, expropriation or differing accounting practices and treatments. Investments in foreign securities are subject to laws of the foreign country that may limit the amount and types of foreign investments. Changes of governments or of economic or monetary policies, in the U.S. or abroad, PRINCIPAL VARIABLE CONTRACTS FUND 101 www.principal.com changes in dealings between nations, currency convertibility or exchange rates could result in investment losses for an Account. Finally, even though certain currencies may be convertible into U.S. dollars, the conversion rates may be artificial relative to the actual market values and may be unfavorable to Account investors. Foreign securities are often traded with less frequency and volume, and therefore may have greater price volatility, than is the case with many U.S. securities. Brokerage commissions, custodial services, and other costs relating to investment in foreign countries are generally more expensive than in the U.S. Though the Accounts intend to acquire the securities of foreign issuers where there are public trading markets, economic or political turmoil in a country in which an Account has a significant portion of its assets or deterioration of the relationship between the U.S. and a foreign country may negatively impact the liquidity of an Account's portfolio. An Account may have difficulty meeting a large number of redemption requests. Furthermore, there may be difficulties in obtaining or enforcing judgments against foreign issuers. An Account may choose to invest in a foreign company by purchasing depositary receipts. Depositary receipts are certificates of ownership of shares in a foreign-based issuer held by a bank or other financial institution. They are alternatives to purchasing the underlying security but are subject to the foreign securities to which they relate. Investments in companies of developing countries may be subject to higher risks than investments in companies in more developed countries. These risks include: . increased social, political and economic instability; . a smaller market for these securities and low or nonexistent volume of trading that results in a lack of liquidity and in greater price volatility; . lack of publicly available information, including reports of payments of dividends or interest on outstanding securities; . foreign government policies that may restrict opportunities, including restrictions on investment in issuers or industries deemed sensitive to national interests; . relatively new capital market structure or market-oriented economy; . the possibility that recent favorable economic developments may be slowed or reversed by unanticipated political or social events in these countries; . restrictions that may make it difficult or impossible for the Account to vote proxies, exercise shareholder rights, pursue legal remedies, and obtain judgments in foreign courts; and . possible losses through the holding of securities in domestic and foreign custodial banks and depositories. In addition, many developing countries have experienced substantial, and in some periods, extremely high rates of inflation for many years. Inflation and rapid fluctuations in inflation rates have had and may continue to have negative effects on the economies and securities markets of those countries. Repatriation of investment income, capital and proceeds of sales by foreign investors may require governmental registration and/or approval in some developing countries. An Account could be adversely affected by delays in or a refusal to grant any required governmental registration or approval for repatriation. Further, the economies of developing countries generally are heavily dependent upon international trade and, accordingly, have been and may continue to be adversely affected by trade barriers, exchange controls, managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries with which they trade. SMALL AND MEDIUM CAPITALIZATION COMPANIES The Accounts (except Bond, Government & High Quality Bond, Money Market and Short-Term Bond) may invest in securities of companies with small- or mid-sized market capitalizations. The Capital Value, Equity Value, LargeCap Blend, LargeCap Stock Index and LargeCap Value Accounts may hold securities of small and medium capitalization companies but not as a principal investment strategy. Market capitalization is defined as total current market value of a company's outstanding common stock. Investments in companies with smaller market capitalizations may involve greater risks and price volatility (wide, rapid fluctuations) than investments in larger, more mature companies. Small companies may be less significant within their industries and may be at a competitive disadvantage relative to their 102 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 larger competitors. While smaller companies may be subject to these additional risks, they may also realize more substantial growth than larger or more established companies. Smaller companies may be less mature than larger companies. At this earlier stage of development, the companies may have limited product lines, reduced market liquidity for their shares, limited financial resources or less depth in management than larger or more established companies. Unseasoned issuers are companies with a record of less than three years continuous operation, including the operation of predecessors and parents. Unseasoned issuers by their nature have only a limited operating history that can be used for evaluating the company's growth prospects. As a result, investment decisions for these securities may place a greater emphasis on current or planned product lines and the reputation and experience of the company's management and less emphasis on fundamental valuation factors than would be the case for more mature growth companies. TEMPORARY DEFENSIVE MEASURES From time to time, as part of its investment strategy, each Account (other than the Money Market Account which may invest in high quality money market securities at any time) may invest without limit in cash and cash equivalents for temporary defensive purposes in response to adverse market, economic or political conditions. To the extent that the Account is in a defensive position, it may lose the benefit of upswings and limit its ability to meet its investment objective. For this purpose, cash equivalents include: bank notes, bank certificates of deposit, bankers' acceptances, repurchase agreements, commercial paper, and commercial paper master notes which are floating rate debt instruments without a fixed maturity. In addition, an Account may purchase U.S. government securities, preferred stocks and debt securities, whether or not convertible into or carrying rights for common stock. LIFETIME ACCOUNTS The performance and risks of each LifeTime Account directly corresponds to the performance and risks of the underlying funds in which the Account invests. By investing in many underlying funds, the LifeTime Accounts have partial exposure to the risks of many different areas of the market. The more a LifeTime Account allocates to stock funds, the greater the expected risk. For Accounts that are farthest from their stated retirement dates, allocations to stocks are relatively high so that investors may benefit from their long-term growth potential, while allocations to fixed-income securities are relatively low. This approach is designed to help investors accumulate the assets needed during their retirement years. Principal intends to gradually shift each LifeTime Account's (except the Lifetime Strategic Income Account) allocation among the underlying funds so that within five to ten years after the stated retirement date, the Account's underlying fund allocation matches the underlying fund allocation of the Principal LifeTime Strategic Income Account. If you are considering investing in a LifeTime Account, you should take into account your estimated retirement date and risk tolerance. In general, each LifeTime Account is managed with the assumption that the investor will invest in a LifeTime Account whose stated date is closest to the date the shareholder retires. Choosing an Account targeting an earlier date represents a more conservative choice; targeting an Account with a later date represents a more aggressive choice. It is important to note that the retirement year of the Account you select should not necessarily represent the specific year you intend to start drawing retirement assets. It should be a guide only. Generally, the potential for higher returns over time is accompanied by the higher risk of a decline in the value of your principal. Investors should realize that the LifeTime Accounts are not a complete solution to their retirement needs. Investors must weigh many factors when considering when to retire, what their retirement needs will be, and what sources of income they may have. Each LifeTime Account indirectly bears its pro-rata share of the expenses of the underlying funds in which it invests, as well as directly incurring expenses. Therefore, investment in a LifeTime Account is more costly than investing directly in shares of the underlying funds. PORTFOLIO TURNOVER "Portfolio Turnover" is the term used in the industry for measuring the amount of trading that occurs in an Account's portfolio during the year. For example, a 100% turnover rate means that on average every security in the portfolio has been replaced once during the year. PRINCIPAL VARIABLE CONTRACTS FUND 103 www.principal.com Accounts with high turnover rates (more than 100%) often have higher transaction costs (which are paid by the Account) and may have an adverse impact on the Account's performance. No turnover rate can be calculated for the Money Market Account because of the short maturities of the securities in which it invests. Turnover rates for each of the other Accounts may be found in the Account's Financial Highlights table. Please consider all the factors when you compare the turnover rates of different funds. A fund with consistently higher total returns and higher turnover rates than another fund may actually be achieving better performance precisely because the managers are active traders. You should also be aware that the "total return" line in the Financial Highlights section already includes portfolio turnover costs. PRICING OF ACCOUNT SHARES Each Account's shares are bought and sold at the current share price. The share price of each Account is calculated each day the New York Stock Exchange ("NYSE") is open (shares are not priced on the days on which the NYSE is closed for trading). The share price is determined at the close of business of the NYSE (normally 3:00 p.m. Central time). When an order to buy or sell shares is received, the share price used to fill the order is the next price calculated after the order is received. For all Accounts, except the Money Market Account, the share price is calculated by: . taking the current market value of the total assets of the Account . subtracting liabilities of the Account . dividing the remainder by the total number of shares owned by the Account. The securities of the Money Market Account are valued at amortized cost. The calculation procedure is described in the SAI. The Money Market Account reserves the right to determine a share price more than once each day. NOTES: . If current market values are not readily available for a security owned by an Account, its fair value is determined using a policy adopted by the Directors. . An Account's securities may be traded on foreign securities markets that generally complete trading at various times during the day prior to the close of the NYSE. Generally, the values of foreign securities used in computing a Fund's NAV are determined at the time the foreign market closes. Foreign securities and currencies are converted to U.S. dollars using the exchange rate in effect at the close of the London Exchange (generally 11:00 a.m. Eastern Time). Occasionally, events affecting the value of foreign securities occur when the foreign market is closed and the NYSE is open. The Account has adopted policies and procedures to "fair value" some or all securities held by an Account if significant events occur after the close of the market on which the foreign securities are traded but before the Account's NAV is calculated. Significant events can be specific to a single security or can include events that affect a particular foreign market or markets. A significant event can also include a general market movement in the U.S. securities markets. If the Manager believes that the market value of any or all of the foreign securities is materially affected by such an event, the securities will be valued, and the Account's NAV will be calculated, using the policy adopted by the Account. These fair valuation procedures are intended to discourage shareholders from investing in the Account for the purpose of engaging in market timing or arbitrage transactions. The trading of foreign securities generally or in a particular country or countries may not take place on all days the NYSE is open, or may trade on days the NYSE is closed. Thus, the value of the foreign securities held by the Account may change on days when shareholders are unable to purchase or redeem shares. . Certain securities issued by companies in emerging market countries may have more than one quoted valuation at any point in time. These may be referred to as local price and premium price. The premium price is often a negotiated price that may not consistently represent a price at which a specific transaction can be effected. The Fund has a policy to value such securities at a price at which the Sub-Advisor expects the securities may be sold. 104 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 DIVIDENDS AND DISTRIBUTIONS The Accounts earn dividends, interest and other income from investments and distribute this income (less expenses) as dividends. The Accounts also realize capital gains from investments and distribute these gains (less any losses) as capital gain distributions. The Accounts normally make dividends and capital gain distributions at least annually, in February. Dividends and capital gain distributions are automatically reinvested in additional shares of the Account making the distribution. MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE THE MANAGER Principal Management Corporation serves as the manager for the Fund. In its handling of the business affairs of the Fund, the Manager provides clerical, recordkeeping and bookkeeping services, and keeps the required financial and accounting records. THE SUB-ADVISORS The Manager has signed a contract with a Sub-Advisor under which the Sub-Advisor agrees to assume the obligations of the Manager to provide investment advisory service for the Account. For these services, the Sub-Advisor is paid a fee by the Manager. Information regarding Sub-Advisors and individual portfolio managers is set forth below. The Statement of Additional Information provides additional information about each portfolio manager's compensation, other accounts managed by the portfolio manager and the portfolio manager's ownership of securities in the Account. MANAGER: The Manager is an indirect subsidiary of Principal Financial Services, Inc. and has managed mutual funds since 1969. As of December 31, 2005, the mutual funds it manages had assets of approximately $28.6 billion. The Manager's address is Principal Financial Group, Des Moines, Iowa 50392-2080.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Principal LifeTime 2010 Doug Loeffler Principal LifeTime 2020 Doug Loeffler Principal LifeTime 2030 Doug Loeffler Principal LifeTime 2040 Doug Loeffler Principal LifeTime 2050 Doug Loeffler Principal LifeTime Strategic Income Doug Loeffler
DOUG LOEFFLER, CFA . - Mr. Loeffler is a Vice President with Principal Management Corporation. He is the senior member of the Manager Research Team that is responsible for analyzing, interpreting and coordinating investment performance data and evaluation of the investment managers under the due diligence program. He is responsible for preparing periodic evaluation reports including both qualitative and quantitative analysis. Mr. Loeffler participates in the manager selection process and portfolio reviews. Joining Principal Management Corporation in 2004, he has 16 years of investment experience including 14 years in the mutual fund industry (Scudder and Founders Asset Management). His background includes quantitative analysis, fundamental analysis and portfolio management focusing on non-U.S. stocks. Mr. Loeffler earned an MBA in Finance at the University of Chicago and a degree in Economics from Washington State University. He has earned the right to use the Chartered Financial Analyst designation. Mr. Loeffler shares responsibility for the day-today management of the LifeTime Accounts with Mr. Laschanzky, a portfolio manager representing Principal. On behalf of Principal, Mr. Laschanzky develops, implements and monitors the Account's strategic or long-term asset class targets and target ranges. On behalf of the Manager, Mr. Loeffler implements the strategic asset allocation Mr. Laschanzky sets. PRINCIPAL VARIABLE CONTRACTS FUND 105 www.principal.com SUB-ADVISOR: AllianceBernstein L.P. ("AllianceBernstein"). As of December 31, 2005, AllianceBernstein managed $579 billion in assets. AllianceBernstein is located at 1345 Avenue of the Americas, New York, NY 10105. The management of and investment decisions for the Account's portfolio are made by the US Value Investment Policy Group, comprised of senior US Value Investment Team members. The US Value Investment Policy Group relies heavily on the fundamental analysis and research of the Adviser's large internal research staff. No one person is principally responsible for making recommendations for the Account's portfolio. the members of the US Value Investment Policy Group with the most significant responsibility for the day-to-day management of the Account's portfolio are: Marilyn Fedak, John Mahedy, John Phillips and Chris Marx. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ LargeCap Value Marilyn Fedak John Mahedy Chris Marx John Phillips
MARILYN G. FEDAK, CFA . Ms. Fedak joined Bernstein in 1984 as a senior portfolio manager. An Executive Vice President of AllianceBernstein since 2000, she is Head of Global Value Equities and chair of the US Large Cap Value Equity Investment Policy Group. Ms. Fedak serves on AllianceBernstein's Management Executive Committee and is also a Director of SCB Inc. She earned a BA from Smith College and an MBA from Harvard University. She has also earned the right to use the Chartered Financial Analyst designation. JOHN MAHEDY, CPA . Mr. Mahedy was named Co-CIO-US Value equities in 2003. He continues to serve as director of research-US Value Equities, a position he has held since 2001. Previously, Mr. Mahedy was a senior research analyst at Bernstein's institutional research and brokerage unit, covering the domestic and international energy industry from 1995 to 2001. He earned a BS and an MBA from New York University. CHRISTOPHER W. MARX . Mr. Marx joined the firm in 1997 as a research analyst. He covered a variety of industries both domestically and internationally, including chemicals, food, supermarkets, beverages and tobacco. Mr. Marx earned an AB in Economics from Harvard, and an MBA from the Stanford Graduate School of Business. JOHN D. PHILLIPS, JR., CFA . Mr. Phillips joined the firm in 1994 and is a senior portfolio manager and member of the US Value Equities Investment Policy Group. He is also chairman of Bernstein's Proxy Voting Committee. Mr. Phillips earned a BA from Hamilton College and an MBA from Harvard University. He has also earned the right to use the Chartered Financial Analyst designation. SUB-ADVISOR: American Century Investment Management, Inc. ("American Century") was founded in 1958. Its office is located in the American Century Tower at 4500 Main Street, Kansas City, MO 64111. As of December 31, 2005, American Century managed $100.9 billion in assets. 106 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Equity Value Brendan Healy, CFA Mark Mallon, CFA Charles A. Ritter, CFA
BRENDAN HEALY, CFA . Mr. Healy, Portfolio Manager, has been a member of the team that manages Large Company Value since he joined American Century in April 2000 and has been a Portfolio Manager since February 2004. Before joining American Century, he spent six years with USAA Investment Management Company as an Equity Analyst. He has a Bachelor's degree in Mechanical Engineering from the University of Arizona and an MBA from the University of Texas-Austin. He has earned the right to use the Chartered Financial Analyst designation. MARK MALLON, CFA . Mr. Mallon, Chief Investment Officer and Executive Vice President, has been a member of the team that manages Large Company Value since its inception in July 1999. He joined American Century in April 1997. Before joining American Century, he spent 19 years at Federated Investors, most recently serving as President and Portfolio Manager of Federated Investment Counseling. Mr. Mallon has a Bachelor of Arts from Westminster College and an MBA from Cornell University. He has earned the right to use the Chartered Financial Analyst designation. CHARLES A. RITTER, CFA . Mr. Ritter, Vice President and Senior Portfolio Manager, has been a member of the team that manages Large Company Value since its inception in July 1999. He joined American Century in December 1998. Before joining American Century, he spent 15 years with Federated Investors, most recently serving as a Vice President and Portfolio Manager for the company. He has a Bachelor's degree in Mathematics and a Master's degree in Economics from Carnegie Mellon University as well as an MBA from the University of Chicago. He has earned the right to use the Chartered Financial Analyst designation. SUB-ADVISOR: Columbus Circle Investors ("CCI") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. CCI was founded in 1975. Its address is Metro Center, One Station Place, Stamford, CT 06902. As of December 31, 2005, CCI had approximately $5.9 billion in assets under management. The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Growth Anthony Rizza
ANTHONY RIZZA, CFA . Mr. Rizza, portfolio manager, joined CCI in 1991. He received a BS in Business from the University of Connecticut. Mr. Rizza has earned the right to use the Chartered Financial Analyst designation and is a member of the Hartford Society of Security Analysts. SUB-ADVISOR: Emerald Advisers, Inc. ("Emerald") is a wholly-owned subsidiary of Emerald Asset Management. Emerald provides professional investment advisory services to institutional investors, high net worth PRINCIPAL VARIABLE CONTRACTS FUND 107 www.principal.com individuals and the general public. As of December 31, 2005, Emerald managed approximately $2.36 billion in assets. Emerald's offices are located at 1703 Oregon Pike Road, Suite 101, Lancaster, Pennsylvania 17601.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ SmallCap Growth Joseph W. Garner Kenneth G. Mertz Stacey L. Sears
The portfolio management and strategy team have long tenures at Emerald, with Ms. Sears joining Emerald in 1991, Mr. Mertz in 1992 and Mr. Garner in 1994. JOSEPH W. GARNER . Mr. Garner joined Emerald in 1994 and serves as Director of Emerald Research and Portfolio Manager. Prior to joining Emerald, Mr. Garner was the Program Manager of the Pennsylvania Economic Development Financing Authority (PEDFA); an Economic Development Analyst with the PA Department of Commerce's Office of Technology Development; and an Industry Research Analyst with the Pittsburgh High Technology Council. Mr. Garner earned an MBA from the Katz Graduate School of Business, University of Pittsburgh, and graduated magna cum laude with a BA in Economics from Millersville University. KENNETH G. MERTZ II, CFA. . Mr. Mertz joined Emerald in 1992 and serves as President of Emerald Advisers, Inc. Formerly he served as Past Trustee, Vice President of the Emerald Mutual Funds (1992-2005) and Chief Investment Officer of the Pennsylvania State Employees' Retirement System (1985-1992). He earned a BA in Economics from Millersville University. Mr. Mertz supervises the entire portfolio management and trading process. As Chief Investment Officer, he has full discretion over all portfolios. Mr. Mertz, Ms. Sears and Mr. Garner work as a team developing strategy. STACEY L. SEARS . Ms. Sears joined Emerald in 1991 and serves as Senior Vice President and Portfolio Manager of Emerald Advisers, Inc. She is co-manager of the Forward Emerald Growth Fund and a member of the Portfolio Management team. Additionally, Ms. Sears maintains research coverage of retail, apparel, consumer goods and consumer technology companies. Ms. Sears earned a BS in Business Administration from Millersville University and an MBA from Villanova University. SUB-ADVISOR: J.P. Morgan Investment Management Inc. ("Morgan"), 522 Fifth Avenue, New York, NY 10036 is an indirect wholly-owned subsidiary of JPMorgan Chase & Co. ("JPMorgan"), a bank holding company. Morgan offers a wide range of services to governmental, institutional, corporate and individual customers and acts as investment advisor to individual and institutional clients. As of December 31, 2005, Morgan had total combined assets under management of approximately $847 billion. The portfolio managers operate as a team, sharing responsibility for the day-to-day management of the portfolio, each strategy does, however, have lead portfolio managers with responsibility for implementing the insight of the team into individual portfolios. The Statement of Additional Information provides additional information about the portfolio managers' compensation, other accounts managed by the portfolio managers and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ SmallCap Value Christopher T. Blum Dennis S. Ruhl
108 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 CHRISTOPHER T. BLUM, CFA . Managing Director of Morgan. Mr. Blum is a portfolio manager in the U.S. Small Cap Equity Group. He rejoined the firm in 2001. Previously, he spent two years as a research analyst responsible for the valuation and acquisition of private equity assets at Pomona Capital. Prior to that, Mr. Blum spent over three years with Morgan where he focused on structured small-cap core and small-cap value accounts. He earned his BBA in Finance at the Bernard M. Baruch School for Business and is a holder of the CFA designation. DENNIS S. RUHL, CFA . Mr. Ruhl, Vice President of Morgan, joined the company in 1999. He is a portfolio manager in the U.S. Small Cap Equity Group. His current responsibilities include managing structured small cap core and value accounts. Previously, he worked on quantitative equity research (focusing on trading) as well as business development. Mr. Ruhl earned Bachelor's degrees in Mathematics and Computer Science and a Master's degree in Computer Science, all from MIT. He has earned the right to use the Chartered Financial Analyst designation. SUB-ADVISOR: Mellon Equity Associates, LLP ("Mellon Equity"), 500 Grant Street, Suite 4200, Pittsburgh, PA 15258. Mellon Equity is a wholly owned subsidiary of Mellon Financial Corporation ("Mellon"). Mellon has approximately $4.7 trillion in assets under management, administration or custody, including $781 billion under management. As of December 31, 2005, Mellon Equity managed approximately $21.3 billion in assets. The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ MidCap Growth Adam T. Logan John O'Toole SmallCap Value Ronald P. Gala Peter D. Goslin
RONALD P. GALA, CFA . Mr. Gala is a portfolio manager of Dreyfus and a Senior Vice President and a principal of Mellon Equity. Mr. Gala has 20 years experience managing equity portfolios, and he is a past president of the Pittsburgh Society of Financial Analysts. Mr. Gala earned his MBA in Finance from the University of Pittsburgh and his BS in Business Administration from Duquesne University. He is a Chartered Financial Analyst. PETER D. GOSLIN, CFA . Mr. Goslin is a Vice President and Portfolio Manager with Mellon Equity. Before joining Mellon Equity in 1999, Mr. Goslin spent over four years with Merrill Lynch. During his tenure with Merrill, he worked as a NASDAQ market maker and an equity index options proprietary trader. Prior to that, he ran Merrill's S&P options desk at the Chicago Mercantile Exchange. Mr. Goslin earned his MBA in Finance at the University of Notre Dame Graduate School of Business following a BS in Finance from St. Vincent College. He has earned the right to use the Chartered Financial Analyst designation. ADAM T. LOGAN, CFA . Joining the company in 1998, Mr. Logan is a portfolio manager and Vice President of Mellon Equity. Previously, he performed duties as a financial analyst in Mellon Financial Corporation's corporate finance department. He is currently responsible for the management of client portfolios with a specific focus on mid and small capitalization securities. He earned a BA in Finance from Westminster College and an MBA from the Katz Graduate School of Business at the University of Pittsburgh. He has earned the right to use the Chartered Financial Analyst designation. JOHN O'TOOLE, CFA . Senior Vice President of Mellon Equity since 1990. Mr. O'Toole holds an MBA in Finance from the University of Chicago and a BA in Economics from the University of Pennsylvania. He is a member of the Association for Investment Management and Research, and the Pittsburgh Society of Financial Analysts. He is a Chartered Financial Analyst. PRINCIPAL VARIABLE CONTRACTS FUND 109 www.principal.com SUB-ADVISOR: Morgan Stanley Investment Management Inc. ("MSIM Inc."), doing business in certain instances (including its role as sub-advisor to the Asset Allocation Account) under the name "Van Kampen," is a registered investment adviser, located at 1221 Avenue of the Americas, New York, New York, 10020, and is a direct subsidiary of Morgan Stanley. As of December 31, 2005, Van Kampen, together with its affiliated asset management companies, had approximately $434.0 billion in asset under management.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Asset Allocation Francine J. Bovich
FRANCINE J. BOVICH . Ms. Bovich is Managing Director of Morgan Stanley and Morgan Stanley & Co. Incorporated since 1997. Principal 1993-1996. Ms. Bovich holds a BA in Economics from Connecticut College, and an MBA in Finance from New York University. Ms. Bovich is co-head of Morgan Stanley's Global Tactical Asset Allocation Team. Ms. Bovich is responsible for the overall allocation of the Fund's assets among equities, bonds and money market instruments. SUB-ADVISOR: Neuberger Berman Management, Inc. ("Neuberger Berman") is an affiliate of Neuberger Berman, LLC. Neuberger Berman, LLC is located at 605 Third Avenue, 2nd Floor, New York, NY 10158-0180. Together with Neuberger Berman, the firms manage more than $105.9 billion in total assets (as of December 31, 2005) and continue an asset management history that began in 1939. Neuberger Berman Management, Inc. is an indirect, wholly owned subsidiary of Lehman Brothers Holdings, Inc. Lehman Brothers is located at 745 Seventh Avenue, New York, NY 10019.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ MidCap Value S. Basu Mullick
The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account. S. BASU MULLICK . Mr. Mullick, Managing Director, Portfolio Manager, joined Neuberger Berman in 1998. He is manager of mid- to large-cap value Partners Fund and mid-cap value strategy totaling $5.4 billion in assets. Prior to joining the company, Mr. Mullick was a portfolio manager at Ark Asset Management. He earned a BA in Economics from the Presidency College, India. He also earned a MA in Economics and a Ph.D., ABD Finance from Rutgers University. SUB-ADVISOR: Principal Global Investors, LLC ("Principal") is an indirectly wholly-owned subsidiary of Principal Life Insurance Company and an affiliate of the Manager. Principal manages equity, fixed-income and real estate investments primarily for institutional investors, including Principal Life. As of December 31, 2005, Principal, together with its affiliated asset management companies, had approximately $159 billion in asset under management. Principal Global Investor's headquarters address is 801 Grand Avenue, Des Moines, Iowa 50392 and has other primary asset management offices in New York, London, Sydney and Singapore. 110 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Bond William C. Armstrong Timothy R. Warrick Capital Value John Pihlblad Diversified International Paul H. Blankenhagen Juliet Cohn Christopher Ibach Equity Income Dirk Laschanzky Government & High Quality Bond Brad Fredericks Lisa Stange International Emerging Markets Michael A. Marusiak Michael L. Reynal International SmallCap Brian W. Pattinson LargeCap Stock Index Dirk Laschanzky Mariateresa Monaco MidCap K. William Nolin Money Market Tracy Reeg Alice Robertson Principal LifeTime 2010 Dirk Laschanzky Principal LifeTime 2020 Dirk Laschanzky Principal LifeTime 2030 Dirk Laschanzky Principal LifeTime 2040 Dirk Laschanzky Principal LifeTime 2050 Dirk Laschanzky Principal LifeTime Strategic Income Dirk Laschanzky Short-Term Bond Zeid Ayer Craig Dawson Martin J. Schafer
WILLIAM C. ARMSTRONG, CFA . Mr. Armstrong is a portfolio manager for Principal. He manages multi-sector portfolios that invest in corporate bonds, mortgage-backed securities, commercial mortgage-backed securities, asset-backed securities, sovereigns, and agencies. He jointed the firm in 1992. Previously he served as a commissioned bank examiner at Federal Deposit Insurance Commission. He earned a Master's degree from the University of Iowa and a Bachelor's degree from Kearney State College. He has earned the right to use the Chartered Financial Analyst designation. ZEID AYER, PH.D., CFA . Mr. Ayer is a portfolio manager at Principal. he is a co-manager of the ultra short and short-term bond portfolios. He is also head of the Structured Debt group that covers asset-backed securities (ABS) and non-agency mortgage-backed securities (MBS). He joined Principal in 2001 and is the primary analyst responsible for mortgage-related ABS and non-agency MBS investments. Previously, Mr. Ayer was an assistant vice president at PNC Financial Services Group. He earned a doctorate in Physics from the University of Notre Dame, a master's in Computational Finance from Carnegie Mellon University and a Bachelor's degree in Physics from St. Xavier's College, Bombay University. He has earned the right to use the Chartered Financial Analyst designation. PAUL H. BLANKENHAGEN, CFA . Mr. Blankenhagen joined the firm in 1992 and was named a portfolio manager in 2000. He is responsible for developing portfolio strategy and the ongoing management of core international equity portfolios. He earned a Master's degree from Drake University and a Bachelor's degree in Finance from Iowa State University. He PRINCIPAL VARIABLE CONTRACTS FUND 111 www.principal.com has earned the right to use the Chartered Financial Analyst designation, and is a member of the Association for Investment Management and Research (AIMR) and the Iowa Society of Financial Analysts. JULIET COHN . Ms. Cohn is a portfolio manager at Principal. She co-manages the core international equity portfolios, with an emphasis on Europe and on the health care sector. Prior to joining the firm in 2003, she served as a director and senior portfolio manager at Allianz Dresdner Asset Management, managing both retail and institutional European accounts. Prior to that, she was a fund manager at London firms Capel Cure Myers and Robert Fleming. She earned a bachelor's degree in Mathematics from Trinity College, Cambridge England. CRAIG DAWSON, CFA . Mr. Dawson is a portfolio manager at Principal. He is co-manager of the ultra short and short term bond portfolios. He joined the firm in 1998 as a research associate, then moved into a portfolio analyst role before moving into a portfoio manager position in 2002. He earned an MBA and a Bachelor's degree in Finance from the University of Iowa. Mr. Dawson has earned the right to use the Chartered Financial Analyst designation. BRAD FREDERICKS. . Mr. Fredericks is a portfolio manager at Principal. He is responsible for co-managing the government securities accounts. His responsibilities include general portfolio overview and security analysis. He joined the firm in 1998 as a financial accountant and was named a portfolio manager in 2002. Previously, Mr. Fredericks was an assistant trader at Norwest Mortgage. He earned a Bachelor's degree in Finance from Iowa State University. Mr. Fredericks is a Fellow of the Life Management Institute (FLMI). CHRISTOPHER IBACH, CFA . Mr. Ibach is an associate portfolio manager and equity research analyst at Principal. He specializes primarily in the analysis of international technology companies, with a particular emphasis on semi-conductor research. Prior to joining Principal in 2000, he gained six years of related industry experience with Motorola, Inc. Mr. Ibach earned an MBA in Finance and a Bachelor's degree in Electrical Engineering from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. DIRK LASCHANZKY, CFA . Mr. Laschanzky is a portfolio manager for Principal, responsible for portfolio implementation strategies, asset allocation and managing the midcap value and index portfolios. Prior to joining Principal in 1997, he was a portfolio manager and analyst for over seven years at AMR Investment Services. He earned an MBA and BA, both in Finance, from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. Mr. Laschanzky shares responsibility for the day-to-day management of the LifeTime Accounts with Mr. Loeffler, a portfolio manager representing the Manager. On behalf of Principal, Mr. Laschanzky develops, implements and monitors the Accounts' strategic or long-term asset class targets and target ranges. On behalf of the Manager, Mr. Loeffler implements the strategic asset allocation Mr. Laschanzky sets. MICHAEL A. MARUSIAK . Mr. Marusiak is a portfolio manager for Principal. He specializes in the management of emerging markets portfolios, as well as regional Asian equity portfolios. Prior to joining Principal in 2000, he was an analyst at Trust Company of the West. He earned an MIA in International Finance from the Columbia University School of International and Public Affairs and a BA in Business Administration and Finance from Simon Fraser University of Burnaby, British Columbia. MARIATERESA MONACO . Ms. Monaco is an portfolio manager at Principal. She serves as portfolio manager for the firm's small-cap growth and index portfiols and as a member of the firm's asset allocation policy group. Prior to joining Principal in 2005, she was a quantitative equity analyst at Fidelity Management and Research supporting a family of institutional equity funds. Ms. Monaco earned an MBA from the Sloan School of Management at the Massachusetts Institute of Technology and a Master's degree in Electrical Engineering from Northeastern University. She also earned a Master's degree in Electrical Engineering from Politecnico di Torino, Italy, and a diploma in Piano from the Conservatorio di Torino, Italy. K. WILLIAM NOLIN, CFA . Mr. Nolin is a portfolio manager for Principal. He serves as the portfolio manager for the firm's international small-cap equity portfolios. He joined the firm in 1994. He earned an MBA from the Yale School of 112 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Management and a Bachelor's degree in Finance from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. BRIAN W. PATTINSON, CFA . Mr. Pattinson is a portfolio manager at Principal. He serves as the portfolio manager for the firm's international small-cap equity portfolios. He joined Principal in 1994. Mr. Pattinson earned an MBA and Bachelor's degree in Finance from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. JOHN PIHLBLAD, CFA . Mr. Pihlblad is a portfolio manager at Principal. He joined the firm in 2000 and led the development of Principal Global Investors' Global Research Platform. He has over 25 years experience in creating and managing quantitative investment systems. Prior to joining Principal, Mr. Pihlblad was a partner and co-founder of GlobeFlex Capital in San Diego where he was responsible for the development and implementation of the investment process for both domestic and international products. He earned a BA from Westminster College. He has earned the right to use the Chartered Financial Analyst designation. TRACY REEG. . Ms. Reeg is a portfolio manager at Principal. She is involved in the portfolio management of money market portfolios. She joined the firm in 1993 and began trading and portfolio management duties in 2000. Ms. Reeg earned a Bachelor's degree in Finance from the University of Northern Iowa. She is a member of the Life Office Management Association (LOMA) and is a Fellow of the Life Management Institute (FLMI). MICHAEL L. REYNAL . Mr. Reynal is a portfolio manager at Principal. He specializes in the management of emerging markets portfolios, as well as regional Asian equity portfolios. Prior to joining Principal in 2001, he was responsible for equity investments in Latin America, the Mediterranean and the Balkans while at Wafra Investment Advisory Group, Inc. in New York. Mr. Reynal earned an MBA from the Amos Tuck School at Dartmouth College, an MA in History from Christ's College at the University of Cambridge and a BA in History from Middlebury College. ALICE ROBERTSON . Ms. Robertson is a trader for Principal on the corporate fixed-income trading desk. She joined the Principal Financial Group in 1990 as a credit analyst and moved to her current position in 1993. Previously, Ms. Robertson was an assistant vice president/commercial paper analyst with Duff & Phelps Credit Company. Ms. Robertson earned her Master's degree in Finance and Marketing from DePaul University and her Bachelor's degree in Economics from Northwestern University. MARTIN J. SCHAFER . Mr. Schafer is a portfolio manager for Principal. He specializes in short-term and long duration portfolios, as well as the Inflation Protection Fund and stable value mandates. He also has experience in managing mortgage-backed securities. Mr. Schafer joined the firm in 1977 and in the early 1980s he developed the firm's secondary mortgage marketing operation. In 1984, he assumed portfolio management responsibility for its residential mortgage portfolio. He began managing mutual fund assets in 1985, institutional portfolios in 1992 and stable value portfolios in 2000. He has earned a Bachelor's degree in Accounting and Finance from the University of Iowa. LISA A. STANGE, CFA . Ms. Stange is a portfolio manager and strategist for Principal. She is responsible for managing the government securities portfolios and the mortgage-backed securities (MBS) within the multi-sector portfolios. As a strategies, Ms. Stange is involved in the formulation of broad investment strategy, quantitative research and product development. Previously, she was co-portfolio manager for U.S. multi-sector portfolios. She joined the firm in 1989. Ms. Stange earned an MBA and a Bachelor's degree from the University of Iowa. She has earned the right to use the Chartered Financial Analyst designation. TIMOTHY R. WARRICK, CFA . Mr. Warrick is a portfolio manager at Principal with responsibility for the corporate and U.S. multi-sector portfolios. He also serves as portfolio management team leader with responsibility for overseeing portfolio management function for all total return fixed income products. Prior to his portfolio management responsibilities with the firm, Mr. Warrick was a fixed income credit analyst and extensively involved in product development He joined the firm in 1990. He received an MBA in Finance from Drake University and a Bachelor's degree in Accounting and Economics from Simpson College. He has earned the right to use the Chartered Financial Analyst designation. PRINCIPAL VARIABLE CONTRACTS FUND 113 www.principal.com SUB-ADVISOR: Principal Real Estate Investors, LLC ("Principal - REI"), an indirect wholly-owned subsidiary of Principal Life and an affiliate of the Manager, was founded in 2000. It manages investments for institutional investors, including Principal Life. As of December 31, 2005, Principal - REI, together with its affiliated asset management companies, had approximately $32.0 billion in asset under management. Principal - REI's address is 801 Grand Avenue, Des Moines, Iowa 50392. The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Real Estate Securities Kelly D. Rush
KELLY D. RUSH, CFA . Mr. Rush directs the Real Estate Investment Trust (REIT) activity for a member company of the Principal Financial Group. Mr. Rush joined the Principal Financial Group in 1987 and has been dedicated to public real estate investments since 1995. His experience includes the structuring of public real estate transactions that included commercial mortgage loans and the issuance of unsecured bonds. He received his Master's degree and Bachelor's degree in Finance from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. SUB-ADVISOR: T. Rowe Price Associates, Inc. ("T. Rowe Price"), a wholly-owned subsidiary of T. Rowe Price Group, Inc., a financial services holding company, has over 68 years of investment management experience. Together with its affiliates, T. Rowe Price had approximately $269.5 billion in assets under management as of December 31, 2005. T. Rowe Price is located at 100 East Pratt Street, Baltimore, MD 21202. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Equity Growth Robert W. Sharps LargeCap Blend William J. Stromberg Richard T. Whitney
ROBERT W. SHARPS, CFA, CPA . Mr. Sharps is a Vice President of T. Rowe Price Group, Inc., and T. Rowe Price. He is also the lead Portfolio Manager with the Large-Cap Growth Strategy Team in the Equity Division. Prior to joining the firm in 1997, Mr. Sharps was a Senior Consultant at KPMG Peat Marwick. He earned a BS, summa cum laude, in Accounting from Towson University and an MBA in Finance from the Wharton School, University of Pennsylvania. He has also earned the Chartered Financial Analyst and Certified Public Accountant accreditations. WILLIAM J. STROMBERG, CFA . Mr. Stromberg is a Vice President of T. Rowe Price Group, Inc., and T. Rowe Price, Director of Global Equity Research, and Co-Director of Equities for T. Rowe Price. Prior to joining the firm in 1987, he was employed as a Systems Engineer for the Westinghouse Defense and Electronics Center. He earned a BA from Johns Hopkins University and an MBA from Tuck School of Business at Dartmouth College. He has earned the right to use the Chartered Financial Analyst designation. 114 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Mr. Stromberg serves as a portfolio coordinator for the Account. Instead of making stock selection decisions, he is responsible for ensuring adherence to portfolio constraints and risk controls, along with managing inter-analyst activity. As the lead portfolio coordinator, Mr. Stromberg has ultimate accountability for the Account. RICHARD T. WHITNEY, CFA . Mr. Whitney is a Vice President of T. Rowe Price Group, Inc. and T. Rowe Price, Director of the firm's Quantitative Equity Group and member of the Equity Steering Committee and Brokerage Control Committee. Prior to joining the firm in 1985, Mr. Whitney was employed by the Chicago Board of Trade and IBM. He earned a BS and an MEE in Electrical Engineering from Rice University and an MBA from the University of Chicago. He has earned the right to use the Chartered Financial Analyst designation. Mr. Whitney serves as a portfolio coordinator for the Fund. Instead of making stock selection decisions, he, along with Mr. Stromberg, is responsible for ensuring adherence to portfolio constraints and risk controls, as well as managing inter-analyst activity. SUB-ADVISOR: UBS Global Asset Management (Americas) Inc., a Delaware corporation located at One North Wacker, Chicago, IL 60606 ("UBS Global AM"), is a registered investment advisor. UBS Global AM, a subsidiary of UBS AG, is a member of the UBS Global Asset Management business group (the "Group") of UBS AG. As of December 31, 2005, UBS Global AM managed approximately $66.12 billion in assets and the Group managed approximately $581.49 billion in assets. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ SmallCap Growth Paul A. Graham, Jr. David N. Wabnik
PAUL A. GRAHAM, JR., CFA . Mr. Graham joined UBS Global AM in 1994 and has had portfolio management responsibilities since 1994. Mr. Graham is Managing Director, Head of Growth Investors and Co-Head of U.S. Small Cap Growth Equity. For eight years prior to joining the firm, he served as a small cap portfolio manager and research analyst at Value Line Asset Management. Mr. Graham received his BA from Dartmouth College. He has earned the right to use the Chartered Financial Analyst designation and is a member of the New York Society of Security Analysts. DAVID N. WABNIK . Mr. Wabnik joined UBS Global AM in 1995 and has been a portfolio manager since 1995. Mr. Wabnik is Executive Director, Co-Head of U.S. SmallCap Growth Equity. For four years prior to joining the firm, he served as a small cap portfolio manager/senior research analyst at Value Line Asset Management. Mr. Wabnik received his BS from Binghamton University and his MBA from Columbia Business School. He has completed the Certified Financial Analyst Level I exam. THE SUB-SUB-ADVISORS Principal Global Investors, LLC ("Principal") has entered into sub-sub-advisory agreements for various Accounts. Under these agreements, each sub-sub-advisor has agreed to assume the obligations of Principal for a certain portion of the Account's assets. The sub-sub-advisor is paid a fee by Principal. Principal is the sub-advisor for the Bond Account. Day-to-day management decisions concerning a portion of the Bond Account's portfolio are made by Spectrum Asset Management, Inc. ("Spectrum"), and Post Advisory Group, LLC ("Post") each of which serves as sub-sub-advisor. PRINCIPAL VARIABLE CONTRACTS FUND 115 www.principal.com Principal is the sub-advisor for the Equity Income Account. Day-to-day management decisions concerning a portion of the Equity Income Account's portfolio are made by Principal Real Estate Investors LLC ("Principal - REI"), and Spectrum each of which serves as sub-sub-advisor. See the discussion regarding Principal - REI provided in connection with the Real Estate Securities Account for a description of the firm and the individual who serves as portfolio manager. SUB-ADVISOR: Post Advisory Group, LLC ("Post") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. Post was founded in April 1992. Its address is 11755 Wilshire Boulevard, Los Angeles, CA 90025. As of December 31, 2005, Post had $8.1 billion in asset under management. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account. LAWRENCE A. POST . Mr. Post is a chief executive office and chief investment officer for Post, an affiliate of Principal. He has over 35 years experience in the investment business, including 25 years in the high yield bond market. Prior to founding Post Advisory Group in 1992, he founded the high yield bond department at Smith Barney, and subsequently served as director of high yield research at Salomon Brothers and co-director of research and senior trader at Drexel Burnham Lambert. He earned an MBA in business administration from the University of Pennsylvania's Wharton School of Business and a Bachelor's degree from Lehigh University. ALLAN SCHWEITZER . Mr. Schweitzer is a Managing Director at Post. Prior to joining Post in 2000, he was a senior high yield analyst at Trust Company of the West ("TCW"). Prior to TCW, he was a high yield research analyst at Putnam Investments. Mr. Schweitzer earned a Bachelor's degree in Business Administration from Washington University at St. Louis and a Master's in Business Administration from the University of Chicago with a concentration in analytical finance and international economics. SUB-ADVISOR: Spectrum Asset Management, Inc. ("Spectrum") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. Spectrum was founded in 1987. Its address is 4 High Ridge Park, Stamford, CT 06905. As of December 31, 2005, Spectrum, together with its affiliated asset management companies, had approximately $13.2 billion in asset under management. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account. FERNANDO DIAZ. . Mr. Diaz is a vice president and assistant portfolio manager for Spectrum. Prior to joining Spectrum in 2000, Mr. Diaz was head of preferred trading at Spear, Leeds & Kellogg and Pershing, a division of DLJ, where he initiated preferred trading operations at both firms. Mr. Diaz has also worked at Goldman Sachs as an analyst in the Investment Banking division and in the Preferred Stock division as a trader and product analyst. L. PHILLIP JACOBY. . Mr. Jacoby is Sr. Vice President and Portfolio Manager for Spectrum and chairman of Spectrum's Investment Committee. Prior to joining Spectrum in 1995, he was a senior investment officer as USL Capital Corporation, a subsidiary of Ford Motor Corporate, and co-managed a $600 million preferred stock portfolio. He earned a earned a his BS in Finance from Boston University. 116 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 BERNARD M. SUSSMAN. . Mr. Sussman is Chief Investment Officer of Spectrum and Chair of its Investment Committee. Prior to joining Spectrum in 1995, Mr. Sussman was a general partner and heard of the Preferred Stock area of Goldman Sachs & Co. He was responsible for sales, trading and underwriting for all preferred products and was instrumental in the development of the hybrid (MIPS) market. He earned both an MBA in Finance and a Bachelor's degree in Industrial Relations from Cornell University. JOSEPH J. URCIUOLI. . Mr. Urciuoli is a senior vice president and director of research for Spectrum and is responsible for all credit research supporting the client portfolios. He is also a portfolio manager. He joined Spectrum in 1998 from Presidential Life Insurance Company where he served as a fixed income analyst and assistant portfolio manager of a $2 billion portfolio. Mr. Urciuoli earned an MBA in Finance and a Bachelor's degree in finance from Long Island University. DUTIES OF THE MANAGER AND SUB-ADVISOR The Manager or Sub-Advisor provides the Directors of the Fund with a recommended investment program. The program must be consistent with the Account's investment objective and policies. Within the scope of the approved investment program, the Sub-Advisor advises the Account on its investment policy and determines which securities are bought or sold, and in what amounts. FEES PAID TO THE MANAGER The Manager is paid a fee by each Account for its services, which includes any fee paid to the Sub-Advisor. The fee paid by each Account (as a percentage of the average daily net assets) for the fiscal year ended December 31, 2005 was:
Asset Allocation 0.80% MidCap 0.57% Bond 0.45% MidCap Growth 0.90% Capital Value 0.60% MidCap Value 1.05% Diversified Money Market International 0.85% 0.49% Equity Growth 0.76% Principal LifeTime 2010 0.12% Equity Income 0.60% Principal LifeTime 2020 0.12% Equity Value 0.85% Principal LifeTime 2030 0.12% Government & High Principal LifeTime 2040 Quality Bond 0.44% 0.12% Growth 0.60% Principal LifeTime 2050 0.12% International Emerging Principal LifeTime Strategic Markets 1.25% Income 0.12% International SmallCap 1.19% Real Estate Securities 0.88% LargeCap Blend 0.75% Short-Term Bond 0.50% LargeCap Stock Index 0.35% SmallCap Growth 1.00% LargeCap Value 0.75% SmallCap Value 1.09%
FEES PAID TO THE SUB-ADVISOR The Sub-Advisor fee paid by each Account (as a percentage of the average daily net assets) for the fiscal year ended December 31, 2005 was:
Asset Allocation 0.36% MidCap 0.14% Bond 0.10% MidCap Growth 0.36% Capital Value 0.14% MidCap Value 0.46% Diversified Money Market International 0.10% 0.07% Equity Growth 0.34% Principal LifeTime 2010 0.04% Equity Income 0.17% Principal LifeTime 2020 0.04% Equity Value 0.40% Principal LifeTime 2030 0.04% Government & High Principal LifeTime 2040 Quality Bond 0.10% 0.04% Growth 0.13% Principal LifeTime 2050 0.04% International Emerging Principal LifeTime Strategic Markets 0.48% Income 0.04% International SmallCap 0.48% Real Estate Securities 0.54% LargeCap Blend 0.30% Short-Term Bond 0.10% LargeCap Stock Index 0.01% SmallCap Growth 0.54% LargeCap Value 0.21% SmallCap Value 0.49%
PRINCIPAL VARIABLE CONTRACTS FUND 117 www.principal.com The Fund and the Manager, under an order received from the SEC, may enter into and materially amend agreements with Sub-Advisors, other than those affiliated with the Manager, without obtaining shareholder approval. For any Account that is relying on that order, the Manager may: . hire one or more Sub-Advisors; . change Sub-Advisors; and . reallocate management fees between itself and Sub-Advisors. The Manager will continue to have the ultimate responsibility for the investment performance of these Accounts due to its responsibility to oversee Sub-Advisors and recommend their hiring, termination and replacement. No Account will rely on the order until it receives approval from its shareholders or, in the case of a new Account, the Account's sole initial shareholder before the Account is available to the other purchasers, and the Account states in its prospectus that it intends to rely on the order. The Asset Allocation, Equity Growth, Equity Value, LargeCap Blend, LargeCap Value, MidCap Growth, MidCap Value, SmallCap Growth and SmallCap Value Accounts have received the necessary shareholder approval and intend to rely on the order. 118 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 GENERAL INFORMATION ABOUT AN ACCOUNT FREQUENT TRADING AND MARKET-TIMING (ABUSIVE TRADING PRACTICES) The Accounts of the Principal Variable Contracts Fund are not designed for frequent trading or market timing activity. The Fund has adopted fair valuation procedures to be used in the case of significant events, including broad market movements, occurring after the close of a foreign market in which securities are traded. The procedures will be followed if the Manager believes the events will impact the value of the foreign securities. These procedures are intended to discourage market timing transactions in shares of the Accounts. The Accounts do not knowingly accommodate frequent purchases and redemptions ("excessive trading") of Fund shares by investors. If you intend to trade frequently and/or use market timing investment strategies, do not purchase these Accounts. The Fund does not knowingly accommodate excessive trading. The Principal Variable Contracts Fund considers frequent trading and market timing activities to be abusive trading practices because they may: . Disrupt the management of the Accounts by; . forcing the Account to hold short-term (liquid) assets rather than investing for long term growth, which results in lost investment opportunities for the Account; and . causing unplanned portfolio turnover; . Hurt the portfolio performance of the Account; and . Increase expenses of the Account due to; . increased broker-dealer commissions; and . increased recordkeeping and related costs. If we are not able to identify such excessive trading practices, The Accounts may be negatively impacted and may cause investors to suffer the harms described. Certain Accounts may be at greater risk for abusive trading practices. For example, those Accounts that invest in foreign securities may appeal to investors attempting to take advantage of time-zone arbitrage. This risk is particularly relevant to the Diversified International, International Emerging Markets and International SmallCap Accounts but does apply to the purchase of foreign securities by any Account. As the Accounts of the Principal Variable Contracts Fund are only available through variable annuity or variable life contracts, the Principal Variable Contracts Fund must rely on Principal Life (as sponsor of the variable contract) to monitor customer trading activity to identify and take action against excessive trading. There can be no certainty that Principal Life will identify and prevent excessive trading in all instances. When Principal Life identifies excessive trading, Principal Life will act to curtail such trading in a fair and uniform manner. If Principal Life, or the Principal Variable Contracts Fund, deem excessive trading practices to be occurring, Principal Life will take action that may include, but is not limited to: . Rejecting exchange instructions from shareholder or other person authorized by the shareholder to direct exchanges; . Restricting submission of exchange requests by, for example, allowing exchange requests to be submitted by 1st class U.S. mail only and disallowing requests made via the internet, by facsimile, by overnight courier or by telephone; . Limiting the dollar amount of an exchange and/or the number of exchanges during a year; . Requiring a holding period of a minimum of 30 days before permitting exchanges among the Accounts where there is evidence of at least one round-trip exchange (exchange or redemption of shares that were purchased within 30 days of the exchange/redemption); and . Taking such other action as directed by the Principal Variable Contracts Fund. The Principal Variable Contracts Fund has reserved the right to accept or reject, without prior written notice, any exchange requests. In some instances, an exchange may be completed prior to a determination of abusive trading. In those instances, Principal Life will reverse an exchange (within three business days of the exchange) and return the account holdings to the positions held prior to the exchange. Principal Life will give you notice in writing in this instance. PRINCIPAL VARIABLE CONTRACTS FUND 119 www.principal.com ELIGIBLE PURCHASERS Only certain eligible purchasers may buy shares of the Accounts. Eligible purchasers are limited to 1) separate accounts of Principal Life or of other insurance companies, 2) Principal Life or any of its subsidiaries or affiliates, 3) trustees of other managers of any qualified profit sharing, incentive or bonus plan established by Principal Life or any of its subsidiaries or affiliates for employees of such company, subsidiary or affiliate. Such trustees or managers may buy Account shares only in their capacities as trustees or managers and not for their personal accounts. The Board of Directors of the Fund reserves the right to broaden or limit the designation of eligible purchaser. Each Account serves as the underlying investment vehicle for variable annuity contracts and variable life insurance policies that are funded through separate accounts established by Principal Life. It is possible that in the future, it may not be advantageous for variable life insurance separate accounts and variable annuity separate accounts to invest in the Accounts at the same time. Although neither Principal Life nor the Fund currently foresees any such disadvantage, the Fund's Board of Directors monitors events in order to identify any material conflicts between such policy owners and contract holders. Material conflict could result from, for example, 1) changes in state insurance laws, 2) changes in Federal income tax law, 3) changes in the investment management of an Account, or 4) differences in voting instructions between those given by policy owners and those given by contract holders. Should it be necessary, the Board would determine what action, if any, should be taken. Such action could include the sale of Account shares by one or more of the separate accounts which could have adverse consequences. SHAREHOLDER RIGHTS The following information applies to each Account of the Principal Variable Contracts Fund, Inc. Each Account share is eligible to vote, either in person or by proxy, at all shareholder meetings for that Account. This includes the right to vote on the election of directors, selection of independent auditors and other matters submitted to meetings of shareholders of the Account. Each share has equal rights with every other share of the Account as to dividends, earnings, voting, assets and redemption. Shares are fully paid, non-assessable and have no preemptive or conversion rights. Shares of an Account are issued as full or fractional shares. Each fractional share has proportionately the same rights including voting as are provided for a full share. Shareholders of the Fund may remove any director with or without cause by the vote of a majority of the votes entitled to be case at a meeting of all Account shareholders. The bylaws of the Fund provide that the Board of Directors of the Fund may increase or decrease the aggregate number of shares that the Fund has the authority to issue, without a shareholder vote. The bylaws of the Fund also provide that the Fund does not need to hold an annual meeting of shareholders unless one of the following is required to be acted upon by shareholders under the Investment Company Act of 1940: election of directors; approval of an investment advisory agreement; ratification of the selection of independent auditors; and approval of the distribution agreement. The Fund intends to hold shareholder meetings only when required by law and at such other times when the Board of Directors deems it to be appropriate. Shareholder inquiries should be directed to: Principal Variable Contracts Fund, Inc., Principal Financial Group, Des Moines, Iowa 50392-2080. NON-CUMULATIVE VOTING The Fund's shares have non-cumulative voting rights. This means that the holders of more than 50% of the shares voting for the election of directors of the Fund can elect 100% of the directors if they choose to do so. In such event, the holders of the remaining shares voting for the election of directors will not be able to elect any directors. Principal Life votes each Account's shares allocated to each of its separate accounts registered under the Investment Company Act of 1940 and attributable to variable annuity contracts or variable life insurance policies participating in the separate accounts. The shares are voted in accordance with instructions received from contract holders, policy owners, participants and annuitants. Other shares of each Account held by each separate account, including shares for which no timely voting instructions are received, are voted in proportion to the instructions that are received with respect to contracts or policies participating that separate account. Shares of each of the Accounts held in the general account of Principal Life or in the unregistered separate accounts are voted in proportion to the instructions that are received with respect to contracts and policies participating in its registered and unregistered separate accounts. If Principal Life determines, under applicable law, that an Account's shares held in one or more separate accounts or in 120 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 its general account need not be voted according to the instructions that are received, it may vote those Account shares in its own right. PURCHASE OF ACCOUNT SHARES Shares are purchased from Princor Financial Services Corporation, the Fund's principal underwriter. There are no sales charges on shares of the Accounts, however, your variable contract may impose a charge. There are no restrictions on amounts to be invested in shares of the Accounts. Shareholder accounts for each Account are maintained under an open account system. Under this system, an account is opened and maintained for each investor. Each investment is confirmed by sending the investor a statement of account showing the current purchase and the total number of shares owned. The statement of account is treated by each Account as evidence of ownership of Account shares. Share certificates are not issued. SALE OF ACCOUNT SHARES This section applies to eligible purchasers other than the separate accounts of Principal Life and its subsidiaries. Each Account sells its shares upon request. There is no charge for the sale. A shareholder sends a written request to the Account requesting the sale of any part or all of the shares. The letter must be signed exactly as the account is registered. If payment is to be made to the registered shareholder or joint shareholder, the Account does not require a signature guarantee. If payment is to be made to another party, the shareholder's signature(s) must be guaranteed by a commercial bank, trust company, credit union, savings and loan association, national securities exchange member or brokerage firm. Shares are redeemed at the net asset value per share next computed after the request is received by the Account in proper and complete form. Sales proceeds are generally sent within three business days after the request is received in proper form. However, the right to sell shares may be suspended during any period when 1) trading on the NYSE is restricted as determined by the SEC or when the NYSE is closed for other than weekends and holidays, or 2) an emergency exists, as determined by the SEC, as a result of which a) disposal by a fund of securities owned by it is not reasonably practicable, b) it is not reasonably practicable for a fund to fairly determine the value of its net assets, or c) the SEC permits suspension for the protection of security holders. If payments are delayed and the instruction is not canceled by the shareholder's written instruction, the amount of the transaction is determined as of the first valuation date following the expiration of the permitted delay. The transaction occurs within five days thereafter. In addition, payments on surrenders attributable to a premium payment made by check may be delayed up to 15 days. This permits payment to be collected on the check. RESTRICTED TRANSFERS Shares of each of the Accounts may be transferred to an eligible purchaser. However, if an Account is requested to transfer shares to other than an eligible purchaser, the Account has the right, at its election, to purchase the shares at the net asset value next calculated after the receipt of the transfer request. However, the Account must give written notification to the transferee(s) of the shares of the election to buy the shares within seven days of the request. Settlement for the shares shall be made within the seven-day period. FINANCIAL STATEMENTS You will receive an annual financial statement for the Fund, audited by the Fund's independent registered public accounting firm, Ernst & Young LLP. That report is a part of this prospectus. You will also receive a semiannual financial statement that is unaudited. FINANCIAL HIGHLIGHTS The following financial highlights tables are intended to help you understand the Fund's financial performance for the periods shown. Certain information reflects results for a single Fund share. The total returns in each table represent the PRINCIPAL VARIABLE CONTRACTS FUND 121 www.principal.com rate that an investor would have earned or lost each period on an investment in the Fund (assuming reinvestment of all distributions). The financial statements for the Fund were audited by Ernst & Young LLP, whose report, along with the financial statements, is included in the most recent annual report for the Fund. To receive a copy of the latest annual or semiannual report for the Fund, you may telephone 1-800-247-4123. FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- ASSET ALLOCATION ACCOUNT ------------------------ Net Asset Value, Beginning of Period.. $12.28 $11.70 $9.82 $11.28 $12.02 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.19 0.14 0.15 0.20 0.24 Net Realized and Unrealized Gain (Loss) on Investments......... 0.51 0.82 1.92 (1.66) (0.71) ---- ---- ---- ----- ----- Total From Investment Operations 0.70 0.96 2.07 (1.46) (0.47) Less Dividends and Distributions: Dividends from Net Investment Income... (0.20) (0.38) (0.19) -- (0.24) Distributions from Realized Gains...... -- -- -- -- (0.03) ---- ----- Total Dividends and Distributions (0.20) (0.38) (0.19) -- (0.27) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $12.78 $12.28 $11.70 $9.82 $11.28 ====== ====== ====== ===== ====== Total Return /(a)/ ... 5.79% 8.49% 21.61% (12.94)% (3.92)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $100,637 $103,131 $98,006 $82,409 $101,904 Ratio of Expenses to Average Net Assets.. 0.86% 0.84% 0.85% 0.84% 0.85% Ratio of Net Investment Income to Average Net Assets.. 1.53% 1.19% 1.49% 1.79% 2.23% Portfolio Turnover Rate................ 83.5% 127.0% 186.0% 255.3% 182.4% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- BOND ACCOUNT ------------ Net Asset Value, Beginning of Period.. $12.31 $12.31 $12.32 $11.84 $11.78 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.50 0.51 0.52 0.51 0.56/(b)/ Net Realized and Unrealized Gain (Loss) on Investments......... (0.20) 0.08 0.02 0.54 0.35/(b)/ ----- ---- ---- ---- ---- Total From Investment Operations 0.30 0.59 0.54 1.05 0.91 Less Dividends and Distributions: Dividends from Net Investment Income... (0.57) (0.59) (0.55) (0.57) (0.85) ----- ----- ----- ----- ----- Total Dividends and Distributions (0.57) (0.59) (0.55) (0.57) (0.85) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $12.04 $12.31 $12.31 $12.32 $11.84 ====== ====== ====== ====== ====== Total Return /(a)/ ... 2.50% 4.98% 4.59% 9.26% 8.12% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $338,044 $286,684 $263,435 $232,839 $166,658 Ratio of Expenses to Average Net Assets.. 0.47% 0.47% 0.47% 0.49% 0.50% Ratio of Net Investment Income to Average Net Assets.. 4.21% 4.23% 4.32% 5.02% 5.73%/(b)/ Portfolio Turnover Rate................ 176.2% 143.6% 82.1% 63.3% 146.1%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Effective January 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies. The effect of this change for the year ended December 31, 2001 was to decrease net investment income per share by $.01, increase net realized and unrealized gains/losses per share by $.01, and decrease the ratio of net investment income to average net assets by .08%. Financial highlights for prior periods have not been restated to reflect this change in presentation. 67 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- CAPITAL VALUE ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $32.39 $29.23 $23.60 $27.78 $30.72 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.54 0.44 0.38 0.39 0.34 Net Realized and Unrealized Gain (Loss) on Investments......... 1.66 3.17 5.63 (4.18) (2.80) ---- ---- ---- ----- ----- Total From Investment Operations 2.20 3.61 6.01 (3.79) (2.46) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.45) (0.38) (0.39) (0.34) Distributions from Realized Gains...... -- -- -- -- (0.14) ----- ----- Total Dividends and Distributions -- (0.45) (0.38) (0.39) (0.48) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $34.59 $32.39 $29.23 $23.60 $27.78 ====== ====== ====== ====== ====== Total Return /(b)/ ... 6.80% 12.36% 25.49% (13.66)% (8.05)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $258,490 $265,580 $248,253 $206,541 $254,484 Ratio of Expenses to Average Net Assets.. 0.61% 0.60% 0.61% 0.61% 0.61% Ratio of Gross Expenses to Average Net Assets.......... -- 0.60%/(e)/ 0.61%/(e)/ 0.61%/(e)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.62% 1.47% 1.47% 1.45% 1.20% Portfolio Turnover Rate................ 120.9% 183.3% 125.7% 142.6% 91.7% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- DIVERSIFIED INTERNATIONAL ACCOUNT --------------------------------- Net Asset Value, Beginning of Period /(a)/ ............... $13.75 $11.48 $8.78 $10.51 $13.90 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.18 0.17 0.13 0.10 0.09 Net Realized and Unrealized Gain (Loss) on Investments......... 3.05 2.22 2.67 (1.78) (3.46) ---- ---- ---- ----- ----- Total From Investment Operations 3.23 2.39 2.80 (1.68) (3.37) Less Dividends and Distributions: Dividends from Net Investment Income... (0.15) (0.12) (0.10) (0.05) (0.02) ----- ----- ----- ----- ----- Total Dividends and Distributions (0.15) (0.12) (0.10) (0.05) (0.02) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $16.83 $13.75 $11.48 $8.78 $10.51 ====== ====== ====== ===== ====== Total Return /(b)/ ... 23.79% 21.03% 32.33% (16.07)% (24.27)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $293,647 $226,753 $167,726 $119,222 $145,848 Ratio of Expenses to Average Net Assets.. 0.97% 0.96% 0.92% 0.92% 0.92% Ratio of Gross Expenses to Average Net Assets.......... 0.97%/(c)/ 0.97%/(d)/ 0.93%/(d)/ 0.93%/(d)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.27% 1.39% 1.33% 1.03% 0.78% Portfolio Turnover Rate................ 121.2% 170.1% 111.5% 82.2% 84.3%
/(a) /Effective May 1, 2005, International Account changed its name to Diversified International Account. /(b) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(c) /Expense ratio without custodian credits. /(d) /Expense ratio without commission rebates and custodian credits. /(e) /Expense ratio without commission rebates. 69 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- EQUITY GROWTH ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $16.02 $14.73 $11.74 $16.29 $20.37 Income from Investment Operations: Net Investment Income (Operating Loss).... -- 0.09 0.06 0.03 0.01 Net Realized and Unrealized Gain (Loss) on Investments......... 1.21 1.28 2.99 (4.54) (2.82) ---- ---- ---- ----- ----- Total From Investment Operations 1.21 1.37 3.05 (4.51) (2.81) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.08) (0.06) (0.04) (0.02) Distributions from Realized Gains...... -- -- -- -- (1.25) ---- ----- Total Dividends and Distributions -- (0.08) (0.06) (0.04) (1.27) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $17.23 $16.02 $14.73 $11.74 $16.29 ====== ====== ====== ====== ====== Total Return /(a)/ ... 7.55% 9.33% 25.95% (27.72)% (14.86)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $274,192 $280,700 $272,831 $219,044 $334,401 Ratio of Expenses to Average Net Assets.. 0.77% 0.72% 0.74% 0.77% 0.75% Ratio of Gross Expenses to Average Net Assets.......... -- 0.77%/(b)/ 0.77%/(b)/ -- -- Ratio of Net Investment Income to Average Net Assets.. 0.00% 0.59% 0.47% 0.19% 0.06% Portfolio Turnover Rate................ 51.6% 147.7% 130.9% 138.8% 88.8% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- EQUITY INCOME ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $9.01 $7.93 $7.26 $8.73 $12.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.37 0.34 0.34 0.37 0.25 Net Realized and Unrealized Gain (Loss) on Investments......... 0.41 1.05 0.66 (1.47) (3.70) ---- ---- ---- ----- ----- Total From Investment Operations 0.78 1.39 1.00 (1.10) (3.45) Less Dividends and Distributions: Dividends from Net Investment Income... (0.01) (0.31) (0.33) (0.37) (0.25) ---- Total Dividends and Distributions (0.01) (0.31) (0.33) (0.37) (0.25) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $9.78 $9.01 $7.93 $7.26 $8.73 ===== ===== ===== ===== ===== Total Return /(a)/ ... 8.67% 17.60% 13.83% (12.61)% (27.70)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $91,489 $44,572 $30,255 $25,079 $33,802 Ratio of Expenses to Average Net Assets.. 0.66% 0.62% 0.61% 0.62% 0.62% Ratio of Net Investment Income to Average Net Assets.. 3.93% 4.13% 4.54% 4.40% 2.22% Portfolio Turnover Rate................ 84.7% 137.2% 22.5% 66.4% 104.2%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. 69 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004/(C)/ ---- ---- EQUITY VALUE ACCOUNT -------------------- Net Asset Value, Beginning of Period.. $11.07 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.15 0.06 Net Realized and Unrealized Gain (Loss) on Investments......... 0.26 1.08 ---- ---- Total From Investment Operations 0.41 1.14 Less Dividends and Distributions: Dividends from Net Investment Income... (0.11) (0.06) Distributions from Realized Gains...... (0.32) (0.01) ----- ----- Total Dividends and Distributions (0.43) (0.07) ----- ----- Net Asset Value, End of Period............ $11.05 $11.07 ====== ====== Total Return /(a)/ ... 3.78% 11.40%/(d)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $3,722 $2,213 Ratio of Expenses to Average Net Assets.. 1.10% 1.10%/(e)/ Ratio of Gross Expenses to Average Net Assets /(b)/ ... 1.14% 1.30%/(e)/ Ratio of Net Investment Income to Average Net Assets.. 1.36% 1.72%/(e)/ Portfolio Turnover Rate................ 26.7% 25.4%/(e)/ 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- GOVERNMENT & HIGH QUALITY BOND ACCOUNT /(F)/ -------------------------------------- Net Asset Value, Beginning of Period.. $11.64 $11.77 $12.00 $11.58 $11.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.44 0.44 0.45 0.43 0.51 Net Realized and Unrealized Gain (Loss) on Investments......... (0.21) (0.04) (0.24) 0.55 0.32 ---- ----- ----- ---- ---- Total From Investment Operations 0.23 0.40 0.21 0.98 0.83 Less Dividends and Distributions: Dividends from Net Investment Income... (0.51) (0.53) (0.44) (0.52) (0.68) Distributions from Realized Gains...... -- -- -- (0.04) -- ---- ----- Total Dividends and Distributions (0.51) (0.53) (0.44) (0.56) (0.68) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $11.36 $11.64 $11.77 $12.00 $11.58 ====== ====== ====== ====== ====== Total Return /(a)/ ... 2.01% 3.56% 1.84% 8.80% 7.61% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $316,047 $334,034 $368,564 $342,001 $193,254 Ratio of Expenses to Average Net Assets.. 0.46% 0.44% 0.44% 0.47% 0.49% Ratio of Net Investment Income to Average Net Assets.. 3.88% 3.82% 3.83% 4.87% 5.63% Portfolio Turnover Rate................ 262.1% 67.2% 110.4% 33.8% 45.9%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without the Manager's voluntary expense limit. /(c) /Period from August 30, 2004, date operations commenced, through December 31, 2004. /(d) /Total return amounts have not been annualized. /(e) /Computed on an annualized basis. /(f) /Effective November 19, 2005, Government Securities Account changed its name to Government & High Quality Bond Account. 70 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- GROWTH ACCOUNT -------------- Net Asset Value, Beginning of Period.. $11.94 $10.95 $8.68 $12.24 $16.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.03 0.07 0.03 0.02 -- Net Realized and Unrealized Gain (Loss) on Investments......... 1.40 0.95 2.26 (3.58) (4.19) ---- ---- ---- ----- ----- Total From Investment Operations 1.43 1.02 2.29 (3.56) (4.19) Less Dividends and Distributions: Dividends from Net Investment Income... (0.08) (0.03) (0.02) -- -- ---- Total Dividends and Distributions (0.08) (0.03) (0.02) -- -- ---- ----- ----- ----- Net Asset Value, End of Period............ $13.29 $11.94 $10.95 $8.68 $12.24 ====== ====== ====== ===== ====== Total Return /(b)/ ... 12.09% 9.38% 26.46% (29.07)% (25.50)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $124,254 $134,956 $141,107 $124,079 $209,879 Ratio of Expenses to Average Net Assets.. 0.62% 0.60% 0.61% 0.61% 0.61% Ratio of Gross Expenses to Average Net Assets.......... -- 0.60%/(f)/ 0.61%/(f)/ 0.61%/(f)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.26% 0.67% 0.35% 0.18% 0.02% Portfolio Turnover Rate................ 78.3% 122.4% 40.8% 27.3% 39.0% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- INTERNATIONAL EMERGING MARKETS ACCOUNT -------------------------------------- Net Asset Value, Beginning of Period.. $14.78 $12.86 $8.24 $8.93 $9.37 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.22 0.12 0.11 0.02 0.08 Net Realized and Unrealized Gain (Loss) on Investments......... 4.46 3.04 4.60 (0.70) (0.48) ---- ---- ---- ----- ----- Total From Investment Operations 4.68 3.16 4.71 (0.68) (0.40) Less Dividends and Distributions: Dividends from Net Investment Income... (0.17) (0.10) (0.08) -- (0.04) Distributions from Realized Gains...... (3.27) (1.14) -- -- -- Tax Return of Capital Distributions /(a)/. -- -- (0.01) (0.01) -- ----- ----- ----- Total Dividends and Distributions (3.44) (1.24) (0.09) (0.01) (0.04) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $16.02 $14.78 $12.86 $8.24 $8.93 ====== ====== ====== ===== ===== Total Return /(b)/ ... 34.29% 24.89% 57.20% (7.63)% (4.24)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $71,639 $43,502 $23,972 $10,835 $6,964 Ratio of Expenses to Average Net Assets.. 1.60% 1.53% 1.71% 1.60% 1.35% Ratio of Gross Expenses to Average Net Assets /(c)/ ... 1.60%/(d)/ 1.55%/(e)/ 1.84%/(e)/ 2.26%/(e)/ 2.33% Ratio of Net Investment Income to Average Net Assets.. 1.45% 0.87% 1.16% 0.39% 0.97% Portfolio Turnover Rate................ 169.6% 171.0% 112.4% 147.7% 137.4%
/(a) /See "Dividends and Distributions to Shareholders" in Notes to Financial Statements. /(b) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(c) /Expense ratio without the Manager's voluntary expense limit. The expense limit was increased on May 1, 2002, and May 1, 2003, and ceased on May 1, 2004. /(d) /Expense ratio without custodian credits. /(e) /Expense ratio without commission rebates and custodian credits. /(f) /Expense ratio without commission rebates. 72 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- INTERNATIONAL SMALLCAP ACCOUNT ------------------------------ Net Asset Value, Beginning of Period.. $17.72 $13.73 $9.06 $10.84 $13.87 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.12 0.11 0.10 0.08 0.04 Net Realized and Unrealized Gain (Loss) on Investments......... 4.96 4.00 4.72 (1.83) (3.07) ---- ---- ---- ----- ----- Total From Investment Operations 5.08 4.11 4.82 (1.75) (3.03) Less Dividends and Distributions: Dividends from Net Investment Income... (0.11) (0.12) (0.15) (0.03) -- Distributions from Realized Gains...... (0.19) -- -- -- -- ---- ----- Total Dividends and Distributions (0.30) (0.12) (0.15) (0.03) -- ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $22.50 $17.72 $13.73 $9.06 $10.84 ====== ====== ====== ===== ====== Total Return /(a)/ ... 29.12% 30.20% 54.15% (16.20)% (21.85)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $143,454 $99,833 $66,242 $38,912 $43,674 Ratio of Expenses to Average Net Assets.. 1.33% 1.30% 1.33% 1.31% 1.41% Ratio of Gross Expenses to Average Net Assets.......... 1.33%/(d)/ 1.31%/(e)/ 1.33%/(e)/ 1.32%/(e)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.63% 0.75% 1.00% 0.77% 0.32% Portfolio Turnover Rate................ 132.3% 140.6% 128.9% 73.6% 123.8% 2005 2004 2003 2002/(F)/ ---- ---- ---- ---- LARGECAP BLEND ACCOUNT ---------------------- Net Asset Value, Beginning of Period.. $10.73 $10.37 $8.43 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.10 0.13 0.10 0.02 Net Realized and Unrealized Gain (Loss) on Investments......... 0.40 0.92 1.90 (1.57) ---- ---- ---- ----- Total From Investment Operations 0.50 1.05 2.00 (1.55) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.11) (0.06) (0.02) Distributions from Realized Gains...... (0.04) (0.58) -- -- ---- ----- ----- Total Dividends and Distributions (0.04) (0.69) (0.06) (0.02) ----- ----- ----- ----- Net Asset Value, End of Period............ $11.19 $10.73 $10.37 $8.43 ====== ====== ====== ===== Total Return /(a)/ ... 4.74% 10.36% 23.76% (15.47)%/(g)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $135,072 $90,751 $54,632 $13,927 Ratio of Expenses to Average Net Assets.. 0.78% 0.76% 0.80% 1.00%/(h)/ Ratio of Gross Expenses to Average Net Assets /(b)/ ... -- 0.78%/(c)/ 0.83%/(c)/ 1.10%/(h)(c)/ Ratio of Net Investment Income to Average Net Assets.. 0.96% 1.23% 1.08% 0.86%/(h)/ Portfolio Turnover Rate................ 44.1% 75.6% 56.2% 49.1%/(h)/
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on May 1, 2004. /(c) /Expense ratio without commission rebates. /(d) /Expense ratio without custodian credits. /(e) /Expense ratio without commission rebates and custodian credits. /(f) /Period from May 1, 2002, date operations commenced, through December 31, 2002. /(g) /Total return amounts have not been annualized. /(h) /Computed on an annualized basis. 73 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- LARGECAP STOCK INDEX ACCOUNT ---------------------------- Net Asset Value, Beginning of Period.. $8.77 $8.06 $6.35 $8.29 $9.52 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.13 0.14 0.10 0.08 0.08 Net Realized and Unrealized Gain (Loss) on Investments......... 0.26 0.70 1.70 (1.94) (1.23) ---- ---- ---- ----- ----- Total From Investment Operations 0.39 0.84 1.80 (1.86) (1.15) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.13) (0.09) (0.08) (0.08) ----- Total Dividends and Distributions -- (0.13) (0.09) (0.08) (0.08) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $9.16 $8.77 $8.06 $6.35 $8.29 ===== ===== ===== ===== ===== Total Return /(a)/ ... 4.47% 10.39% 28.32% (22.44)% (12.10)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $179,143 $158,237 $118,638 $72,949 $73,881 Ratio of Expenses to Average Net Assets.. 0.38% 0.37% 0.39% 0.39% 0.40% Ratio of Gross Expenses to Average Net Assets /(b)/ ... 0.38% 0.37% 0.39% 0.39% 0.41% Ratio of Net Investment Income to Average Net Assets.. 1.52% 1.64% 1.42% 1.22% 1.05% Portfolio Turnover Rate................ 13.1% 20.5% 15.7% 15.1% 10.8% 2005 2004 2003 2002/(D)/ ---- ---- ---- ---- LARGECAP VALUE ACCOUNT ---------------------- Net Asset Value, Beginning of Period.. $11.88 $10.80 $8.52 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.18 0.19 0.16 0.06 Net Realized and Unrealized Gain (Loss) on Investments......... 0.46 1.22 2.23 (1.48) ---- ---- ---- ----- Total From Investment Operations 0.64 1.41 2.39 (1.42) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.16) (0.11) (0.06) Distributions from Realized Gains...... (0.07) (0.17) -- -- ----- ----- ----- Total Dividends and Distributions (0.07) (0.33) (0.11) (0.06) ----- ----- ----- ----- Net Asset Value, End of Period............ $12.45 $11.88 $10.80 $8.52 ====== ====== ====== ===== Total Return /(a)/ ... 5.44% 13.09% 28.05% (14.24)%/(e)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $122,221 $80,721 $47,221 $13,186 Ratio of Expenses to Average Net Assets.. 0.77% 0.75% 0.74% 0.96%/(f)/ Ratio of Gross Expenses to Average Net Assets /(c)/ ... -- 0.76%/(g)/ 0.79%/(g)/ 1.00%/(f)(g)/ Ratio of Net Investment Income to Average Net Assets.. 1.52% 1.65% 1.77% 1.79%/(f)/ Portfolio Turnover Rate................ 19.7% 23.2% 17.1% 5.9%/(f)/
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on April 29, 2005. /(c) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on May 1, 2004. /(d) /Period from May 1, 2002, date operations commenced, through December 31, 2002. /(e) /Total return amounts have not been annualized. /(f) /Computed on an annualized basis. /(g) /Expense ratio without commission rebates. 74 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MIDCAP ACCOUNT -------------- Net Asset Value, Beginning of Period.. $39.63 $37.56 $28.54 $32.09 $34.47 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.45 0.39 0.35 0.30 0.24 Net Realized and Unrealized Gain (Loss) on Investments......... 3.12 6.05 9.01 (3.08) (1.50) ---- ---- ---- ----- ----- Total From Investment Operations 3.57 6.44 9.36 (2.78) (1.26) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.39) (0.34) (0.30) (0.24) Distributions from Realized Gains...... (0.66) (3.98) -- (0.47) (0.88) ---- ----- ----- ----- ----- Total Dividends and Distributions (0.66) (4.37) (0.34) (0.77) (1.12) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $42.54 $39.63 $37.56 $28.54 $32.09 ====== ====== ====== ====== ====== Total Return /(a)/ ... 9.21% 17.76% 32.81% (8.75)% (3.71)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $420,812 $395,304 $334,204 $248,986 $278,707 Ratio of Expenses to Average Net Assets.. 0.58% 0.59% 0.61% 0.62% 0.62% Ratio of Gross Expenses to Average Net Assets.......... -- 0.59%/(b)/ 0.61%/(b)/ 0.62%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.13% 1.02% 1.09% 0.98% 0.77% Portfolio Turnover Rate................ 49.9% 38.9% 44.9% 67.9% 73.6% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MIDCAP GROWTH ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $9.84 $8.80 $6.26 $8.49 $10.46 Income from Investment Operations: Net Investment Income (Operating Loss).... (0.02) (0.03) (0.03) (0.04) (0.05) Net Realized and Unrealized Gain (Loss) on Investments......... 1.37 1.07 2.57 (2.19) (1.68) ---- ---- ---- ----- ----- Total From Investment Operations 1.35 1.04 2.54 (2.23) (1.73) Less Dividends and Distributions: Distributions from Realized Gains...... -- -- -- -- (0.24) ---- ----- Total Dividends and Distributions -- -- -- -- (0.24) ---- ----- Net Asset Value, End of Period............ $11.19 $9.84 $8.80 $6.26 $8.49 ====== ===== ===== ===== ===== Total Return /(a)/ ... 13.72% 11.82% 40.58% (26.27)% (16.92)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $68,471 $59,674 $54,288 $21,934 $27,838 Ratio of Expenses to Average Net Assets.. 0.92% 0.86% 0.91% 0.91% 0.97% Ratio of Gross Expenses to Average Net Assets.......... -- 0.92%/(b)/ 0.94%/(b)/ 0.92%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. (0.15)% (0.30)% (0.39)% (0.55)% (0.66)% Portfolio Turnover Rate................ 97.0% 47.7% 67.5% 43.1% 55.2%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. 75 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MIDCAP VALUE ACCOUNT -------------------- Net Asset Value, Beginning of Period.. $15.38 $14.13 $10.48 $11.68 $12.57 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.05 0.02 0.01 -- 0.01 Net Realized and Unrealized Gain (Loss) on Investments......... 1.53 3.10 3.81 (1.16) (0.35) ---- ---- ---- ----- ----- Total From Investment Operations 1.58 3.12 3.82 (1.16) (0.34) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.01) (0.01) -- (0.01) Distributions from Realized Gains...... (0.39) (1.86) (0.16) (0.04) (0.54) ----- ----- ----- ----- ----- Total Dividends and Distributions (0.39) (1.87) (0.17) (0.04) (0.55) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $16.57 $15.38 $14.13 $10.48 $11.68 ====== ====== ====== ====== ====== Total Return /(a)/ ... 10.55% 22.67% 36.49% (9.96)% (2.58)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $112,437 $78,166 $52,054 $24,766 $11,778 Ratio of Expenses to Average Net Assets.. 1.07% 1.05% 1.05% 1.04% 1.36% Ratio of Gross Expenses to Average Net Assets.......... -- 1.08%/(b)/ 1.08%/(b)/ 1.10%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.32% 0.11% 0.11% 0.03% 0.12% Portfolio Turnover Rate................ 90.6% 59.2% 55.5% 75.3% 208.8% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MONEY MARKET ACCOUNT -------------------- Net Asset Value, Beginning of Period.. $1.000 $1.000 $1.000 $1.000 $1.000 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.027 0.009 0.007 0.014 0.039 ----- ----- ----- ----- ----- Total From Investment Operations 0.027 0.009 0.007 0.014 0.039 Less Dividends and Distributions: Dividends from Net Investment Income... (0.027) (0.009) (0.007) (0.014) (0.039) ------ ------ ------ ------ ------ Total Dividends and Distributions (0.027) (0.009) (0.007) (0.014) (0.039) ------ ------ ------ ------ ------ Net Asset Value, End of Period............ $1.000 $1.000 $1.000 $1.000 $1.000 ====== ====== ====== ====== ====== Total Return /(a)/ ... 2.69% 0.92% 0.74% 1.42% 3.92% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $150,653 $140,553 $151,545 $201,455 $180,923 Ratio of Expenses to Average Net Assets.. 0.61% 0.49% 0.49% 0.49% 0.50% Ratio of Net Investment Income to Average Net Assets.. 2.66% 0.91% 0.74% 1.40% 3.70%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. 76 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004/(D)/ ---- ---- PRINCIPAL LIFETIME 2010 ACCOUNT ------------------------------- Net Asset Value, Beginning of Period.. $10.84 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.02 0.11 Net Realized and Unrealized Gain (Loss) on Investments......... 0.59 0.82 ---- ---- Total From Investment Operations 0.61 0.93 Less Dividends and Distributions: Dividends from Net Investment Income... (0.01) (0.09) Distributions from Realized Gains...... (0.07) -- ---- ----- Total Dividends and Distributions (0.08) (0.09) ----- ----- Net Asset Value, End of Period............ $11.37 $10.84 ====== ====== Total Return /(a)/ ... 5.70% 9.31%/(e)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $12,930 $11 Ratio of Expenses to Average Net Assets /(b)/ .............. 0.16% 0.16%/(f)/ Ratio of Gross Expenses to Average Net Assets /(b)/ /(c)/ .............. 0.20% 10.02%/(f)/ Ratio of Net Investment Income to Average Net Assets.. 0.22% 3.21%/(f)/ Portfolio Turnover Rate................ 4.3% 3.0%/(f)/ 2005 2004/(D)/ ---- ---- PRINCIPAL LIFETIME 2020 ACCOUNT ------------------------------- Net Asset Value, Beginning of Period.. $10.97 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... (0.01) 0.13 Net Realized and Unrealized Gain (Loss) on Investments......... 0.75 0.93 ---- ---- Total From Investment Operations 0.74 1.06 Less Dividends and Distributions: Dividends from Net Investment Income... (0.02) (0.09) Distributions from Realized Gains...... (0.08) -- ---- ----- Total Dividends and Distributions (0.10) (0.09) ----- ----- Net Asset Value, End of Period............ $11.61 $10.97 ====== ====== Total Return /(a)/ ... 6.77% 10.62%/(e)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $26,753 $15 Ratio of Expenses to Average Net Assets /(b)/ .............. 0.13% 0.13%/(f)/ Ratio of Gross Expenses to Average Net Assets /(b)/ /(c)/ .............. 0.16% 8.72%/(f)/ Ratio of Net Investment Income to Average Net Assets.. (0.10)% 3.65%/(f)/ Portfolio Turnover Rate................ 3.1% 2.6%/(f)/
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Does not include expenses of the investment companies in which the Account invests. /(c) /Expense ratio without the Manager's voluntary expense limit. The expense limit became a contractual limit on November 21, 2005. /(d) /Period from August 30, 2004, date operations commenced, through December 31, 2004. /(e) /Total return amounts have not been annualized. /(f) /Computed on an annualized basis. 77 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004/(E)/ ---- ---- PRINCIPAL LIFETIME 2030 ACCOUNT ------------------------------- Net Asset Value, Beginning of Period.. $10.97 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.01 0.30 Net Realized and Unrealized Gain (Loss) on Investments......... 0.73 0.76 ---- ---- Total From Investment Operations 0.74 1.06 Less Dividends and Distributions: Dividends from Net Investment Income... (0.02) (0.09) Distributions from Realized Gains...... (0.06) -- ---- ----- Total Dividends and Distributions (0.08) (0.09) ----- ----- Net Asset Value, End of Period............ $11.63 $10.97 ====== ====== Total Return /(a)/ ... 6.76% 10.60%/(f)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $3,918 $151 Ratio of Expenses to Average Net Assets /(b)/ .............. 0.16% 0.16%/(g)/ Ratio of Gross Expenses to Average Net Assets /(b) (c)/ 0.38% 2.14%/(g)/ Ratio of Net Investment Income to Average Net Assets.. 0.08% 8.58%/(g)/ Portfolio Turnover Rate................ 11.5% 4.8%/(g)/ 2005 2004/(E)/ ---- ---- PRINCIPAL LIFETIME 2040 ACCOUNT ------------------------------- Net Asset Value, Beginning of Period.. $11.09 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.01 0.19 Net Realized and Unrealized Gain (Loss) on Investments......... 0.79 0.99 ---- ---- Total From Investment Operations 0.80 1.18 Less Dividends and Distributions: Dividends from Net Investment Income... (0.02) (0.09) Distributions from Realized Gains...... (0.05) -- ---- ----- Total Dividends and Distributions (0.07) (0.09) ----- ----- Net Asset Value, End of Period............ $11.82 $11.09 ====== ====== Total Return /(a)/ ... 7.27% 11.78%/(f)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $1,893 $147 Ratio of Expenses to Average Net Assets /(b)/ .............. 0.13% 0.14%/(g)/ Ratio of Gross Expenses to Average Net Assets /(b) (d)/ 0.56% 1.47%/(g)/ Ratio of Net Investment Income to Average Net Assets.. 0.12% 5.35%/(g)/ Portfolio Turnover Rate................ 18.2% 9.4%/(g)/
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Does not include expenses of the investment companies in which the Account invests. /(c) /Expense ratio without the Manager's voluntary expense limit. The expense limit became a contractual limit on November 21, 2005. /(d) /Expense ratio without the Manager's voluntary expense limit. The expense limit was decreased on April 29, 2005, and became a contractual limit on November 21, 2005. /(e) /Period from August 30, 2004, date operations commenced, through December 31, 2004. /(f) /Total return amounts have not been annualized. /(g) /Computed on an annualized basis. 78 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004/(D)/ ---- ---- PRINCIPAL LIFETIME 2050 ACCOUNT ------------------------------- Net Asset Value, Beginning of Period.. $11.09 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.01 0.11 Net Realized and Unrealized Gain (Loss) on Investments......... 0.82 1.06 ---- ---- Total From Investment Operations 0.83 1.17 Less Dividends and Distributions: Dividends from Net Investment Income... (0.02) (0.08) Distributions from Realized Gains...... (0.05) -- ---- ----- Total Dividends and Distributions (0.07) (0.08) ----- ----- Net Asset Value, End of Period............ $11.85 $11.09 ====== ====== Total Return /(a)/ ... 7.56% 11.74%/(e)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $1,160 $88 Ratio of Expenses to Average Net Assets /(b)/ .............. 0.12% 0.13%/(f)/ Ratio of Gross Expenses to Average Net Assets /(b)/ /(c)/ .............. 1.11% 1.49%/(f)/ Ratio of Net Investment Income to Average Net Assets.. 0.11% 3.04%/(f)/ Portfolio Turnover Rate................ 4.2% 13.0%/(f)/ 2005 2004/(D)/ ---- ---- PRINCIPAL LIFETIME STRATEGIC INCOME ACCOUNT ------------------------------------------- Net Asset Value, Beginning of Period.. $10.68 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.06 0.12 Net Realized and Unrealized Gain (Loss) on Investments......... 0.46 0.65 ---- ---- Total From Investment Operations 0.52 0.77 Less Dividends and Distributions: Dividends from Net Investment Income... (0.03) (0.09) Distributions from Realized Gains...... (0.12) -- ---- ----- Total Dividends and Distributions (0.15) (0.09) ----- ----- Net Asset Value, End of Period............ $11.05 $10.68 ====== ====== Total Return /(a)/ ... 4.96% 7.66%/(e)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $5,463 $11 Ratio of Expenses to Average Net Assets /(b)/ .............. 0.14% 0.14%/(f)/ Ratio of Gross Expenses to Average Net Assets /(b)/ /(g)/ .............. 0.27% 10.09%/(f)/ Ratio of Net Investment Income to Average Net Assets.. 0.60% 3.30%/(f)/ Portfolio Turnover Rate................ 8.4% 2.9%/(f)/
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Does not include expenses of the investment companies in which the Account invests. /(c) /Expense ratio without the Manager's voluntary expense limit. The expense limit was decreased on April 29, 2005, and came to be contractual on November 21, 2005. /(d) /Period from August 30, 2004, date operations commenced, through December 31, 2004. /(e) /Total return amounts have not been annualized. /(f) /Computed on an annualized basis. /(g) /Expense ratio without the Manager's voluntary expense limit. The expense limit became a contractual limit on November 21, 2005. 79 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- REAL ESTATE SECURITIES ACCOUNT ------------------------------ Net Asset Value, Beginning of Period.. $17.88 $14.90 $11.24 $10.77 $10.29 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.40 0.39 0.49 0.35 0.42 Net Realized and Unrealized Gain (Loss) on Investments......... 2.39 4.66 3.87 0.48 0.47 ---- ---- ---- ---- ---- Total From Investment Operations 2.79 5.05 4.36 0.83 0.89 Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.35) (0.42) (0.35) (0.41) Distributions from Realized Gains...... (0.16) (1.72) (0.28) (0.01) -- ---- ----- ----- ----- ----- Total Dividends and Distributions (0.16) (2.07) (0.70) (0.36) (0.41) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $20.51 $17.88 $14.90 $11.24 $10.77 ====== ====== ====== ====== ====== Total Return /(a)/ ... 15.85% 34.53% 38.91% 7.72% 8.75% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $178,922 $146,022 $93,018 $46,358 $22,457 Ratio of Expenses to Average Net Assets.. 0.89% 0.90% 0.91% 0.92% 0.92% Ratio of Gross Expenses to Average Net Assets ......... -- 0.90% 0.92% -- -- Ratio of Net Investment Income to Average Net Assets.. 2.16% 2.37% 3.83% 3.99% 4.55% Portfolio Turnover Rate................ 23.6% 58.8% 53.9% 54.4% 92.4% 2005 2004 2003/(D)/ ---- ---- ---- SHORT-TERM BOND ACCOUNT ----------------------- Net Asset Value, Beginning of Period /(c)/ ............... $10.12 $9.99 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.33 0.25 0.13 Net Realized and Unrealized Gain (Loss) on Investments......... (0.15) (0.12) (0.05) ----- ----- ----- Total From Investment Operations 0.18 0.13 0.08 Less Dividends and Distributions: Dividends from Net Investment Income... (0.19) -- (0.09) ---- ----- ----- Total Dividends and Distributions (0.19) -- (0.09) ---- ----- ----- Net Asset Value, End of Period............ $10.11 $10.12 $9.99 ====== ====== ===== Total Return /(a)/ ... 1.80% 1.30% 0.78%/(e)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $83,822 $56,241 $20,552 Ratio of Expenses to Average Net Assets.. 0.57% 0.53% 0.57%/(f)/ Ratio of Gross Expenses to Average Net Assets/(b)/..... -- -- 0.57%/(f)/ Ratio of Net Investment Income to Average Net Assets.. 3.26% 2.53% 2.15%/(f)/ Portfolio Turnover Rate................ 74.3% 34.8% 5.0%/(f)/
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on May 1, 2004. /(c) /Effective November 19, 2005, Limited Term Bond Account changed its name to Short-Term Bond Account. /(d) /Period from May 1, 2003, date operations commenced, through December 31, 2003. /(e) /Total return amounts have not been annualized. /(f) /Computed on an annualized basis. 80 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- SMALLCAP GROWTH ACCOUNT ----------------------- Net Asset Value, Beginning of Period.. $9.30 $8.36 $5.74 $10.60 $15.59 Income from Investment Operations: Net Investment Income (Operating Loss).... (0.07) (0.06) (0.04) (0.05) (0.10) Net Realized and Unrealized Gain (Loss) on Investments......... 0.69 1.00 2.66 (4.81) (4.89) ---- ---- ---- ----- ----- Total From Investment Operations 0.62 0.94 2.62 (4.86) (4.99) ---- ---- ---- ----- ----- Net Asset Value, End of Period............ $9.92 $9.30 $8.36 $5.74 $10.60 ===== ===== ===== ===== ====== Total Return /(a)/ ... 6.67% 11.24% 45.64% (45.85)% (32.01)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $66,656 $63,453 $55,628 $32,754 $55,966 Ratio of Expenses to Average Net Assets.. 1.05% 0.99% 0.99% 0.95% 1.05% Ratio of Gross Expenses to Average Net Assets ......... -- 1.01%/(b)/ 1.02%/(b)/ 1.06%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. (0.77)% (0.70)% (0.64)% (0.68)% (0.92)% Portfolio Turnover Rate................ 68.2% 43.3% 54.1% 287.9% 152.2% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- SMALLCAP VALUE ACCOUNT ---------------------- Net Asset Value, Beginning of Period.. $16.83 $15.04 $10.30 $11.37 $11.26 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.07 0.03 0.06 0.06 0.09 Net Realized and Unrealized Gain (Loss) on Investments......... 0.96 3.37 5.14 (1.07) 0.60 ---- ---- ---- ----- ---- Total From Investment Operations 1.03 3.40 5.20 (1.01) 0.69 Less Dividends and Distributions: Dividends from Net Investment Income... (0.01) (0.03) (0.05) (0.06) (0.09) Distributions from Realized Gains...... (0.24) (1.58) (0.41) -- (0.49) ---- ----- ----- ----- ----- Total Dividends and Distributions (0.25) (1.61) (0.46) (0.06) (0.58) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $17.61 $16.83 $15.04 $10.30 $11.37 ====== ====== ====== ====== ====== Total Return /(a)/ ... 6.22% 23.08% 50.61% (8.86)% 6.25% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $132,035 $107,206 $82,135 $44,217 $30,888 Ratio of Expenses to Average Net Assets.. 1.13% 1.12% 1.16% 1.28% 1.24% Ratio of Gross Expenses to Average Net Assets.......... -- 1.13%/(b)/ 1.18%/(b)/ 1.29%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.38% 0.21% 0.50% 0.68% 0.95% Portfolio Turnover Rate................ 45.3% 38.0% 54.0% 77.4% 67.8%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. 82 122 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 ADDITIONAL INFORMATION Additional information about the Fund (including the Fund's policy regarding the disclosure of portfolio securities) is available in the Statement of Additional Information dated May 1, 2006 which is incorporated by reference into this prospectus. Additional information about the Funds' investments is available in the Fund's annual and semiannual reports to shareholders. In the Funds' annual report, you will find a discussion of the market conditions and investment strategies that significantly affected the Funds' performance during the last fiscal year. The Statement of Additional Information and the Fund's annual and semi-annual reports can be obtained free of charge by writing or telephoning Princor Financial Services Corporation, P.O. Box 10423, Des Moines, IA 50306. In addition, the Fund makes its Statement of Additional Information and annual and semi-annual reports available, free of charge, on http:// www.principal.com. To request this and other information about the Fund and to make shareholder inquiries, telephone 1-800-247-4123. Information about the Fund (including the Statement of Additional Information) can be reviewed and copied at the Commission's Public Reference Room in Washington, D.C. Information on the operation of the Public Reference Room may be obtained by calling the Commission at 1-202-942-8090. Reports and other information about the Fund are available on the EDGAR Database on the Commission's internet site at http://www.sec.gov. Copies of this information may be obtained, upon payment of a duplicating fee, by electronic request at the following E-mail address: publicinfo@sec.gov, or by writing the Commission's Public Reference Section, Washington, D.C. 20549-0102. The U.S. government does not insure or guarantee an investment in any of the Accounts. There can be no assurance that the Money Market Account will be able to maintain a stable share price of $1.00 per share. Shares of the Accounts are not deposits or obligations of, or guaranteed or endorsed by, any financial institution, nor are shares of the Accounts federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other agency. Principal Variable Contracts Fund, Inc. SEC File 811-01944 PRINCIPAL VARIABLE CONTRACTS FUND 123 www.principal.com PRINCIPAL VARIABLE CONTRACTS FUND, INC.
ACCOUNTS OF THE FUND -------------------- ASSET ALLOCATION ACCOUNT LARGECAP GROWTH EQUITY ACCOUNT BALANCED ACCOUNT LARGECAP STOCK INDEX ACCOUNT BOND ACCOUNT LARGECAP VALUE ACCOUNT CAPITAL VALUE ACCOUNT MIDCAP ACCOUNT DIVERSIFIED INTERNATIONAL ACCOUNT MIDCAP GROWTH ACCOUNT EQUITY GROWTH ACCOUNT MIDCAP VALUE ACCOUNT EQUITY INCOME ACCOUNT MONEY MARKET ACCOUNT GOVERNMENT & HIGH QUALITY BOND REAL ESTATE SECURITIES ACCOUNT ACCOUNT (previously Government Securities SHORT-TERM BOND ACCOUNT Account) GROWTH ACCOUNT (previously Limited Term Bond Account) INTERNATIONAL EMERGING MARKETS SMALLCAP ACCOUNT ACCOUNT INTERNATIONAL SMALLCAP ACCOUNT SMALLCAP GROWTH ACCOUNT LARGECAP BLEND ACCOUNT SMALLCAP VALUE ACCOUNT
This Prospectus describes a mutual fund organized by Principal Life Insurance Company/(R)/ ("Principal Life"). The Fund provides a choice of investment objectives through the Accounts listed above. The date of this Prospectus is May 1, 2006. As with all mutual funds, neither the Securities and Exchange Commission ("SEC") nor any State Securities Commission has approved or disapproved of these securities or determined if this prospectus is accurate or complete. It is a criminal offense to represent otherwise. TABLE OF CONTENTS ACCOUNT DESCRIPTIONS....................................................3 Asset Allocation Account..............................................5 Balanced Account......................................................8 Bond Account..........................................................11 Capital Value Account.................................................15 Diversified International Account.....................................18 Equity Growth Account.................................................21 Equity Income Account.................................................24 Government & High Quality Bond Account (f/k/a Government Securities Account)..................................27 Growth Account........................................................31 International Emerging Markets Account................................33 International SmallCap Account........................................36 LargeCap Blend Account................................................39 LargeCap Growth Equity Account ........................................42 LargeCap Stock Index Account..........................................44 LargeCap Value Account................................................46 MidCap Account........................................................48 MidCap Growth Account.................................................51 MidCap Value Account..................................................54 Money Market Account..................................................57 Real Estate Securities Account........................................60 Short-Term Bond Account (f/k/a Limited Term Bond Account).............63 SmallCap Account......................................................66 SmallCap Growth Account...............................................69 SmallCap Value Account................................................72 CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.........................75 PRICING OF ACCOUNT SHARES...............................................81 DIVIDENDS AND DISTRIBUTIONS.............................................81 MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE..........................82 The Manager...........................................................82 The Sub-Advisors......................................................82 Duties of the Manager and Sub-Advisors................................94 Fees Paid to the Manager..............................................94 Fees Paid to the Sub-Advisor..........................................94 GENERAL INFORMATION ABOUT AN ACCOUNT....................................95 Frequent Trading and Market-Timing (Abusive Trading Practices)........95 Eligible Purchasers...................................................96 Shareholder Rights....................................................96 Non-Cumulative Voting.................................................97 Purchase of Account Shares............................................97 Sale of Account Shares................................................97 Restricted Transfers..................................................98 Financial Statements..................................................98 FINANCIAL HIGHLIGHTS....................................................98 ADDITIONAL INFORMATION..................................................111 ACCOUNT DESCRIPTIONS The Principal Variable Contracts Fund (the "Fund") is made up of Accounts. Each Account has its own investment objective. Principal Management Corporation*, the "Manager" of the Fund, has selected a Sub-Advisor for the Accounts based on the Sub-Advisor's experience with the investment strategy for which it was selected. The Manager seeks to provide a wide range of investment approaches through the Fund. The Sub-Advisors are: . AllianceBernstein L.P. ("AllianceBernstein") . Columbus Circle Investors ("CCI")* . Emerald Advisers, Inc. ("Emerald") . Grantham, Mayo, Van Otterloo & Co. LLC ("GMO") . J.P. Morgan Investment Management Inc. ("Morgan") . Mellon Equity Associates, LLP ("Mellon Equity") . Morgan Stanley Investment Management Inc. ("MSIM Inc.") doing business as "Van Kampen" . Neuberger Berman Management Inc. ("Neuberger Berman") . Principal Global Investors, LLC ("Principal")* . Principal Real Estate Investors, LLC ("Principal - REI")* . T. Rowe Price Associates, Inc. ("T. Rowe Price") . UBS Global Asset Management (Americas) Inc. ("UBS Global AM") * CCI, Principal, Principal - REI, Principal Management Corporation and Princor Financial Services Corporation ("Princor") are affiliates of Principal Life Insurance Company and with it are subsidiaries of Principal Financial Group, Inc. and members of the Principal Financial Group/(R)/. In the description for each Account, there is important information about the Account's: MAIN STRATEGIES AND RISKS These sections describe each Account's investment objective and summarize how each Account intends to achieve its investment objective. The Board of Directors may change an Account's objective or the investment strategies without a shareholder vote if it determines such a change is in the best interests of the Account. If there is a material change to the Account's investment objective or investment strategies, you should consider whether the Account remains an appropriate investment for you. There is no guarantee that an Account will meet its objective. The sections also describe each Account's primary investment strategies (including the type or types of securities in which the Account invests), any policy of the Account to concentrate in securities of issuers in a particular industry or group of industries and the main risks associated with an investment in the Account. A fuller discussion of risks appears later in the Prospectus under the caption "Certain Investment Strategies and Related Risks." Each Account may invest up to 100% of its assets in cash and cash equivalents for temporary defensive purposes in response to adverse market, economic or political condition as more fully described under the caption "Certain Investment Strategies and Related Risks-Temporary Defensive Measures." Each Account is designed to be a portion of an investor's portfolio. None of the Accounts is intended to be a complete investment program. You should consider the risks of each Account before making an investment and be prepared to maintain the investment during periods of adverse market conditions. INVESTMENT RESULTS A bar chart and a table are included with each Account that has annual returns for a full calendar year. They show the Account's annual returns and its long-term performance. The chart shows how the Account's performance has varied from year-to-year. The table compares the Account's performance over time to that of: . a broad-based securities market index (An index measures the market price of a specific group of securities in a particular market or securities in a market sector. You cannot invest directly in an index. An index does not have an investment advisor and does not pay any commissions or expenses. If an index had expenses, its performance would be lower.); and Principal Variable Contracts Fund 3 www.principal.com . an average of mutual funds with a similar investment objective and management style. The averages used are prepared by independent statistical services. An Account's past performance is not necessarily an indication of how the Account will perform in the future. Call the Principal Variable Contracts Fund at 1-800-247-4123 to get the current 7-day yield for the Money Market Account. FEES AND EXPENSES The annual operating expenses for each Account are deducted from that Account's assets. Each Account's operating expenses are shown with the description of the Account and are stated as a percentage of Account assets. A discussion of fees and expenses appears later in the Prospectus under the caption "The Costs of Investing." The fees and expenses shown do not include the effect of any separate account expenses or other contract level expenses. If such charges were included, overall expenses would be higher and would lower performance. The description of each Account includes examples of the costs associated with investing in the Account. The examples are intended to help you compare the cost of investing in a particular Account with the cost of investing in other mutual funds. The examples assume you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The examples also assume that your investment has a 5% total return each year and that the Account's operating expenses remain the same. Your actual costs of investing in a particular Account may be higher or lower than the costs assumed for purposes of the examples. NOTES: . No salesperson, dealer or other person is authorized to give information or make representations about an Account other than those contained in this Prospectus. Information or representations not contained in this Prospectus may not be relied upon as having been made by the Principal Variable Contracts Fund, an Account, the Manager, any Sub-Advisor or Princor. . Investments in these Accounts are not deposits of a bank and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. 4 Principal Variable Contracts Fund 1-800-247-4123 ASSET ALLOCATION ACCOUNT The Account seeks to generate a total investment return consistent with preservation of capital. MAIN STRATEGIES The Account invests in a portfolio of securities that is broadly diversified by asset class, global region, country, economic sector, and currency. The Portfolio Manager makes the Account's broad asset allocation decisions and delegates responsibility for selection specific individual securities to the internal, active management teams of the Sub-Advisor, Van Kampen. In deciding how to allocate the Account's assets, Van Kampen assesses three sets of factors: . the relative value of the stock, bond and money markets in the various regions, countries and economic sectors; . the long-term dynamic forces that are driving economies, economic sectors, and companies; and . the short-term technical forces that are affecting market pricing. Factors evaluated include growth rates in gross domestic product, inflation and corporation earnings, labor market conditions, interest rate levels, sales growth, return on equity, dividend yields, price to book ratios and currency valuations. From time-to-time, Van Kampen changes the Account's allocation of assets in various ways, including by asset class, by global region, by country, by economic sector and by currency, in order to keep the portfolio in alignment with global investment outlook. Allocation among asset classes is designed to lessen overall investment risk by diversifying the Account's assets among different types of investments in different markets. Van Kampen reallocates among asset classes and eliminates asset classes for a period of time, when in its judgement the shift offers better prospects of achieving the investment objective of the Account. Under normal market conditions, abrupt reallocations among asset classes will not occur. Van Kampen does not allocate a specific percentage of the Account's assets to a class. Over time, it expects the asset mix to be within the following ranges: . 25% to 75% in equity securities; . 20% to 60% in fixed-income securities; and . 0% to 40% in money market instruments. The Account may invest up to 100% of its assets in foreign securities. Allowable instruments include individual securities (stocks (without regard to the market capitalization of the issuing company) and bonds), equity and interest rate futures, currency forward contracts, futures contracts, Exchange Traded Funds, fixed-income TRAINS and listed options. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. Van Kampen may utilize currency contracts, currency or index futures or other derivatives for hedging or other purposes, including modifying the Account's exposure to various currency, equity or fixed-income market. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. Principal Variable Contracts Fund 5 www.principal.com CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.) FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. HEDGING STRATEGIES . Use of forward foreign currency exchange contracts, currency or index futures or other derivatives involves risks. The contracts may increase the Account's volatility and, thus, could involve a significant risk. If the Sub-Advisor's predictions are inaccurate, the adverse consequences to the Account (e.g., a reduction in the Account's net asset value) may leave the Account in a worse position than if these strategies were not used. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking a moderate risk approach towards long-term growth. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. 6 Principal Variable Contracts Fund 1-800-247-4123 Van Kampen has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"12.92 "1997"18.19 "1998"9.18 "1999"19.49 "2000"1.61 "2001"-3.92 "2002"-12.94 "2003"21.61 "2004"8.49 The Account's highest/lowest quarterly returns "2005"5.79 during this time period were: HIGHEST Q2 '03 12.11% LOWEST Q3 '02 -12.41% LOGO The year-to-date return as of March 31, 2006 is 3.34%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* ASSET ALLOCATION ACCOUNT .............. 5.79 3.14 7.52 8.25 S&P 500 Index ........ 4.91 0.54 9.07 11.02 Lehman Brothers Aggregate Bond Index . 2.43 5.87 6.17 6.92 MSCI EAFE (Europe, Australia, Far East) Index - ND ........... 13.54 4.56 5.84 6.03 Morningstar Moderate Allocation Category Average .............. 5.29 2.93 7.35 8.55 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (June 1, 1994).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM THE ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.80% Other Expenses................... 0.06 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.86%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 ASSET ALLOCATION ACCOUNT $88 $274 $477 $1,061
Principal Variable Contracts Fund 7 www.principal.com BALANCED ACCOUNT The Account seeks to generate a total return consisting of current income and capital appreciation. MAIN STRATEGIES The Account seeks growth of capital and current income by investing primarily in common stocks and corporate bonds. It may also invest in other equity securities, government bonds and notes (obligations of the U.S. government or its agencies or instrumentalities) and cash. Though the percentages in each category are not fixed, common stocks generally represent 40% to 70% of the Account's assets. The remainder of the Account's assets is invested in bonds and cash. The Sub-Advisor, Principal, utilizes an asset allocation approach to the management and development of a diversified balanced account. The strategy incorporates a wide range of asset classes and investment styles with primary emphasis placed on equity versus fixed income allocation decisions. Secondary focus is then placed on growth versus value, large cap versus small cap, and domestic versus international equity exposure. Strategic or long-term asset class targets are determined with gradual adjustments to the mix to enhance risk-adjusted results over time. Any asset allocation adjustments fall within a predetermined range and do not deviate by more than 10% of the long-term asset class targets. All marginal shifts in the asset mix are based on a consistent three-dimensional analytical framework. First, securities are reviewed based on price, earnings, and yield measures relative to long-term historical norms. Next, fundamental economic and market conditions are analyzed to identify opportunities, and finally, market trends are used to compare relative price strength and investor sentiment. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. Because the Account invests in both stocks and bonds, the Account may underperform stock funds when stocks are in favor and underperform bond funds when bonds are in favor. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. Risks for this Account include: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates, credit rating, and effective maturities. When interest rates fall, the price of a bond rises and when interest rates rise, the price declines. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade are commonly referred to as "junk bonds" or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.) FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some 8 Principal Variable Contracts Fund 1-800-247-4123 investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates. This may increase the volatility of the Account. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 115.3%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking current income as well as long-term growth of capital. Principal Variable Contracts Fund 9 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"13.13 "1997"17.93 "1998"11.91 "1999"2.4 "2000"0.13 "2001"-6.96 "2002"-13.18 "2003"18.82 "2004"10.05 The Account's highest/lowest quarterly returns "2005"6.79 during this time period were: HIGHEST Q2 '03 9.82% LOWEST Q3 '02 -9.61% LOGO The year-to-date return as of March 31, 2006 is 3.69%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* BALANCED ACCOUNT ..... 6.79 2.44 5.61 8.43 60% S&P 500 Index/40% Lehman Brothers Aggregate Bond Index . 4.01 2.96 8.24 10.52 Morningstar Moderate Allocation Category Average .............. 5.29 2.93 7.35 9.52 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (December 18, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.59% Other Expenses................... 0.05 ---- TOTAL ACCOUNT OPERATING EXPENSES 0.64%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 BALANCED ACCOUNT $65 $205 $357 $798
10 Principal Variable Contracts Fund 1-800-247-4123 BOND ACCOUNT The Account seeks to provide as high a level of income as is consistent with preservation of capital and prudent investment risk. MAIN STRATEGIES Under normal circumstances, the Account invests at least 80% of its assets in intermediate maturity fixed-income or debt securities rated BBB or higher by Standard & Poor's Rating Service ("S&P") or Baa or higher by Moody's Investors Service, Inc. ("Moody's"). The Account considers the term "bond" to mean any debt security. Under normal circumstances, the Account invests in: . securities issued or guaranteed by the U.S. government or its agencies or instrumentalities; . mortgage-backed securities representing an interest in a pool of mortgage loans; . debt securities and taxable municipal bonds rated, at the time of purchase, in one of the top four categories by S&P or Moody's or, if not rated, in the opinion of the Sub-Advisor, Principal, of comparable quality; and . securities issued or guaranteed by the governments of Canada (provincial or federal government) or the United Kingdom payable in U.S. dollars. The rest of the Account's assets may be invested in: . preferred and common stock that may be convertible (may be exchanged for a fixed number of shares of common stock of the same issuer) or may be non-convertible; or . securities rated less than the four highest grades of S&P or Moody's (i.e. less than investment grade (commonly known as "junk bonds")) but not lower than CCC- (S&P) or Caa (Moody's). The Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income. Under a reverse repurchase agreement, the Account sells securities and agrees to repurchase them at a specified date and price. The Account pays interest on this "secured financing" and attempts to make money on the difference between the financing rate and the interest it earns by investing the proceeds of the financing. While a reverse repurchase agreement is outstanding, the Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account may lend its portfolio securities to brokers, dealers and other financial institutions. In connection with such loans, the Account remains the owner of the loaned securities and continues to be entitled to payments in amounts equal to the interest, dividends or other distributions payable on the loaned securities. Loans of portfolio securities may not exceed 33 1/3% of the value of the Account's total assets (including the value of all assets received as collateral for loan). In connection with such loans the Account will receive collateral from the borrower equal to at least 100% of the value of the loaned securities. The Account may actively trade securities in an attempt to achieve its investment objective. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: MUNICIPAL SECURITIES . Principal and interest payments of municipal securities may not be guaranteed by the issuing body and may be payable only from monies derived from a particular source. If the source does not perform as expected, principal and income payments may not be made on time or at all. In addition, the market for municipal securities is often thin and may be temporarily affected by large purchases and sales, including those of the Account. General conditions in the financial markets and the size of a particular offering may also negatively affect the returns of a municipal security. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining Principal Variable Contracts Fund 11 www.principal.com interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates. This may increase the volatility of the Account. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation maybe chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. REVERSE REPURCHASE AGREEMENTS. . This strategy involves the risk that interest costs on money borrowed may exceed the return on securities purchased with the borrowed money. In addition, reverse repurchase agreements may increase the volatility of the Fund. LENDING OF SECURITIES . If the Account lends its portfolio securities and the borrower of the securities fail financially, the Account may experience delays in recovering the loaned securities or exercising its rights in the collateral. Loans are made only to borrowers that are deemed by the Sub-Advisor to be of good financial standing. PORTFOLIO DURATION . The average portfolio duration of the Account normally varies within a three- to six-year time frame based on Sub-Advisor's forecast for interest rates. Duration is a measure of the expected life of a fixed-income security that is used to determine the sensitivity of a security's price to changes in interest rates. For example, if the portfolio duration of the Account is three years, a change of 1% in the market's yield results in a change of approximately 3% in the value of the Account's securities. The longer a security's duration, the more sensitive it is to changes in interest rates. An Account with a longer average portfolio duration will be more sensitive to changes in interest rates than an Account with a shorter average portfolio duration. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates. When interest rates rise, the value of fixed-income securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of fixed-income securities. Some fixed-income investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.) DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. COMMODITY-LINKED DERIVATIVE INSTRUMENTS . The use of commodity-linked derivative instruments may subject the Account to greater volatility than investments in traditional securities. The value of commodity-linked derivative 12 Principal Variable Contracts Fund 1-800-247-4123 instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 176.2%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking diversification by investing in a fixed-income mutual fund. Principal Variable Contracts Fund 13 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"2.36 "1997"10.6 "1998"7.69 "1999"-2.59 "2000"8.17 "2001"8.12 "2002"9.26 "2003"4.59 "2004"4.98 The Account's highest/lowest quarterly returns "2005"2.5 during this time period were: HIGHEST Q3 '97 4.37% LOWEST Q1 '96-3.24% LOGO The year-to-date return as of March 31, 2006 is -0.55%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* BOND ACCOUNT ......... 2.50 5.86 5.50 7.69 Lehman Brothers Aggregate Bond Index . 2.43 5.87 6.17 7.78 Morningstar Intermediate-Term Bond Category Average...... 1.79 5.32 5.38 7.11 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (December 18, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.45% Other Expenses................... 0.02% ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.47%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 BOND ACCOUNT $48 $151 $263 $591
14 Principal Variable Contracts Fund 1-800-247-4123 CAPITAL VALUE ACCOUNT The Account seeks to provide long-term capital appreciation and secondarily growth of investment income. MAIN STRATEGIES The Account invests primarily in common stock and other equity securities of large capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with large market capitalizations (those with market capitalizations similar to companies in the Russell 1000/(R)// /Value Index (as of March 31, 2006 this range was between approximately $688 million and $387.4 billion) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Up to 25% of Account assets may be invested in foreign securities. The Account invests in stocks that, in the opinion of the Sub-Advisor, Principal, are undervalued in the marketplace at the time of purchase. Value stocks are often characterized by below average price/earnings ratios (P/E) and above average dividend yields relative to the overall market. Securities for the Account are selected by consideration of the quality and price of individual issuers rather than forecasting stock market trends. The selection process focuses on four key elements: . determination that a stock is selling below its fair market value; . early recognition of changes in a company's underlying fundamentals; . evaluation of the sustainability of fundamental changes; and . by monitoring a stock's behavior in the market, evaluation of the timeliness of the investment. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization value stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Principal Variable Contracts Fund 15 www.principal.com ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 120.9%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks, but who prefer investing in companies that appear to be considered undervalued relative to similar companies. 16 Principal Variable Contracts Fund 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"23.5 "1997"28.53 "1998"13.58 "1999"-4.29 "2000"2.16 "2001"-8.05 "2002"-13.66 "2003"25.49 "2004"12.36 The Account's highest/lowest quarterly returns "2005"6.8 during this time period were: HIGHEST Q2 '03 15.52% LOWEST Q3 '02 -15.10% LOGO The year-to-date return as of March 31, 2006 is 6.07%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT CAPITAL VALUE ACCOUNT 6.80 3.64 7.74 11.92* Russell 1000 Value Index................. 7.05 5.28 10.94 14.32** Morningstar Large Value Category Average 5.88 3.96 8.85 13.21** Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 13, 1970). ** Lifetime results are measured from December 31, 1978 (earliest date for which information is available).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.60% Other Expenses................... 0.01% ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.61%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 CAPITAL VALUE ACCOUNT $62 $195 $340 $762
Principal Variable Contracts Fund 17 www.principal.com DIVERSIFIED INTERNATIONAL ACCOUNT The Account seeks long-term growth of capital by investing in a portfolio of equity securities of companies established outside of the U.S. MAIN STRATEGIES The Account invests in a portfolio of equity securities of companies domiciled in any of the nations of the world. The Account invests in securities of: . companies with their principal place of business or principal office outside the U.S.; . companies for which the principal securities trading market is outside the U.S.; and . companies, regardless of where their securities are traded, that derive 50% or more of their total revenue from goods or services produced or sales made outside the U.S. The Account has no limitation on the percentage of assets that are invested in any one country or denominated in any one currency. However, under normal market conditions, the Account intends to have at least 80% of its assets invested in companies in at least three different countries. One of those countries may be the U.S. though currently the Account does not intend to invest in equity securities of U.S. companies. Investments may be made anywhere in the world. Primary consideration is given to securities of corporations of Western Europe, North America and Australasia (Australia, Japan and Far East Asia). Changes in investments are made as prospects change for particular countries, industries or companies. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. The Account may actively trade securities in an attempt to achieve its investment objective. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as companies in more developed countries. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more 18 Principal Variable Contracts Fund 1-800-247-4123 volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 121.2%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital in markets outside of the U.S. who are able to assume the increased risks of higher price volatility and currency fluctuations associated with investments in international stocks which trade in non-U.S. currencies. Principal Variable Contracts Fund 19 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"25.09 "1997"12.24 "1998"9.98 "1999"25.93 "2000"-8.34 "2001"-24.27 "2002"-16.07 "2003"32.33 "2004"21.03 The Account's highest/lowest quarterly returns "2005"23.79 during this time period were: HIGHEST Q2 '03 17.25% LOWEST Q3 '02 -18.68% LOGO The year-to-date return as of March 31, 2006 is 11.97%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS DIVERSIFIED INTERNATIONAL ACCOUNT. 23.79 4.73 8.43 Citigroup BMI Global ex-US Index/(1)/...... 19.59 8.09 7.79 MSCI EAFE (Europe, Australia, Far East) Index - ND ........... 13.54 4.56 5.84 Morningstar Foreign Large Blend Category Average .............. 14.55 2.93 6.47 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 2, 1994). ** Lifetime results are measured from the Index inception date (December 31, 1994). ///(1)/ This index is now the benchmark against which the Account measures its performance. The Manager and the portfolio manager believe it better represents the universe of investment choices open to the Account under its investment philosophy. The index formerly used is also shown. LIFE OF ACCOUNT* DIVERSIFIED 8.09 INTERNATIONAL ACCOUNT. Citigroup BMI Global 8.02** ex-US Index/(1)/...... MSCI EAFE (Europe, 5.94 Australia, Far East) Index - ND ........... Morningstar Foreign 6.27 Large Blend Category Average .............. Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured f the date the Account was first sold (May 2, 1994). ** Lifetime results are measured the Index inception date (December 31, 1994). ///(1)/ This index is now the benchmark against which the Account measures its performance. The Manager and the portfolio manager believe it better represents the universe of investment choices open to the Account under its investment philosophy. The index formerly used is also shown.
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES
Management Fees.................... 0.85% Other Expenses..................... 0.12 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.97%
(EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005 EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate 20 Principal Variable Contracts Fund 1-800-247-4123 account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES -------------------------------------------------------------------------------------------- 1 3 5 10 DIVERSIFIED INTERNATIONAL ACCOUNT $99 $309 $536 $1,190
Principal Variable Contracts Fund 21 www.principal.com EQUITY GROWTH ACCOUNT The Account seeks to provide long-term capital appreciation by investing primarily in equity securities. MAIN STRATEGIES The Account seeks to maximize long-term capital appreciation by investing primarily in growth-oriented equity securities of U.S. and, to a limited extent, foreign companies that exhibit strong growth and free cash flow potential. These companies are generally characterized as "growth" companies. Under normal market conditions, the Account invests at least 80% of its net assets in equity securities of companies with market capitalizations within the range of companies in the Russell 1000/(R)// /Growth Index (as of March 31, 2006, this range was between approximately $952 million and $368.9 billion) at the time of purchase. The Account's investments in foreign companies will be limited to 25% of its total assets. The Account may also purchase futures and options, in keeping with Account objectives. The Sub-Advisor, T. Rowe Price, generally looks for companies with an above-average rate of earnings and cash flow growth and a lucrative niche in the economy that gives them the ability to sustain earnings momentum even during times of slow economic growth. As a growth investor, T. Rowe Price believes that when a company increases its earnings faster than both inflation and the overall economy, the market will eventually reward it with a higher stock price. In pursuing its investment objective, the Sub-Advisor has the discretion to purchase some securities that do not meet its normal investment criteria, as described above, when it perceives an unusual opportunity for gain. These special situations might arise when the Sub-Advisor believes a security could increase in value for a variety of reasons, including a change in management, an extraordinary corporate event, or a temporary imbalance in the supply of or demand for the securities. The Account may sell securities for a variety of reasons, such as to secure gains, limit losses, or redeploy assets into more promising opportunities. The Account may actively trade securities in an attempt to achieve its investment objective. Futures and options contracts may be bought or sold for any number of reasons, including: to manage exposure to changes in interest rates and foreign currencies; as an efficient means of increasing or decreasing fund overall exposure to a specific part or broad segment of the U.S. or a foreign market; in an effort to enhance income; to protect the value of portfolio securities; and to serve as a cash management tool. Call or put options may be purchased or sold on securities, financial indices, and foreign currencies. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization growth-oriented stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation, making returns more dependent on market increases and decreases. Growth stocks may therefore be more vulnerable than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's 22 Principal Variable Contracts Fund 1-800-247-4123 portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed an Account's initial investment in such contracts. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 51.6%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks that may have greater risks than stocks of companies with lower potential for earnings growth. Principal Variable Contracts Fund 23 www.principal.com T. Rowe Price became the Sub-Advisor to the Account on August 24, 2004. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"28.05 "1997"30.86 "1998"18.95 "1999"39.5 "2000"-11.71 "2001"-14.86 "2002"-27.72 "2003"25.95 "2004"9.33 The Account's highest/lowest quarterly returns "2005"7.55 during this time period were: HIGHESTQ4 '9822.68% LOWEST Q1 '01-18.25% LOGO The year-to-date return as of March 31, 2006 is 1.57%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* EQUITY GROWTH ACCOUNT 7.55 -1.84 8.39 10.89 Russell 1000 Growth Index................. 5.26 -3.58 6.73 9.20 Morningstar Large Growth Category Average .............. 6.46 -3.36 6.95 9.09 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (June 1, 1994).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.76% Other Expenses................... 0.01 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.77%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 EQUITY GROWTH ACCOUNT $79 $246 $428 $954
24 Principal Variable Contracts Fund 1-800-247-4123 EQUITY INCOME ACCOUNT The Account seeks to achieve high current income and long-term growth of income and capital. MAIN STRATEGIES The Account seeks to achieve its objective by investing primarily in equity securities (such as common stocks), preferred securities, shares of real estate investment trusts (REITs) and convertible securities. In selecting securities, the Sub-Advisor, Principal, places an emphasis on securities with potentially high dividend yields. Under normal market conditions, the Account invests at least 80% of its assets in equity securities. The Account may invest up to 25% of its assets in securities of foreign companies. When determining how to invest the Account's assets in equity securities, Principal seeks stocks that it believes are undervalued in the marketplace at the time of purchase. Securities for the Account are selected by consideration of the quality and price of individual issuers rather than forecasting stock market trends. The selection process focuses on: . the determination that a stock is selling below its fair market value; . an early recognition of changes in a company's underlying fundamentals; . an evaluation of the sustainability of fundamental changes; and . monitoring a stock's behavior in the market. In selecting preferred securities for the Account, Principal focuses on the financial services industry (i.e., banking, insurance and commercial finance). For a security to be considered for the Account, Principal will assess the credit risk within the context of the yield available on the preferred security. The Sub-Advisor also may consider whether the companies' securities have a favorable income-paying history and whether income payments are expected to continue to increase. REITs are corporations or business trusts that are permitted to eliminate corporate level federal income taxes by meeting certain requirements of the Internal Revenue Code. In selecting REITs for the Account, Principal focuses on equity REITs which primarily own property and generate revenue from rental income. Principal seeks to diversify the Account's REIT holdings by property types (e.g. apartment REITs, mall REITs, office and industrial REITs). MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. VALUE STOCKS . The Account's potential investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. INTEREST RATE CHANGES . Changes in interest rates may adversely affect the value of an investor's securities. When interest rates rise, the value of preferred securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of preferred securities. Some investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. PREPAYMENT OR CALL RISK . Some investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Principal Variable Contracts Fund 25 www.principal.com Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. EQUITY REITS . Equity REITs are affected by the changes in the value of the properties owned by the trust. In addition, they: . may not be diversified with regard to the types of tenants (thus subject to business developments of the tenant(s)); . may not be diversified with regard to the geographic locations of the properties (thus subject to regional economic developments); and . are subject to cash flow dependency of its tenants. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. INVESTOR PROFILE The Account may be an appropriate investment for investors who seek dividends to generate income or to be reinvested for growth and accept fluctuations in the value of investments. 26 Principal Variable Contracts Fund 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999"2.29 "2000"19.18 "2001"-27.7 "2002"-12.61 "2003"13.83 "2004"17.6 The Account's highest/lowest quarterly returns "2005"8.67 during this time period were: HIGHESTQ3 '0018.18% LOWEST Q3 '01-16.65% LOGO The year-to-date return as of March 31, 2006 is 7.04%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* EQUITY INCOME ACCOUNT ........ 8.67 -1.67 3.40 Russell 1000 Value Index ..... 7.05 5.28 5.69 Morningstar Moderate Allocation Category Average .. 5.29 2.93 4.29 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.60% Other Expenses............................. 0.06 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.66%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 EQUITY INCOME ACCOUNT $67 $211 $368 $822
Principal Variable Contracts Fund 27 www.principal.com GOVERNMENT & HIGH QUALITY BOND ACCOUNT F/K/A GOVERNMENT SECURITIES ACCOUNT The Account seeks a high level of current income, liquidity and safety of principal. MAIN STRATEGIES The Account seeks to achieve its investment objective by investing primarily (at least 80% of its assets) in securities that are issued by the U.S. Government, its agencies or instrumentalities. The Account may invest in mortgage-backed securities representing an interest in a pool of mortgage loans. These securities are rated AAA by Standard & Poor's Corporation or Aaa by Moody's Investor Services, Inc. or, if unrated, determined by the Sub-Advisor, Principal, to be of equivalent quality. The Account relies on the professional judgment of Principal to make decisions about the Account's portfolio securities. The basic investment philosophy of Principal is to seek undervalued securities that represent good long-term investment opportunities. Securities may be sold when Principal believes they no longer represent good long-term value. The Account may also hold cash and cash equivalents. The size of the Account's cash position depends on various factors, including market conditions and purchases and redemptions of Account shares. A large cash position could impact the ability of the Account to achieve its objective but it also would reduce the Account's exposure in the event of a market downturn and provide liquidity to make additional investments or to meet redemptions. The Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income. Under a reverse repurchase agreement, the Account sells securities and agrees to repurchase them at a specified date and price. The Account pays interest on this "secured financing" and attempts to make money on the difference between the financing rate and the interest it earns by investing the proceeds of the financing. While a reverse repurchase agreement is outstanding, the Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account may lend its portfolio securities to brokers, dealers and other financial institutions. In connection with such loans, the Account remains the owner of the loaned securities and continues to be entitled to payments in amounts equal to the interest, dividends or other distributions payable on the loaned securities. Loans of portfolio securities may not exceed 33 1/3% of the value of the Account's total assets (including the value of all assets received as collateral for loan). In connection with such loans the Account will receive collateral from the borrower equal to at least 100% of the value of the loaned securities. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: U.S. GOVERNMENT SECURITIES . U.S. Government securities do not involve the degree of credit risk associated with investments in lower quality fixed-income securities. As a result, the yields available from U.S. Government securities are generally lower than the yields available from many other fixed-income securities. Like other fixed-income securities, the values of U.S. Government securities change as interest rates fluctuate. Fluctuations in the value of the Account's securities do not affect interest income on securities already held by the Account, but are reflected in the Account's price per share. Since the magnitude of these fluctuations generally is greater at times when the Account's average maturity is longer, under certain market conditions the Account may invest in short-term investments yielding lower current income rather than investing in higher yielding longer term securities. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates. When interest rates rise, the value of fixed-income securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of fixed-income securities. Some fixed-income investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. 28 Principal Variable Contracts Fund 1-800-247-4123 CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. U.S. GOVERNMENT SPONSORED SECURITIES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. Prepayments, unscheduled principal payments, may result from voluntary prepayment, refinancing or foreclosure of the underlying mortgage. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates and potentially increasing the volatility of the Account. In addition, prepayments may cause losses on securities purchased at a premium (dollar amount by which the price of the bond exceeds its face value). At times, mortgage-backed securities may have higher than market interest rates and are purchased at a premium. Unscheduled prepayments are made at par and cause the Account to experience a loss of some or all of the premium. DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. REVERSE REPURCHASE AGREEMENTS. . This strategy involves the risk that interest costs on money borrowed may exceed the return on securities purchased with the borrowed money. In addition, reverse repurchase agreements may increase the volatility of the Fund. LENDING OF SECURITIES . If the Account lends its portfolio securities and the borrower of the securities fail financially, the Account may experience delays in recovering the loaned securities or exercising its rights in the collateral. The Account lends its securities only to borrowers that the Sub-Advisor determines are creditworthy. PORTFOLIO DURATION . The average portfolio duration of the Account normally varies within a three- to six-year time frame based on Sub-Advisor's forecast for interest rates. Duration is a measure of the expected life of a fixed-income security that is used to determine the sensitivity of a security's price to changes in interest rates. For example, if the portfolio duration of the Account is three years, a change of 1% in the market's yield results in a change of approximately 3% in the value of the Account's securities. The longer a security's duration, the more sensitive it is to changes in interest rates. An Account with a longer average portfolio duration will be more sensitive to changes in interest rates than an Account with a shorter average portfolio duration. Principal Variable Contracts Fund 29 www.principal.com ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading cost which may have an adverse impact on the Account's performance. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 262.1%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking diversification by investing in a fixed-income mutual fund. 30 Principal Variable Contracts Fund 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"3.35 "1997"10.39 "1998"8.27 "1999"-0.29 "2000"11.4 "2001"7.61 "2002"8.8 "2003"1.84 "2004"3.56 The Account's highest/lowest quarterly returns "2005"2.01 during this time period were: HIGHEST Q2 '97 4.52% LOWEST Q1 '96 -1.90% LOGO The year-to-date return as of March 31, 2006 is -0.45%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* GOVERNMENT & HIGH QUALITY BOND ACCOUNT . 2.01 4.72 5.62 7.30 Lehman Brothers Government/Mortgage Index................. 2.63 5.40 6.01 7.56 Morningstar Intermediate Government Category Average .............. 1.90 4.62 5.12 6.67 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (April 9, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.44% Other Expenses................... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.46%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 GOVERNMENT & HIGH QUALITY BOND ACCOUNT $47 $148 $258 $579
Principal Variable Contracts Fund 31 www.principal.com GROWTH ACCOUNT The Account seeks long-term growth of capital through the purchase primarily of common stocks, but the Account may invest in other securities. MAIN STRATEGIES The Account invests primarily in common stocks and other equity securities of large capitalization companies with strong earnings growth potential. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with large market capitalizations (those with market capitalizations similar to companies in the Russell 1000/(R)/ Growth Index (as of March 31, 2006 this range was between approximately $952 million and $368.9 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. The Sub-Advisor, CCI, uses a bottom-up approach (focusing on individual stock selection rather than forecasting stock market trends) in its selection of individual securities that it believes have an above average potential for earnings growth. Selection is based on the premise that companies doing better than expected will have rising securities prices, while companies producing less than expected results will not. CCI refers to its discipline as positive momentum and positive surprise. Through in-depth analysis of company fundamentals in the context of the prevailing economic environment, CCI seeks to select companies that meet the criteria of positive momentum and positive surprise in reported results. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization growth-oriented stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks that may have greater risks than stocks of companies with lower potential for earnings growth. 32 Principal Variable Contracts Fund 1-800-247-4123 CCI became the Sub-Advisor to the Account on January 5, 2005. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"12.51 "1997"26.96 "1998"21.36 "1999"16.44 "2000"-10.15 "2001"-25.5 "2002"-29.07 "2003"26.46 "2004"9.38 The Account's highest/lowest quarterly returns "2005"12.09 during this time period were: HIGHESTQ4 '9821.35% LOWEST Q1 '01-23.55% LOGO The year-to-date return as of March 31, 2006 is 4.86%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* GROWTH ACCOUNT ....... 12.09 -3.91 4.04 5.97 Russell 1000 Growth Index................. 5.26 -3.58 6.73 9.27 Morningstar Large Growth Category Average .............. 6.46 -3.36 6.95 9.05 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (May 2, 1994).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.60% Other Expenses................... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.62%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 GROWTH ACCOUNT $63 $199 $346 $774
Principal Variable Contracts Fund 33 www.principal.com INTERNATIONAL EMERGING MARKETS ACCOUNT The Account seeks long-term growth of capital by investing primarily in equity securities of issuers in emerging market countries. MAIN STRATEGIES The Account seeks to achieve its objective by investing in common stocks of companies in emerging market countries. For this Account, the term "emerging market country" means any country which is considered to be an emerging country by the international financial community (including the International Bank for Reconstruction and Development (also known as the World Bank) and the International Financial Corporation). These countries generally include every nation in the world except the United States, Canada, Japan, Australia, New Zealand and most nations located in Western Europe. Investing in many emerging market countries is not feasible or may involve unacceptable political risk. Principal, the Sub-Advisor, focuses on those emerging market countries that it believes have strongly developing economies and markets which are becoming more sophisticated. Under normal conditions, at least 80% of the Account's assets are invested in emerging market country equity securities. The Account invests in securities of: . companies with their principal place of business or principal office in emerging market countries; . companies for which the principal securities trading market is an emerging market country; or . companies, regardless of where their securities are traded, that derive 50% or more of their total revenue from either goods or services produced in emerging market countries or sales made in emerging market countries. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. EMERGING MARKET COUNTRIES . Investments in emerging market countries involve special risks. Certain emerging market countries have historically experienced, and may continue to experience, certain economic problems. These may include: high rates of inflation, high interest rates, exchange rate fluctuations, large amounts of debt, balance of payments and trade difficulties, and extreme poverty and unemployment. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect 34 Principal Variable Contracts Fund 1-800-247-4123 against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading cost which may have an adverse impact on the Account's performance. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 169.6%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital in securities of emerging market countries who are able to assume the increased risks of higher price volatility and currency fluctuations associated with investments in international stocks which trade in non-U.S. currencies. Principal Variable Contracts Fund 35 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2001"-4.24 "2002"-7.63 "2003"57.2 "2004"24.89 The Account's highest/lowest quarterly returns "2005"34.29 during this time period were: HIGHESTQ4 '0126.63% LOWEST Q3 '01-23.90% LOGO The year-to-date return as of March 31, 2006 is 15.59%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* INTERNATIONAL EMERGING MARKETS ACCOUNT....... 34.29 18.45 16.31 MSCI Emerging Markets Free Index - NDTR/(1)/ 34.00 19.08 18.64 MSCI Emerging Markets Free Index - ID ...... 30.31 16.23 14.18 Morningstar Diversified Emerging Markets Category Average .............. 31.64 18.59 16.26 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (October 24, 2000). ///(1)/ This index is now the benchmark against which the Account measures its performance. The Manager and portfolio manager believe it better represents the universe of investment choices open to the Account under its investment philosophy. The index formerly used is also shown.
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.25% Other Expenses............................. 0.35 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.60%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate 36 Principal Variable Contracts Fund 1-800-247-4123 account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------- 1 3 5 10 INTERNATIONAL EMERGING MARKETS ACCOUNT $163 $505 $871 $1,900
Principal Variable Contracts Fund 37 www.principal.com INTERNATIONAL SMALLCAP ACCOUNT The Account seeks long-term growth of capital by investing in a portfolio of equity securities of companies established outside of the U.S. MAIN STRATEGIES The Account invests primarily in equity securities of non-U.S. companies with comparatively smaller market capitalizations. Under normal market conditions, the Account invests at least 80% of its assets in securities of companies similar in size to companies included in the Citigroup Extended Market Index (EMI) World ex US (as of March 31, 2006 this range was between approximately $3.3 million and $26.1 billion). Market capitalization is defined as total current market value of a company's outstanding common stock. The Account invests in securities of: . companies with their principal place of business or principal office outside the U.S.; . companies for which the principal securities trading market is outside the U.S.; and . companies, regardless of where their securities are traded, that derive 50% or more of their total revenue from goods or services produced or sales made outside the U.S. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller 38 Principal Variable Contracts Fund 1-800-247-4123 capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 132.3%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital in smaller companies outside of the U.S. who are able to assume the increased risks of higher price volatility and currency fluctuations associated with investments in international stocks which trade in non-U.S. currencies. Principal Variable Contracts Fund 39 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999"93.81 "2000"-11.5 "2001"-21.85 "2002"-16.2 "2003"54.15 "2004"30.2 The Account's highest/lowest quarterly returns "2005"29.12 during this time period were: HIGHESTQ4 '9936.59% LOWEST Q3 '01-21.49% LOGO The year-to-date return as of March 31, 2006 is 15.21%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* INTERNATIONAL SMALLCAP ACCOUNT 29.12 11.16 13.32 Citigroup Extended Market Index (EMI) World ex US ...... 11.70 4.32 9.36 Morningstar Foreign Small/Mid Growth Category Average ...... 24.79 8.46 12.37 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.19% Other Expenses............................. 0.14 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.33%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 INTERNATIONAL SMALLCAP ACCOUNT $135 $421 $729 $1,601
40 Principal Variable Contracts Fund 1-800-247-4123 LARGECAP BLEND ACCOUNT The Account seeks long-term growth of capital. MAIN STRATEGIES The Account pursues its investment objective by investing primarily in equity securities of U.S. companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with large market capitalizations (those with market capitalizations within the range of companies in the Standard & Poor's 500 Stock Index ("S&P 500 Index") (as of March 31, 2006 this range was between approximately $579 million and $371.6 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. The market capitalization of companies in the Account's portfolio and the S&P 500 Index will change over time, and the Account will not automatically sell or cease to purchase a stock of a company it already owns just because the company's market capitalization grows or falls outside of the index range. In addition, the Account has the ability to purchase stocks whose market capitalization falls below the range of companies in the S&P 500 Index. The Account's Sub-Advisor, T. Rowe Price, uses a disciplined portfolio construction process whereby it weights each sector approximately the same as the S&P 500 Index. Individual holdings within each sector, and their weights within the portfolio, can vary substantially from the S&P 500 Index. A team of T. Rowe Price equity analysts is directly responsible for selecting stocks for the Account. Analysts select stocks from the industries they cover based on rigorous fundamental analysis that assesses the quality of the business franchise, earnings growth potential for the company, and stock valuation. The Account seeks to take full advantage of the analysts' focused expertise in their industries. A team of portfolio managers supervises the analysts and has the responsibility for the overall structure of the Account and coordinating Account investments. They also oversee the quantitative analysis that helps the analysts manage their industry-specific portfolios. In pursuing its investment objective, the Account's management has the discretion to purchase some securities that do not meet its normal investment criteria, as described above, when it perceives an unusual opportunity for gain. These special situations might arise when T. Rowe Price believes a security could increase in value for a variety of reasons, including a change in management, an extraordinary corporate event, or a temporary imbalance in the supply of or demand for the securities. The Account will generally remain fully invested (less than 5% cash reserves) and will be sector neutral when compared to the S&P 500 Index. While the majority of assets will be invested in large-capitalization U.S. common stocks, small- and mid-capitalization stocks and foreign stocks (up to 25% of total assets) may also be purchased in keeping with Account objectives. Securities may be sold for a variety of reasons, such as to secure gains, limit losses, or redeploy assets into more promising opportunities. Futures and options contracts may be bought or sold for any number of reasons, including: to manage exposure to changes in interest rates and foreign currencies; as an efficient means of increasing or decreasing fund overall exposure to a specific part or broad segment of the U.S. or a foreign market; in an effort to enhance income; to protect the value of portfolio securities; and to serve as a cash management tool. Call or put options may be purchased or sold on securities, financial indices, and foreign currencies. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's equity securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: Principal Variable Contracts Fund 41 www.principal.com STOCK MARKET VOLATILITY . The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation, making returns more dependent on market increases and decreases. Growth stocks may therefore be more vulnerable than non-growth stocks to market changes. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. SECTOR RISK . The Sub-Advisor may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As the Sub-Advisor allocates more of the Account's portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in an aggressively managed portfolio of common stocks, but who prefer investing in larger, established companies. 42 Principal Variable Contracts Fund 1-800-247-4123 T. Rowe Price became the Sub-Advisor to the Account effective March 9, 2004. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2003"23.76 "2004"10.36 "2005"4.74 The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q2 '03 14.07% LOGO LOWEST Q1 '03 -3.91% The year-to-date return as of March 31, 2006 is 4.21%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF ACCOUNT* LARGECAP BLEND ACCOUNT...................... 4.74 5.31 S&P 500 Index ................... .......... 4.91 5.99 Morningstar Large Blend Category Average ... 5.77 5.57 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 2002).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees...................................... 0.75% Other Expenses....................................... 0.03 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.78%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. This Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 LARGECAP BLEND ACCOUNT $80 $249 $433 $966
Principal Variable Contracts Fund 43 www.principal.com LARGECAP GROWTH EQUITY ACCOUNT The Account seeks to achieve long-term growth of capital. MAIN STRATEGIES The Account invests primarily in common stock of U.S. companies, with a focus on growth stocks. Growth stocks are issues (or securities) that the Sub-Advisor, GMO, believes are fast-growing and whose earnings are believed to likely increase over time. Growth in earnings may lead to an increase in the price of the stock. The Sub-Advisor invests mainly in large companies, although investments can be made in companies of any size. Under normal market conditions, the Account invests at least 80% of its assets in equity securities of companies with large market capitalizations. The Account typically makes equity investments in companies chosen from among the 1,000 U.S. exchange-listed companies with the largest market capitalization. Market capitalization is defined as total current market value of a company's outstanding common stock. In addition, the Account may invest up to 25% of its assets in foreign securities, including American Depository Receipts (ADRs), at the time of purchase. When deciding whether to buy or sell stocks for the Account, GMO considers, among other factors, a company's valuation, financial strength, competitive position in its industry, projected future earnings, cash flows and dividends. In addition to the main investment strategies described above, GMO may make other investments, such as investments in preferred stocks, convertible securities and debt instruments. These investments may be subject to other risks as described later in this prospectus and/or the Statement of Additional Information. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization growth-oriented stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. INTEREST RATE CHANGES . Changes in interest rates may adversely affect the value of an investor's securities. When interest rates rise, the value of preferred securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of preferred securities. Some investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. 44 Principal Variable Contracts Fund 1-800-247-4123 INVESTOR PROFILE The Account may be an appropriate investment for investors who are seeking long-term growth and are willing to accept the potential for short-term, volatile fluctuations in the value of their investment. This Account is designed as a long-term investment with growth potential. Principal Variable Contracts Fund 45 www.principal.com GMO became the Sub-Advisor to the Account on March 31, 2004. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2001"-30.08 "2002"-33.27 "2003"23.14 "2004"3.16 The Account's highest/lowest quarterly returns "2005"3.63 during this time period were: HIGHESTQ4 '0112.16% LOWEST Q3 '01-21.14% LOGO The year-to-date return as of March 31, 2006 is 1.26%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* LARGECAP GROWTH EQUITY ACCOUNT 3.63 -9.29 -13.27 Russell 1000 Growth Index .... 5.26 -3.58 -6.99 Morningstar Large Growth Category Average.............. 6.46 -3.36 -5.29 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (October 24, 2000).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.00% Other Expenses............................. 0.09% ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.09%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------- 1 3 5 10 LARGECAP GROWTH EQUITY ACCOUNT $111 $347 $601 $1,329
46 Principal Variable Contracts Fund 1-800-247-4123 LARGECAP STOCK INDEX ACCOUNT The Account seeks long-term growth of capital. MAIN STRATEGIES Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies that compose the Standard & Poor's ("S&P") 500 Index. The Sub-Advisor, Principal, attempts to mirror the investment performance of the Index by allocating the Account's assets in approximately the same weightings as the S&P 500. The S&P 500 is an unmanaged index of 500 common stocks chosen to reflect the industries of the U.S. economy and is often considered a proxy for the stock market in general. Each stock is weighted by its market capitalization which means larger companies have greater representation in the Index than smaller ones. As of March 31, 2006, the market capitalization range of the Index was between approximately $579 million and $371.6 billion. Over the long-term, Principal seeks a very close correlation between performance of the Account, before expenses, and that of the S&P 500. It is unlikely that a perfect correlation of 1.00 will be achieved. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. Because of the difficulty and expense of executing relatively small stock trades, the Account may not always be invested in the less heavily weighted S&P 500 stocks. At times, the Account's portfolio may be weighted differently from the S&P 500, particularly if the Account has a small level of assets to invest. In addition, the Account's ability to match the performance of the S&P 500 is affected to some degree by the size and timing of cash flows into and out of the Account. The Account is managed to attempt to minimize such effects. Principal reserves the right to omit or remove any of the S&P 500 stocks from the Account if it determines that the stock is not sufficiently liquid. In addition, a stock might be excluded or removed from the Account if extraordinary events or financial conditions lead Principal to believe that it should not be a part of the Account's assets. Principal may also elect to omit any S&P 500 stocks from the Account if such stocks are issued by an affiliated company. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's equity securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth stocks typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. Principal Variable Contracts Fund 47 www.principal.com INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital, willing to accept the potential for volatile fluctuations in the value of investments and preferring a passive, rather than active, management style. NOTE: "Standard & Poor's 500" and "S&P 500/(R)/" are trademarks of The McGraw-Hill Companies, Inc. and have been licensed by the Manager. The Account is not sponsored, endorsed, sold or promoted by Standard and Poor's and Standard & Poor's makes no representation regarding the advisability of investing in the Account. 48 Principal Variable Contracts Fund 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2000"-9.67 "2001"-12.1 "2002"-22.44 "2003"28.32 "2004"10.39 The Account's highest/lowest quarterly returns "2005"4.47 during this time period were: HIGHEST Q2 '03 15.28% LOWEST Q3 '02 -17.27% LOGO The year-to-date return as of March 31, 2006 is 4.17%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* LARGECAP STOCK INDEX ACCOUNT . 4.47 0.18 -0.11 S&P 500 Index ................ 4.91 0.54 0.54 Morningstar Large Blend Category Average.............. 5.77 0.50 1.55 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 3, 1999).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees ................. ......... 0.25%* Other Expenses .................. ......... 0.03 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.28% *Effective January 1, 2006.
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 LARGECAP STOCK INDEX ACCOUNT $29 $90 $157 $356
Principal Variable Contracts Fund 49 www.principal.com LARGECAP VALUE ACCOUNT The Account seeks long-term growth of capital. MAIN STRATEGIES The Account invests primarily in undervalued equity securities of companies among the 750 largest by market capitalization that the Sub-Advisor, AllianceBernstein, believes offer above-average potential for growth in future earnings. Under normal market conditions, the Account generally invests at least 80% of its assets in companies with large market capitalizations (those with market capitalizations similar to companies in the Russell 1000/(R)/ Value Index (as of March 31, 2006, this range was between approximately $688 million and $387.4 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. The Account may invest up to 25% of its assets in securities of foreign companies. AllianceBernstein employs an investment strategy, generally described as "value" investing, that involves seeking securities that: . exhibit low financial ratios (particularly stock price-to-book value (liquidation value), but also stock price-to-earnings and stock price-to-cash flow); . can be acquired for less than what AllianceBernstein believes is the issuer's intrinsic value; or . whose price appears attractive relative to the value of the dividends expected to be paid by the issuer in the future. Value oriented investing entails a strong "sell discipline" in that it generally requires the sale of securities that have reached their intrinsic value or a target financial ratio. Value oriented investments may include securities of companies in cyclical industries during periods when such securities appear to AllianceBernstein to have strong potential for capital appreciation or securities of "special situation" companies. A special situation company is one that AllianceBernstein believes has potential for significant future earnings growth but has not performed well in the recent past. These situations include companies with management changes, corporate or asset restructuring or significantly undervalued assets. For AllianceBernstein, identifying special situation companies and establishing an issuer's intrinsic value involves fundamental research about such companies and issuers. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization value stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks but who prefer investing in companies that appear to be considered undervalued relative to similar companies. 50 Principal Variable Contracts Fund 1-800-247-4123 AllianceBernstein has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2003"28.05 "2004"13.09 "2005"5.44 The Account's highest/lowest quarterly returns during this time period were: HIGHEST Q2 '03 16.19% LOGO LOWEST Q1 '03 -5.04% The year-to-date return as of March 31, 2006 is 5.20%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF ACCOUNT* LARGECAP VALUE ACCOUNT...................... 5.44 7.63 Russell 1000 Value Index ........ .......... 7.05 8.81 Morningstar Large Value Category Average ... 5.88 6.76 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 2002).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees...................................... 0.75% Other Expenses....................................... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.77%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 LARGECAP VALUE ACCOUNT $79 $246 $428 $954
Principal Variable Contracts Fund 51 www.principal.com MIDCAP ACCOUNT The Account seeks to achieve capital appreciation by investing primarily in securities of emerging and other growth-oriented companies. MAIN STRATEGIES The Account invests primarily in common stocks and other equity securities of medium capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with medium market capitalizations (those with market capitalizations similar to companies in the Russell MidCap/(R)/ Index (as of March 31, 2006, this range was between approximately $688 million and $22.1 billion) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Up to 25% of Account assets may be invested in foreign securities. In selecting securities for investment, the Sub-Advisor, Principal, looks at stocks with value and/or growth characteristics and constructs an investment portfolio that has a "blend" of stocks with these characteristics. In managing the assets of the Account, Principal does not have a policy of preferring one of these categories to the other. The value orientation emphasizes buying stocks at less than their inherent value and avoiding stocks whose price has been artificially built up. The growth orientation emphasizes buying stocks of companies whose potential for growth of capital and earnings is expected to be above average. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. MAIN RISKS The Account is subject to the risk that its principal market segment, medium capitalization stocks, may underperform compared to other market segments or to the equity markets as a whole. Because different types of stocks tend to shift in and out of favor depending on market and economic conditions, the Account's performance may sometimes be lower or higher than that of other types of funds. The value of the Account's equity securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. 52 Principal Variable Contracts Fund 1-800-247-4123 MEDIUM CAPITALIZATIONS . Companies with medium capitalizations may have a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the potential for short-term fluctuations in the value of investments. Principal Variable Contracts Fund 53 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"21.11 "1997"22.75 "1998"3.69 "1999"13.04 "2000"14.59 "2001"-3.71 "2002"-8.75 "2003"32.81 "2004"17.76 The Account's highest/lowest quarterly returns "2005"9.21 during this time period were: HIGHESTQ4 '9923.31% LOWEST Q3 '98-20.01% LOGO The year-to-date return as of March 31, 2006 is 4.55%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* MIDCAP ACCOUNT ....... 9.21 8.46 11.60 14.11 Russell Midcap Index . 12.65 8.45 12.49 14.57 Morningstar Mid-Cap Blend Category Average 9.21 8.14 11.74 14.12 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (December 18, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.57% Other Expenses................... 0.01 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.58%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MIDCAP ACCOUNT $59 $186 $324 $726
54 Principal Variable Contracts Fund 1-800-247-4123 MIDCAP GROWTH ACCOUNT The Account seeks long-term growth of capital. MAIN STRATEGIES Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with medium market capitalization (those with market capitalizations similar to companies in the Russell Midcap/(R)/ Growth Index (as of March 31, 2006, this range was between approximately $952 million and $21.9 billion)) at the time of purchase. In the view of the Sub-Advisor, Mellon Equity, many medium-sized companies: . are in fast growing industries; . offer superior earnings growth potential; and . are characterized by strong balance sheets and high returns on equity. The Account may also hold investments in large and small capitalization companies, including emerging and cyclical growth companies. The Account may invest up to 25% of its net assets in securities of foreign companies, including securities of issuers in emerging countries and securities quoted in foreign currencies. Mellon Equity uses valuation models designed to identify common stocks of companies that have demonstrated consistent earnings momentum and delivered superior results relative to market analyst expectations. Other considerations include profit margins, growth in cash flow and other standard balance sheet measures. The securities held are generally characterized by strong earnings momentum measures and higher expected earnings per share growth. The valuation model incorporates information about the relevant criteria as of the most recent period for which data are available. Once ranked, the securities are categorized under the headings "buy," "sell" or "hold." The decision to buy, sell or hold is made by Mellon Equity based primarily on output of the valuation model. However, that decision may be modified due to subsequently available or other specific relevant information about the security. In addition, Mellon Equity manages risk by diversifying across companies and industries, limiting the potential adverse impact from any one stock or industry. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. MEDIUM CAPITALIZATIONS . Companies with medium capitalizations may have a limited operating history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency Principal Variable Contracts Fund 55 www.principal.com exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. EMERGING MARKET COUNTRIES . Investments in emerging market countries involve special risks. Certain emerging market countries have historically experienced, and may continue to experience, certain economic problems. These may include: high rates of inflation, high interest rates, exchange rate fluctuations, large amounts of debt, balance of payments and trade difficulties, and extreme poverty and unemployment. FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are denominated in foreign currencies, the value of the net assets of the Account as measured in U.S. dollars will be affected by changes in exchange rates. To protect against future uncertainties in foreign currency exchange rates, the Account is authorized to enter into certain foreign currency exchange transactions. In addition, the Account's foreign investments may be less liquid and their price more volatile than comparable investments in U.S. securities. Settlement periods may be longer for foreign securities and portfolio liquidity may be affected. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth and willing to accept the potential for short-term fluctuations in the value of their investments. 56 Principal Variable Contracts Fund 1-800-247-4123 Mellon Equity has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999"10.67 "2000"8.1 "2001"-16.92 "2002"-26.27 "2003"40.58 "2004"11.82 The Account's highest/lowest quarterly returns "2005"13.72 during this time period were: HIGHESTQ4 '0124.12% LOWEST Q3 '01-25.25% LOGO The year-to-date return as of March 31, 2006 is 7.08%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* MIDCAP GROWTH ACCOUNT ........ 13.72 1.83 3.12 Russell Midcap Growth Index .. 12.10 1.38 5.30 Morningstar Mid-Cap Growth Category Average.............. 9.70 0.01 6.65 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.90% Other Expenses............................. 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.92%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MIDCAP GROWTH ACCOUNT $94 $293 $509 $1,131
Principal Variable Contracts Fund 57 www.principal.com MIDCAP VALUE ACCOUNT The Account seeks long-term growth of capital by investing primarily in equity securities of companies with value characteristics and market capitalizations. MAIN STRATEGIES The Account invests primarily in common stocks of medium capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with a medium market capitalization (those with market capitalizations similar to companies in the Russell Midcap/(R)/ Value Index (as of March 31, 2006, this range was between approximately $688 million and $22.1 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Companies may range from the well-established and well known to the new and unseasoned. The Account may invest up to 25% of its assets in securities of foreign companies. The stocks are selected using a value oriented investment approach by Neuberger Berman, the Sub-Advisor. Neuberger Berman identifies value stocks in several ways. Factors it considers in identifying value stocks may include: . strong fundamentals, such as a company's financial, operational and competitive positions; . consistent cash flow; and . a sound earnings record through all phases of the market cycle. Neuberger Berman may also look for other characteristics in a company, such as a strong position relative to competitors, a high level of stock ownership among management, and a recent sharp decline in stock price that appears to be the result of a short-term market overreaction to negative news. Neuberger Berman believes that, over time, securities that are undervalued are more likely to appreciate in price and are subject to less risk of price decline than securities whose market prices have already reached their perceived economic value. This approach also involves selling portfolio securities when Neuberger Berman believes they have reached their potential, when the securities fail to perform as expected or when other opportunities appear more attractive. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. MEDIUM CAPITALIZATIONS . Companies with medium capitalizations may have a limited operating history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency 58 Principal Variable Contracts Fund 1-800-247-4123 exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth and willing to accept short-term fluctuations in the value of investments. Principal Variable Contracts Fund 59 www.principal.com Neuberger Berman has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2000"31.03 "2001"-2.58 "2002"-9.96 "2003"36.49 "2004"22.67 The Account's highest/lowest quarterly returns "2005"10.55 during this time period were: HIGHEST Q2 '03 14.93% LOWEST Q3 '02 -14.54% LOGO The year-to-date return as of March 31, 2006 is 4.70%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* MIDCAP VALUE ACCOUNT ......... 10.55 10.18 13.65 Russell Midcap Value Index ... 12.65 12.21 10.93 Morningstar Mid-Cap Value Category Average.............. 8.41 9.36 10.54 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 3, 1999).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees ................. ......... 1.05% Other Expenses .................. ......... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.07%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MIDCAP VALUE ACCOUNT $109 $340 $590 $1,306
60 Principal Variable Contracts Fund 1-800-247-4123 MONEY MARKET ACCOUNT The Account has an investment objective of as high a level of current income available from investments in short-term securities as is consistent with preservation of principal and maintenance of liquidity. MAIN STRATEGIES The Account invests its assets in a portfolio of high quality, short-term money market instruments. The investments are U.S. dollar denominated securities which the Sub-Advisor, Principal, believes present minimal credit risks. At the time the Account purchases each security, it is an "eligible security" as defined in the regulations issued under the Investment Company Act of 1940, as amended. The Account maintains a dollar weighted average portfolio maturity of 90 days or less. It intends to hold its investments until maturity. However, the Account may sell a security before it matures: . to take advantage of market variations; . to generate cash to cover sales of Account shares by its shareholders; or . upon revised credit opinions of the security's issuer. The sale of a security by the Account before maturity may not be in the best interest of the Account. The sale of portfolio securities is usually a taxable event. The Account does have an ability to borrow money to cover the redemption of Account shares. It is the policy of the Account to be as fully invested as possible to maximize current income. Securities in which the Account invests include: . securities issued or guaranteed by the U.S. government, including treasury bills, notes and bonds; . securities issued or guaranteed by agencies or instrumentalities of the U.S. government. These are backed either by the full faith and credit of the U.S. government or by the credit of the particular agency or instrumentality; . bank obligations including: . certificates of deposit which generally are negotiable certificates against funds deposited in a commercial bank; or . bankers acceptances which are time drafts drawn on a commercial bank, usually in connection with international commercial transactions. . commercial paper which is short-term promissory notes issued by U.S. or foreign corporations primarily to finance short-term credit needs; . corporate debt consisting of notes, bonds or debentures which at the time of purchase by the Account has 397 days or less remaining to maturity; . repurchase agreements under which securities are purchased with an agreement by the seller to repurchase the security at the same price plus interest at a specified rate. Generally these have a short maturity (less than a week) but may also have a longer maturity; and . taxable municipal obligations which are short-term obligations issued or guaranteed by state and municipal issuers which generate taxable income. Among the certificates of deposit typically held by the Account are Eurodollar and Yankee obligations which are issued in U.S. dollars by foreign banks and foreign branches of U.S. banks. Before the Sub-Advisor selects a Eurodollar or Yankee obligation, however, the foreign issuer undergoes the same credit-quality analysis and tests of financial strength as an issuer of domestic securities. MAIN RISKS As with all mutual funds, the value of the Account's assets may rise or fall. Although the Account seeks to preserve the value of an investment at $1.00 per share, it is possible to lose money by investing in the Account. An investment in the Account is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. As with any security, the securities in which the Account invests have associated risks. These include risks of: CREDIT RISK . Credit risk pertains to the issuer's ability to make scheduled principal or interest payments. This may reduce the Account's stream of income and decrease the Account's yield. Principal Variable Contracts Fund 61 www.principal.com INTEREST RATE RISK . The value of the Account's shares is directly impacted by trends in interest rates. If interest rates rise, the value of debt securities generally will fall. REPURCHASE AGREEMENTS . The Account may invest in repurchase agreements with commercial banks, brokers and dealers considered by the Sub-Advisor to be creditworthy. Default or insolvency of the other party is a potential risk to the Account. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in securities issued by government-sponsored enterprises. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. EURODOLLAR AND YANKEE OBLIGATIONS . Eurodollar and Yankee obligations have risks similar to U.S. money market instruments, such as income risk and credit risk. Other risks of Eurodollar and Yankee obligations include the possibilities that: a foreign government will not let U.S. dollar-denominated assets leave the country; the banks that issue Eurodollar obligations may not be subject to the same regulations as U.S. banks; and adverse political or economic developments will affect investments in a foreign country. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking monthly dividends without incurring much principal risk. 62 Principal Variable Contracts Fund 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"5.07 "1997"5.04 "1998"5.2 "1999"4.84 "2000"6.07 "2001"3.92 "2002"1.42 "2003"0.74 "2004"0.92 "2005"2.69 TO OBTAIN THE ACCOUNT'S CURRENT YIELD INFORMATION, PLEASE CALL 1-800-247-4123 LOGO The year-to-date return as of March 31, 2006 is 1.00%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* Money Market Account . 2.69 1.93 3.60 3.15 *Lifetime results are measured from the date the Account was first sold (March 18, 1983).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.49% Other Expenses................... 0.12 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.61%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MONEY MARKET ACCOUNT $62 $195 $340 $762
Principal Variable Contracts Fund 63 www.principal.com REAL ESTATE SECURITIES ACCOUNT The Account seeks to generate a total return by investing primarily in equity securities of companies principally engaged in the real estate industry. MAIN STRATEGIES Under normal market conditions, the Account invests at least 80% of its net assets in equity securities of companies principally engaged in the real estate industry. For purposes of the Account's investment policies, a real estate company has at least 50% of its assets, income or profits derived from products or services related to the real estate industry. Real estate companies include real estate investment trusts and companies with substantial real estate holdings such as paper, lumber, hotel and entertainment companies. Companies whose products and services relate to the real estate industry include building supply manufacturers, mortgage lenders and mortgage servicing companies. Real estate investment trusts ("REITs") are corporations or business trusts that are permitted to eliminate corporate level federal income taxes by meeting certain requirements of the Internal Revenue Code. REITs are characterized as: . equity REITs, which primarily own property and generate revenue from rental income; . mortgage REITs, which invest in real estate mortgages; and . hybrid REITs, which combine the characteristics of both equity and mortgage REITs. In selecting securities for the Account, the Sub-Advisor focuses on equity REITs. The Account may invest up to 25% of its assets in securities of foreign real estate companies. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SECTOR RISK . Because the Account invests at least 80% of its net assets in securities of companies principally engaged in the real estate industry, the Account is also subject to sector risk; that is, the possibility that the real estate sector may underperform other sectors or the market as a whole. As more of the Account's portfolio holdings to the real estate sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. The share price of the Account may fluctuate more widely than the value of shares of a fund that invests in a broader range of industries. Securities of real estate companies are subject to securities market risks as well as risks similar to those of direct ownership of real estate. These include: . declines in the value of real estate . risks related to general and local economic conditions . dependency on management skills . heavy cash flow dependency . possible lack of available mortgage funds . overbuilding . extended vacancies in properties . increases in property taxes and operating expenses . changes in zoning laws . expenses incurred in the cleanup of environmental problems . casualty or condemnation losses . changes in interest rates 64 Principal Variable Contracts Fund 1-800-247-4123 In addition to the risks listed above, equity REITs are affected by the changes in the value of the properties owned by the trust. Mortgage REITs are affected by the quality of the credit extended. Both equity and mortgage REITs: . may not be diversified with regard to the types of tenants (thus subject to business developments of the tenant(s)); . may not be diversified with regard to the geographic locations of the properties (thus subject to regional economic developments); and . are subject to cash flow dependency of its tenants. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. INVESTOR PROFILE The Account may be an appropriate investment for investors who seek a total return, want to invest in companies engaged in the real estate industry and accept the potential for volatile fluctuations in the value of investments. Principal Variable Contracts Fund 65 www.principal.com Principal REI has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999"-4.48 "2000"30.97 "2001"8.75 "2002"7.72 "2003"38.91 "2004"34.53 The Account's highest/lowest quarterly returns "2005"15.85 during this time period were: HIGHEST Q4 '04 17.84% LOWEST Q3 '99-8.40% LOGO The year-to-date return as of March 31, 2006 is 16.34%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* REAL ESTATE SECURITIES ACCOUNT 15.85 20.46 15.23 MSCI US REIT Index ........... 12.52 18.80 12.60 Morningstar Specialty - Real Estate Category Average ...... 11.59 18.58 12.68 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.88% Other Expenses............................. 0.01 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.89%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ------------------------------------------------------------------------------------------ 1 3 5 10 REAL ESTATE SECURITIES ACCOUNT $91 $284 $493 $1,096
66 Principal Variable Contracts Fund 1-800-247-4123 SHORT-TERM BOND ACCOUNT F/K/A LIMITED TERM BOND ACCOUNT The Account seeks to provide current income. MAIN STRATEGIES The Account invests primarily in short-term fixed-income securities. Under normal circumstances, the Account maintains a dollar-weighted effective maturity of not more than three years. In determining the average effective maturity of the Fund's assets, the maturity date of a callable security or prepayable securities may be adjusted to reflect the judgment of Principal, the Sub-Advisor, regarding the likelihood of the security being called or prepaid. The Account considers the term "bond" to mean any debt security. Under normal circumstances, it invests at least 80% of its assets in: . securities issued or guaranteed by the U.S. government or its agencies or instrumentalities; . debt securities of U.S. issuers rated in the three highest grades by Standard & Poor's Rating Service or Moody's Investors Service, Inc. or, if unrated, in the opinion of the Sub-Advisor, Principal, of comparable quality; and . mortgage-backed securities representing an interest in a pool of mortgage loans. The rest of the Account's assets may be invested in a variety of financial instruments, including securities in the fourth highest rating category or their equivalent. Securities in the fourth highest category are "investment grade." While they are considered to have adequate capacity to pay interest and repay principal, they do have speculative characteristics. Changes in economic and other conditions are more likely to affect the ability of the issuer to make principal and interest payments than is the case with issuers of higher rated securities. The Account may invest up to 15% of its assets in below-investment-grade fixed-income securities. Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (please see "High Yield Securities" in the section of the prospectus entitled "Certain Investment Strategies and Related Risks) The Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income. Under a reverse repurchase agreement, the Account sells securities and agrees to repurchase them at a specified date and price. The Account pays interest on this "secured financing" and attempts to make money on the difference between the financing rate and the interest it earns by investing the proceeds of the financing. While a reverse repurchase agreement is outstanding, the Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account may lend its portfolio securities to brokers, dealers and other financial institutions. In connection with such loans, the Account remains the owner of the loaned securities and continues to be entitled to payments in amounts equal to the interest, dividends or other distributions payable on the loaned securities. Loans of portfolio securities may not exceed 33 1/3% of the value of the Account's total assets (including the value of all assets received as collateral for loan). In connection with such loans the Account will receive collateral from the borrower equal to at least 100% of the value of the loaned securities. MAIN RISKS As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates. When interest rates rise, the value of fixed-income securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of fixed-income securities. Some fixed-income investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. Principal Variable Contracts Fund 67 www.principal.com CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. PORTFOLIO DURATION. . The average portfolio duration of the Account normally is less than three years and is based on Principal's forecast for interest rates. Duration is a measure of the expected life of a fixed-income security that is used to determine the sensitivity of a security's price to changes in interest rates. For example, if the portfolio duration of the Account is three years, a change of 1% in the market's yield results in a change of approximately 3% in the value of the Account's securities. The longer a security's duration, the more sensitive it is to changes in interest rates. An Account with a longer average portfolio duration will be more sensitive to changes in interest rates than an Account with a shorter average portfolio duration. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates. This may increase the volatility of the Account. REVERSE REPURCHASE AGREEMENTS. . This strategy involves the risk that interest costs on money borrowed may exceed the return on securities purchased with the borrowed money. In addition, reverse repurchase agreements may increase the volatility of the Fund. LENDING OF SECURITIES . If the Account lends its portfolio securities and the borrower of the securities fail financially, the Account may experience delays in recovering the loaned securities or exercising its rights in the collateral. Loans are made only to borrowers that are deemed by the Sub-Advisor to be of good financial standing. HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade are commonly referred to as junk bonds or high yield securities. These securities offer a higher yield than other, higher rated securities, but they carry a greater degree of risk and are considered speculative by the major credit rating agencies. (Please see High Yield Securities in the section of the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.) DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. COMMODITY-LINKED DERIVATIVE INSTRUMENTS . The use of commodity-linked derivative instruments may subject the Account to greater volatility than investments in traditional securities. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-- 68 Principal Variable Contracts Fund 1-800-247-4123 Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking diversification by investing in a fixed-income mutual fund. Principal Variable Contracts Fund 69 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"2004"1.3 "2005"1.8 The Account's highest/lowest quarterly returns LOGO during this time period were: HIGHEST Q1 '04 1.50% LOWEST Q2 '04 -1.58% The year-to-date return as of March 31, 2006 is 0.28%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR LIFE OF ACCOUNT* SHORT-TERM BOND ACCOUNT .................... 1.80 1.46 Lehman Brothers Mutual Fund 1-5 Gov't/Credit Index ...................................... 1.44 1.87 Morningstar Short-Term Bond Category Average 1.43 1.64 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 2003).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees...................................... 0.50% Other Expenses....................................... 0.07 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.57%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ---------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SHORT-TERM BOND ACCOUNT $58 $183 $318 $714
70 Principal Variable Contracts Fund 1-800-247-4123 SMALLCAP ACCOUNT The Account seeks long-term growth of capital by investing primarily in equity securities of companies with comparatively small market capitalizations. MAIN STRATEGIES The Account invests primarily in common stocks of small capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with small market capitalizations (those with market capitalizations similar to companies in the Russell 2000/(R)/ Index (as of March 31, 2006, this range was between approximately $23 million and $5.4 billion)) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. The Account may invest up to 25% of its assets in securities of foreign companies. In selecting securities for investment, the Sub-Advisor, Principal, looks at stocks with value and/or growth characteristics and constructs an investment portfolio that has a "blend" of stocks with these characteristics. In managing the assets of the Account, Principal does not have a policy of preferring one of these categories to the other. The value orientation emphasizes buying stocks at less than their investment value and avoiding stocks whose price has been artificially built up. The growth orientation emphasizes buying stocks of companies whose potential for growth of capital and earnings is expected to be above average. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. Principal may purchase securities issued as part of, or a short period after, companies' initial public offerings ("IPOs"), and may at times dispose of those shares shortly after their acquisition. MAIN RISKS The Account's share price may fluctuate more than that of funds primarily invested in stocks of mid-sized and large companies and may underperform as compared to the securities of larger companies. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. MEDIUM CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. Principal Variable Contracts Fund 71 www.principal.com VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments, may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 125.8%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the potential for volatile fluctuations in the value of investments. 72 Principal Variable Contracts Fund 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999 "43.58 "2000"-11.73 "2001 "2.55 "2002"-27.33 "2003 "36.82 "2004 "19.82 The Account's highest/lowest quarterly returns "2005 "7.04 during this time period were: HIGHESTQ2 '9926.75% LOWEST Q3 '01-25.61% LOGO The year-to-date return as of March 31, 2006 is 11.13%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* SMALLCAP ACCOUNT ............. 7.04 5.51 3.66 Russell 2000 Index ........... 4.55 8.22 5.77 Morningstar Small Blend Category Average.............. 6.62 9.89 8.23 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 0.85% Other Expenses............................. 0.03 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.88%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SMALLCAP ACCOUNT $90 $281 $488 $1,084
Principal Variable Contracts Fund 73 www.principal.com SMALLCAP GROWTH ACCOUNT The Account seeks long-term growth of capital. The Manager has selected UBS Global AM and Emerald as Sub-Advisors to the Account. MAIN STRATEGIES The Account pursues its investment objective by investing primarily in equity securities. Under normal market conditions, the Account invests at least 80% of its assets in equity securities of companies with small market capitalizations (those with market capitalizations equal to or smaller than the greater of 1) $2.5 billion or 2) the highest market capitalization of the companies in the Russell 2000/(R)/ Growth Index at the time of purchase (as of March 31, 2005, this range was between approximately $23 million and $5.4 billion)). Market capitalization is defined as total current market value of a company's outstanding common stock. The Account may invest up to 25% of its assets in securities of foreign companies. UBS Global AM seeks to invest in companies that possess dominant market positions or franchises, a major technical edge, or a unique competitive advantage. To this end, UBS Global AM considers earnings revision trends, positive stock price momentum and strong fundamentals when selecting securities. The Account may also invest in securities of emerging growth companies which are companies that UBS Global AM expects to experience above average earnings or cash flow growth or meaningful changes in underlying asset values. Investments in equity securities may include common stock and preferred stock. Utilizing fundamental analysis, Emerald seeks to invest in the common stock of companies with distinct competitive advantages, strong management teams, leadership positions, high revenue and earnings growth rates versus peers, differentiated growth drivers and limited sell-side research. The Account may purchase securities issued as part of, or a short period after, companies' initial public offerings and may at times dispose of those shares shortly after their acquisition. The Manager may, from time-to-time, reallocate Account assets among the Sub-Advisors. The decision to do so may be based on a variety of factors, including but not limited to: the investment capacity of each Sub-Advisor, portfolio diversification, volume of net cash flows, fund liquidity, investment performance, investment strategies, changes in each Sub-Advisor's firm or investment professionals, or changes in the number of Sub-Advisors. Ordinarily, reallocations of Account assets among Sub-Advisors will occur as a Sub-Advisor liquidates assets in the normal course of portfolio management and with net new cash flows; however, at times reallocations may occur by transferring assets in cash or in kind among Sub-Advisors. MAIN RISKS The Account's share price may fluctuate more than that of funds primarily invested in stocks of mid-sized and large companies and may underperform as compared to the securities of larger companies. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operation history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities which may be more volatile in price than larger company securities, especially over the short-term. GROWTH STOCKS . Because growth securities typically do not make dividend payments to shareholders, investment returns are based on capital appreciation making returns more dependent on market increases and decreases. Growth stocks may therefore be more volatile than non-growth stocks to market changes. 74 Principal Variable Contracts Fund 1-800-247-4123 SECTOR RISK . UBS Global AM may group companies with similar characteristics into broad categories called sectors. Therefore, the Account is also subject to sector risk; that is, the possibility that a certain sector may underperform other sectors or the market as a whole. As UBS Global AM allocates more of the Account's portfolio holdings to a particular sector, the Account's performance will be more susceptible to any economic, business or other developments that generally affect that sector. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Emerging market countries and companies doing business in emerging market countries may not have the same range of opportunities as more developed countries companies in more developed countries . INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks that may have greater risks than stocks of companies with lower potential for earnings growth. Principal Variable Contracts Fund 75 www.principal.com UBS Global AM became the Sub-Advisor to the Account on October 1, 2002. On August 24, 2004, Emerald also became Sub-Advisor to the Account. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999 "95.69 "2000"-13.91 "2001"-32.01 "2002"-45.85 "2003 "45.64 The Account's highest/lowest quarterly returns "2004"11.24 during this time period were: HIGHESTQ4 '9959.52% LOWEST Q3 '01-37.66% LOGO The year-to-date return as of March 31, 2006 is 13.41%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* SMALLCAP GROWTH ACCOUNT ...... 6.67 -8.64 1.29 Russell 2000 Growth Index .... 4.15 2.28 1.46 Morningstar Small Growth Category Average.............. 5.74 2.17 6.26 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.00% Other Expenses............................. 0.05 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.05%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SMALLCAP GROWTH ACCOUNT $107 $334 $579 $1,283
76 Principal Variable Contracts Fund 1-800-247-4123 SMALLCAP VALUE ACCOUNT The Account seeks long-term growth of capital. The Manager has selected Mellon Equity and Morgan as Sub-Advisors to the Account. MAIN STRATEGIES The Account invests primarily in a diversified group of equity securities of U.S. companies with small market capitalizations (those with market capitalizations similar to companies in the Russell 2000/(R)/ Value Index (as of March 31, 2006, this range was between approximately $29 million and $4.2 billion)) at the time of purchase. Under normal market conditions, the Account invests at least 80% of its assets in equity securities of such companies. Emphasis is given to those companies that exhibit value characteristics. Value securities generally have above average dividend yield and below average price to earnings (P/E) ratios. Up to 25% of the Account's assets may be invested in foreign securities. The Sub-Advisor, Morgan, uses quantitative and fundamental research, systematic stock valuation and a disciplined portfolio construction process. It seeks to enhance returns and reduce the volatility in the value of the Account relative to that of the U.S. small company value universe, represented by the Russell 2000/(R)/ Value Index. Morgan continuously screens the small company universe to identify for further analysis those companies that exhibit favorable factor rankings. Such factors include various valuation and momentum measures. Morgan ranks these companies within economic sectors according to their relative attractiveness. Morgan then selects for purchase the companies it feels to be most attractive within each economic sector. Under normal market conditions, the portion of the Account sub-advised by Morgan will have sector weightings comparable to that of the U.S. small company value universe though it may under or over-weight selected economic sectors. In addition, as a company moves out of the market capitalization range of the small company universe, it generally becomes a candidate for sale. Morgan may also purchase securities issued as part of, or a short period after, companies' initial public offerings ("IPOs"), and may at times dispose of those shares shortly after their acquisition. In selecting investments for the Account, the Sub-Advisor, Mellon Equity, uses a disciplined investment process that combines fundamental analysis and risk management with a multi-factor model that searches for undervalued stocks. Undervalued stocks are those selling at a low price relative to their profits and prospective earnings growth. The stock evaluation process uses several different characteristics, including changes in earnings estimates and change in price-to-earnings ratios, in an attempt to identify value among individual stocks. Rather than using broad economic or market trends, Mellon Equity selects stocks on a company-by-company basis. To ensure ample diversification, the portion of the Account's assets managed by Mellon Equity are allocated among industries and economic sectors in similar proportions to those of the Index. The portfolio is generally kept broadly diversified in an attempt to capture opportunities that may be realized quickly during periods of above-average market volatility. By maintaining such a diversified stance, stock selection drives performance. Since the Account has a long-term investment perspective, Mellon Equity does not intend to respond to short-term market fluctuations or to acquire securities for the purpose of short-term trading. The Manager may, from time-to-time, reallocate Account assets among the Sub-Advisors. The decision to do so may be based on a variety of factors, including but not limited to: the investment capacity of each Sub-Advisor, portfolio diversification, volume of net cash flows, fund liquidity, investment performance, investment strategies, changes in each Sub-Advisor's firm or investment professionals, or changes in the number of Sub-Advisors. Ordinarily, reallocations of Account assets among Sub-Advisors will occur as a Sub-Advisor liquidates assets in the normal course of portfolio management and with net new cash flows; however, at times reallocations may occur by transferring assets in cash or in kind among Sub-Advisors. Principal Variable Contracts Fund 77 www.principal.com MAIN RISKS The Account's share price may fluctuate more than that of funds primarily invested in stocks of mid-sized and large companies and may underperform as compared to the securities of larger companies. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is affected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. SMALL CAPITALIZATIONS . Companies with small capitalizations are often companies with a limited operational history. Such companies may have been created in response to cultural, economic, regulatory or technological developments. Such developments can have significant impact or negative effect on smaller capitalization companies securities that may be more volatile in price than larger company securities, especially over the short-term. VALUE STOCKS . The Account's investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets and currencies may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. Companies doing business in emerging markets may not have the same range of opportunities as companies in more developed countries. INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in IPOs exposes it to the additional risks associated with companies that have little operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile and share prices of certain newly-public companies have fluctuated in significant amounts over short periods of time. In addition, neither Sub-Advisor can guarantee continued access to IPO offerings and may at times dispose of those shares shortly after their acquisition. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth and willing to accept volatile fluctuations in the value of their investment. The Account is not designed for investors seeking income or conservation of capital. 78 Principal Variable Contracts Fund 1-800-247-4123 Morgan has been the Account's Sub-Advisor since its inception. On August 8, 2005, Mellon Equity also became Sub-Advisor to the Account. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1999 "21.45 "2000 "23.87 "2001"6.25 "2002"-8.86 "2003 "50.61 "2004 "23.08 The Account's highest/lowest quarterly returns "2005"6.22 during this time period were: HIGHEST Q2 '03 23.76% LOWEST Q3 '02 -17.74% LOGO The year-to-date return as of March 31, 2006 is 13.36%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS LIFE OF ACCOUNT* SMALLCAP VALUE ACCOUNT ....... 6.22 13.78 12.31 Russell 2000 Value Index ..... 4.71 13.55 9.19 Morningstar Small Value Category Average.............. 6.13 13.50 9.60 Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 1, 1998).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees............................ 1.09% Other Expenses............................. 0.04 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 1.13%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES -------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 SMALLCAP VALUE ACCOUNT $115 $359 $622 $1,375
Principal Variable Contracts Fund 79 www.principal.com CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS The Statement of Additional Information (SAI) contains additional information about investment strategies and their related risks. SECURITIES AND INVESTMENT PRACTICES MARKET VOLATILITY . Equity securities include common stocks, preferred stocks, convertible securities, depositary receipts, rights and warrants. Common stocks, the most familiar type, represent an equity (ownership) interest in a corporation. The value of a company's stock may fall as a result of factors directly relating to that company, such as decisions made by its management or lower demand for the company's products or services. A stock's value may also fall because of factors affecting not just the company, but also companies in the same industry or in a number of different industries, such as increases in production costs. The value of a company's stock may also be affected by changes in financial markets that are relatively unrelated to the company or its industry, such as changes in interest rates or currency exchange rates. In addition, a company's stock generally pays dividends only after the company invests in its own business and makes required payments to holders of its bonds and other debt. For this reason, the value of a company's stock will usually react more strongly than its bonds and other debt to actual or perceived changes in the company's financial condition or prospects. Stocks of smaller companies may be more vulnerable to adverse developments than those of larger companies. Fixed-income securities include bonds and other debt instruments that are used by issuers to borrow money from investors. The issuer generally pays the investor a fixed, variable or floating rate of interest. The amount borrowed must be repaid at maturity. Some debt securities, such as zero coupon bonds, do not pay current interest, but are sold at a discount from their face values. INTEREST RATE CHANGES . Fixed-income securities are sensitive to changes in interest rates. In general, fixed-income security prices rise when interest rates fall and fall when interest rates rise. Longer term bonds and zero coupon bonds are generally more sensitive to interest rate changes. CREDIT RISK . Fixed-income security prices are also affected by the credit quality of the issuer. Investment grade debt securities are medium and high quality securities. Some bonds, such as lower grade or "junk" bonds, may have speculative characteristics and may be particularly sensitive to economic conditions and the financial condition of the issuers. REPURCHASE AGREEMENTS AND LOANED SECURITIES Although not a principal investment strategy, each of the Accounts may invest a portion of its assets in repurchase agreements. Repurchase agreements typically involve the purchase of debt securities from a financial institution such as a bank, savings and loan association or broker-dealer. A repurchase agreement provides that the Account sells back to the seller and that the seller repurchases the underlying securities at a specified price on a specific date. Repurchase agreements may be viewed as loans by an Account collateralized by the underlying securities. This arrangement results in a fixed rate of return that is not subject to market fluctuation while the Account holds the security. In the event of a default or bankruptcy by a selling financial institution, the affected Account bears a risk of loss. To minimize such risks, the Account enters into repurchase agreements only with large, well-capitalized and well-established financial institutions. In addition, the value of the securities collateralizing the repurchase agreement is, and during the entire term of the repurchase agreement remains, at least equal to the repurchase price, including accrued interest. Each of the Accounts may lend its portfolio securities to unaffiliated broker-dealers and other unaffiliated qualified financial institutions. REVERSE REPURCHASE AGREEMENTS An Account may use reverse repurchase agreements to obtain cash to satisfy unusually heavy redemption requests or for other temporary or emergency purposes without the necessity of selling portfolio securities, or to earn additional income on portfolio securities, such as Treasury bills or notes. In a reverse repurchase agreement, an Account sells a portfolio security to another party, such as a bank or broker-dealer, in return for cash and agrees to repurchase the instrument at a particular price and time. While a reverse repurchase agreement is outstanding, an Account will 80 Principal Variable Contracts Fund 1-800-247-4123 maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account will enter into reverse repurchase agreements only with parties that the Sub-Advisor deems creditworthy. Using reverse repurchase agreements to earn additional income involves the risk that the interest earned on the invested proceeds is less than the expense of the reverse repurchase agreement transaction. This technique may also have a leveraging effect on the Account, although the Account's intent to segregate assets in the amount of the repurchase agreement minimizes this effect. CURRENCY CONTRACTS The Accounts may enter into currency contracts, currency futures contracts and options, and options on currencies for hedging and other purposes. A forward currency contract involves a privately negotiated obligation to purchase or sell a specific currency at a future date at a price set in the contract. An Account will not hedge currency exposure to an extent greater than the aggregate market value of the securities held or to be purchased by the Account (denominated or generally quoted or currently convertible into the currency). Hedging is a technique used in an attempt to reduce risk. If an Account's Sub-Advisor hedges market conditions incorrectly or employs a strategy that does not correlate well with the Account's investment, these techniques could result in a loss. These techniques may increase the volatility of an Account and may involve a small investment of cash relative to the magnitude of the risk assumed. In addition, these techniques could result in a loss if the other party to the transaction does not perform as promised. There is also a risk of government action through exchange controls that would restrict the ability of the Account to deliver or receive currency. FORWARD COMMITMENTS Although not a principal investment strategy, each of the Accounts may enter into forward commitment agreements. These agreements call for the Account to purchase or sell a security on a future date at a fixed price. Each of the Accounts may also enter into contracts to sell its investments either on demand or at a specific interval. WARRANTS Each of the Accounts may invest in warrants though none of the Accounts use such investments as a principal investment strategy. A warrant is a certificate granting its owner the right to purchase securities from the issuer at a specified price, normally higher than the current market price. HIGH YIELD SECURITIES The Asset Allocation, Balanced, Bond, MidCap Value and Short-Term Bond Accounts may invest in debt securities rated lower than BBB by S&P or Baa by Moody's or, if not rated, determined to be of equivalent quality by the Manager or the Sub-Advisor. Such securities are sometimes referred to as high yield or "junk bonds" and are considered speculative. Investment in high yield bonds involves special risks in addition to the risks associated with investment in highly rated debt securities. High yield bonds may be regarded as predominantly speculative with respect to the issuer's continuing ability to meet principal and interest payments. Moreover, such securities may, under certain circumstances, be less liquid than higher rated debt securities. Analysis of the creditworthiness of issuers of high yield securities may be more complex than for issuers of higher quality debt securities. The ability of an Account to achieve its investment objective may, to the extent of its investment in high yield bonds, be more dependent on such credit analysis than would be the case if the Account were investing in higher quality bonds. High yield bonds may be more susceptible to real or perceived adverse economic and competitive industry conditions than higher-grade bonds. The prices of high yield bonds have been found to be less sensitive to interest rate changes than more highly rated investments, but more sensitive to adverse economic downturns or individual corporate developments. If the issuer of high yield bonds defaults, an Account may incur additional expenses to seek recovery. The secondary market on which high yield bonds are traded may be less liquid than the market for higher-grade bonds. Less liquidity in the secondary trading market could adversely affect the price at which an Account could sell a high Principal Variable Contracts Fund 81 www.principal.com yield bond and could adversely affect and cause large fluctuations in the daily price of the Account's shares. Adverse publicity and investor perceptions, whether or not based on fundamental analysis, may decrease the value and liquidity of high yield bonds, especially in a thinly traded market. The use of credit ratings for evaluating high yield bonds also involves certain risks. For example, credit ratings evaluate the safety of principal and interest payments, not the market value risk of high yield bonds. Also, credit rating agencies may fail to change credit ratings in a timely manner to reflect subsequent events. If a credit rating agency changes the rating of a portfolio security held by an Account, the Account may retain the security if the Manager or Sub-Advisor thinks it is in the best interest of shareholders. INITIAL PUBLIC OFFERINGS ("IPOS") Certain of the Accounts may invest in IPOs. An IPO is a company's first offering of stock to the public. IPO risk is that the market value of IPO shares will fluctuate considerably due to factors such as the absence of a prior public market, unseasoned trading, the small number of shares available for trading and limited information about the issuer. The purchase of IPO shares may involve high transaction costs. IPO shares are subject to market risk and liquidity risk. In addition, the market for IPO shares can be speculative and/or inactive for extended periods of time. The limited number of shares available for trading in some IPOs may make it more difficult for an Account to buy or sell significant amounts of shares without an unfavorable impact on prevailing prices. Investors in IPO shares can be affected by substantial dilution in the value of their shares by sales of additional shares and by concentration of control in existing management and principal shareholders. When an Account's asset base is small, a significant portion of the Account's performance could be attributable to investments in IPOs because such investments would have a magnified impact on the Account. As the Account's assets grow, the effect of the Account's investments in IPOs on the Account's performance probably will decline, which could reduce the Account's performance. Because of the price volatility of IPO shares, an Account may choose to hold IPO shares for a very short period of time. This may increase the turnover of the Account's portfolio and lead to increased expenses to the Account, such as commissions and transaction costs. By selling IPO shares, the Account may realize taxable gains it will subsequently distribute to shareholders. DERIVATIVES To the extent permitted by its investment objectives and policies, each of the Accounts (except Money Market) may invest in securities that are commonly referred to as derivative securities. Generally, a derivative is a financial arrangement, the value of which is derived from, or based on, a traditional security, asset, or market index. Certain derivative securities are described more accurately as index/structured securities. Index/structured securities are derivative securities whose value or performance is linked to other equity securities (such as depositary receipts), currencies, interest rates, indices or other financial indicators (reference indices). Some derivatives, such as mortgage-related and other asset-backed securities, are in many respects like any other investment, although they may be more volatile or less liquid than more traditional debt securities. There are many different types of derivatives and many different ways to use them. Futures and options are commonly used for traditional hedging purposes to attempt to protect an Account from exposure to changing interest rates, securities prices, or currency exchange rates and for cash management purposes as a low-cost method of gaining exposure to a particular securities market without investing directly in those securities. The Accounts may enter into put or call options, future contracts, options on futures contracts and over-the-counter swap contracts (e.g., interest rate swaps, total return swaps and credit default swaps) for both hedging and non-hedging purposes. Generally, no Account may invest in a derivative security unless the reference index or the instrument to which it relates is an eligible investment for the Account. The return on a derivative security may increase or decrease, depending upon changes in the reference index or instrument to which it relates. The risks associated with derivative investments include: . the risk that the underlying security, interest rate, market index or other financial asset will not move in the direction the Manager or Sub-Advisor anticipated; . the possibility that there may be no liquid secondary market which may make it difficult or impossible to close out a position when desired; 82 Principal Variable Contracts Fund 1-800-247-4123 . the risk that adverse price movements in an instrument can result in a loss substantially greater than an Account's initial investment; and . the counterparty may fail to perform its obligations. EXCHANGE TRADED FUNDS (ETFS) These are a type of index fund bought and sold on a securities exchange. An ETF trades like common stock and represents a fixed portfolio of securities designed to rack a particular market index. The Accounts could purchase an ETF to temporarily gain exposure to a portion of the U.S. or a foreign market while awaiting purchase of underlying securities. The risks of owning an ETF generally reflect the risks of owning the underlying securities they are designed to track, although ETFs have management fees that increase their costs. CONVERTIBLE SECURITIES Convertible securities are fixed-income securities that an Account has the right to exchange for equity securities at a specified conversion price. The option allows the Account to realize additional returns if the market price of the equity securities exceeds the conversion price. For example, the Account may hold fixed-income securities that are convertible into shares of common stock at a conversion price of $10 per share. If the market value of the shares of common stock reached $12, the Account could realize an additional $2 per share by converting its fixed-income securities. Convertible securities have lower yields than comparable fixed-income securities. In addition, at the time a convertible security is issued the conversion price exceeds the market value of the underlying equity securities. Thus, convertible securities may provide lower returns than non-convertible fixed-income securities or equity securities depending upon changes in the price of the underlying equity securities. However, convertible securities permit the Account to realize some of the potential appreciation of the underlying equity securities with less risk of losing its initial investment. The Accounts treat convertible securities as both fixed-income and equity securities for purposes of investment policies and limitations because of their unique characteristics. The Accounts may invest in convertible securities without regard to their ratings. FOREIGN INVESTING As a principal investment strategy, the Asset Allocation, Diversified International, International Emerging Markets and International SmallCap Accounts may invest Account assets in securities of foreign companies. The other Accounts (except Government & High Quality Bond) may invest in securities of foreign companies but not as a principal investment strategy. For the purpose of this restriction, foreign companies are: . companies with their principal place of business or principal office outside the U.S.; and . companies for which the principal securities trading market is outside the U.S. Foreign companies may not be subject to the same uniform accounting, auditing and financial reporting practices as are required of U.S. companies. In addition, there may be less publicly available information about a foreign company than about a U.S. company. Securities of many foreign companies are less liquid and more volatile than securities of comparable U.S. companies. Commissions on foreign securities exchanges may be generally higher than those on U.S. exchanges, although each Account seeks the most favorable net results on its portfolio transactions. Foreign markets also have different clearance and settlement procedures than those in U.S. markets. In certain markets there have been times when settlements have been unable to keep pace with the volume of securities transactions, making it difficult to conduct these transactions. Delays in settlement could result in temporary periods when a portion of Account assets is not invested and earning no return. If an Account is unable to make intended security purchases due to settlement problems, the Account may miss attractive investment opportunities. In addition, an Account may incur a loss as a result of a decline in the value of its portfolio if it is unable to sell a security. With respect to certain foreign countries, there is the possibility of expropriation or confiscatory taxation, political or social instability, or diplomatic developments that could affect an Account's investments in those countries. In addition, an Account may also suffer losses due to nationalization, expropriation or differing accounting practices and treatments. Investments in foreign securities are subject to laws of the foreign country that may limit the amount and types of foreign investments. Changes of governments or of economic or monetary policies, in the U.S. or abroad, Principal Variable Contracts Fund 83 www.principal.com changes in dealings between nations, currency convertibility or exchange rates could result in investment losses for an Account. Finally, even though certain currencies may be convertible into U.S. dollars, the conversion rates may be artificial relative to the actual market values and may be unfavorable to Account investors. Foreign securities are often traded with less frequency and volume, and therefore may have greater price volatility, than is the case with many U.S. securities. Brokerage commissions, custodial services, and other costs relating to investment in foreign countries are generally more expensive than in the U.S. Though the Accounts intend to acquire the securities of foreign issuers where there are public trading markets, economic or political turmoil in a country in which an Account has a significant portion of its assets or deterioration of the relationship between the U.S. and a foreign country may negatively impact the liquidity of an Account's portfolio. An Account may have difficulty meeting a large number of redemption requests. Furthermore, there may be difficulties in obtaining or enforcing judgments against foreign issuers. An Account may choose to invest in a foreign company by purchasing depositary receipts. Depositary receipts are certificates of ownership of shares in a foreign-based issuer held by a bank or other financial institution. They are alternatives to purchasing the underlying security but are subject to the foreign securities to which they relate. Investments in companies of developing countries may be subject to higher risks than investments in companies in more developed countries. These risks include: . increased social, political and economic instability; . a smaller market for these securities and low or nonexistent volume of trading that results in a lack of liquidity and in greater price volatility; . lack of publicly available information, including reports of payments of dividends or interest on outstanding securities; . foreign government policies that may restrict opportunities, including restrictions on investment in issuers or industries deemed sensitive to national interests; . relatively new capital market structure or market-oriented economy; . the possibility that recent favorable economic developments may be slowed or reversed by unanticipated political or social events in these countries; . restrictions that may make it difficult or impossible for the Account to vote proxies, exercise shareholder rights, pursue legal remedies, and obtain judgments in foreign courts; and . possible losses through the holding of securities in domestic and foreign custodial banks and depositories. In addition, many developing countries have experienced substantial, and in some periods, extremely high rates of inflation for many years. Inflation and rapid fluctuations in inflation rates have had and may continue to have negative effects on the economies and securities markets of those countries. Repatriation of investment income, capital and proceeds of sales by foreign investors may require governmental registration and/or approval in some developing countries. An Account could be adversely affected by delays in or a refusal to grant any required governmental registration or approval for repatriation. Further, the economies of developing countries generally are heavily dependent upon international trade and, accordingly, have been and may continue to be adversely affected by trade barriers, exchange controls, managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries with which they trade. SMALL AND MEDIUM CAPITALIZATION COMPANIES The Accounts (except Bond, Government & High Quality Bond, Money Market and Short-Term Bond) may invest in securities of companies with small- or mid-sized market capitalizations. The Capital Value, LargeCap Blend, LargeCap Growth Equity, LargeCap Stock Index and LargeCap Value Accounts may hold securities of small and medium capitalization companies but not as a principal investment strategy. Market capitalization is defined as total current market value of a company's outstanding common stock. Investments in companies with smaller market capitalizations may involve greater risks and price volatility (wide, rapid fluctuations) than investments in larger, more mature companies. Small companies may be less significant within their industries and may be at a competitive disadvantage 84 Principal Variable Contracts Fund 1-800-247-4123 relative to their larger competitors. While smaller companies may be subject to these additional risks, they may also realize more substantial growth than larger or more established companies. Smaller companies may be less mature than larger companies. At this earlier stage of development, the companies may have limited product lines, reduced market liquidity for their shares, limited financial resources or less depth in management than larger or more established companies. Unseasoned issuers are companies with a record of less than three years continuous operation, including the operation of predecessors and parents. Unseasoned issuers by their nature have only a limited operating history that can be used for evaluating the company's growth prospects. As a result, investment decisions for these securities may place a greater emphasis on current or planned product lines and the reputation and experience of the company's management and less emphasis on fundamental valuation factors than would be the case for more mature growth companies. TEMPORARY DEFENSIVE MEASURES From time to time, as part of its investment strategy, each Account (other than the Money Market Account which may invest in high quality money market securities at any time) may invest without limit in cash and cash equivalents for temporary defensive purposes in response to adverse market, economic or political conditions. To the extent that the Account is in a defensive position, it may lose the benefit of upswings and limit its ability to meet its investment objective. For this purpose, cash equivalents include: bank notes, bank certificates of deposit, bankers' acceptances, repurchase agreements, commercial paper, and commercial paper master notes which are floating rate debt instruments without a fixed maturity. In addition, an Account may purchase U.S. government securities, preferred stocks and debt securities, whether or not convertible into or carrying rights for common stock. PORTFOLIO TURNOVER "Portfolio Turnover" is the term used in the industry for measuring the amount of trading that occurs in an Account's portfolio during the year. For example, a 100% turnover rate means that on average every security in the portfolio has been replaced once during the year. Accounts with high turnover rates (more than 100%) often have higher transaction costs (which are paid by the Account) and may have an adverse impact on the Account's performance. No turnover rate can be calculated for the Money Market Account because of the short maturities of the securities in which it invests. Turnover rates for each of the other Accounts may be found in the Account's Financial Highlights table. Please consider all the factors when you compare the turnover rates of different funds. A fund with consistently higher total returns and higher turnover rates than another fund may actually be achieving better performance precisely because the managers are active traders. You should also be aware that the "total return" line in the Financial Highlights section already includes portfolio turnover costs. PRICING OF ACCOUNT SHARES Each Account's shares are bought and sold at the current share price. The share price of each Account is calculated each day the New York Stock Exchange ("NYSE") is open (shares are not priced on the days on which the NYSE is closed for trading). The share price is determined at the close of business of the NYSE (normally 3:00 p.m. Central time). When an order to buy or sell shares is received, the share price used to fill the order is the next price calculated after the order is received. For all Accounts, except the Money Market Account, the share price is calculated by: . taking the current market value of the total assets of the Account . subtracting liabilities of the Account . dividing the remainder by the total number of shares owned by the Account. The securities of the Money Market Account are valued at amortized cost. The calculation procedure is described in the SAI. The Money Market Account reserves the right to determine a share price more than once each day. NOTES: Principal Variable Contracts Fund 85 www.principal.com . If current market values are not readily available for a security owned by an Account, its fair value is determined using a policy adopted by the Directors. . An Account's securities may be traded on foreign securities markets that generally complete trading at various times during the day prior to the close of the NYSE. Generally, the values of foreign securities used in computing a Fund's NAV are determined at the time the foreign market closes. Foreign securities and currencies are converted to U.S. dollars using the exchange rate in effect at the close of the London Exchange (generally 11:00 a.m. Eastern Time). Occasionally, events affecting the value of foreign securities occur when the foreign market is closed and the NYSE is open. The Account has adopted policies and procedures to "fair value" some or all securities held by an Account if significant events occur after the close of the market on which the foreign securities are traded but before the Account's NAV is calculated. Significant events can be specific to a single security or can include events that affect a particular foreign market or markets. A significant event can also include a general market movement in the U.S. securities markets. If the Manager believes that the market value of any or all of the foreign securities is materially affected by such an event, the securities will be valued, and the Account's NAV will be calculated, using the policy adopted by the Account. These fair valuation procedures are intended to discourage shareholders from investing in the Account for the purpose of engaging in market timing or arbitrage transactions. The trading of foreign securities generally or in a particular country or countries may not take place on all days the NYSE is open, or may trade on days the NYSE is closed. Thus, the value of the foreign securities held by the Account may change on days when shareholders are unable to purchase or redeem shares. . Certain securities issued by companies in emerging market countries may have more than one quoted valuation at any point in time. These may be referred to as local price and premium price. The premium price is often a negotiated price that may not consistently represent a price at which a specific transaction can be effected. The Fund has a policy to value such securities at a price at which the Sub-Advisor expects the securities may be sold. DIVIDENDS AND DISTRIBUTIONS The Accounts earn dividends, interest and other income from investments and distribute this income (less expenses) as dividends. The Accounts also realize capital gains from investments and distribute these gains (less any losses) as capital gain distributions. The Accounts normally make dividends and capital gain distributions at least annually, in February. Dividends and capital gain distributions are automatically reinvested in additional shares of the Account making the distribution. MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE THE MANAGER Principal Management Corporation serves as the manager for the Fund. In its handling of the business affairs of the Fund, the Manager provides clerical, recordkeeping and bookkeeping services, and keeps the required financial and accounting records. THE SUB-ADVISORS The Manager has signed a contract with a Sub-Advisor under which the Sub-Advisor agrees to assume the obligations of the Manager to provide investment advisory service for the Account. For these services, the Sub-Advisor is paid a fee by the Manager. Information regarding Sub-Advisors and individual portfolio managers is set forth below. The Statement of Additional Information provides additional information about each portfolio manager's compensation, other accounts managed by the portfolio manager and the portfolio manager's ownership of securities in the Account. MANAGER: The Manager is an indirect subsidiary of Principal Financial Services, Inc. and has managed mutual funds since 1969. As of December 31, 2005, the mutual funds it manages had assets of approximately $28.6 billion. The Manager's address is Principal Financial Group, Des Moines, Iowa 50392-2080. 86 Principal Variable Contracts Fund 1-800-247-4123 SUB-ADVISOR: AllianceBernstein L.P. ("AllianceBernstein") managed $579 billion in assets as of December 31, 2005. AllianceBernstein is located at 1345 Avenue of the Americas, New York, NY 10105. The management of and investment decisions for the Account's portfolio are made by the US Value Investment Policy Group, comprised of senior US Value Investment Team members. The US Value Investment Policy Group relies heavily on the fundamental analysis and research of the Adviser's large internal research staff. No one person is principally responsible for making recommendations for the Account's portfolio. the members of the US Value Investment Policy Group with the most significant responsibility for the day-to-day management of the Account's portfolio are: Marilyn Fedak, John Mahedy, John Phillips and Chris Marx. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ LargeCap Value Marilyn Fedak John Mahedy Chris Marx John Phillips
MARILYN G. FEDAK, CFA . Ms. Fedak joined Bernstein in 1984 as a senior portfolio manager. An Executive Vice President of AllianceBernstein since 2000, she is Head of Global Value Equities and chair of the US Large Cap Value Equity Investment Policy Group. Ms. Fedak serves on AllianceBernstein's Management Executive Committee and is also a Director of SCB Inc. She earned a BA from Smith College and an MBA from Harvard University. She has also earned the right to use the Chartered Financial Analyst designation. JOHN MAHEDY, CPA . Mr. Mahedy was named Co-CIO-US Value equities in 2003. He continues to serve as director of research-US Value Equities, a position he has held since 2001. Previously, Mr. Mahedy was a senior research analyst at Bernstein's institutional research and brokerage unit, covering the domestic and international energy industry from 1995 to 2001. He earned a BS and an MBA from New York University. CHRISTOPHER W. MARX . Mr. Marx joined the firm in 1997 as a research analyst. He covered a variety of industries both domestically and internationally, including chemicals, food, supermarkets, beverages and tobacco. Mr. Marx earned an AB in Economics from Harvard, and an MBA from the Stanford Graduate School of Business. JOHN D. PHILLIPS, JR., CFA . Mr. Phillips joined the firm in 1994 and is a senior portfolio manager and member of the US Value Equities Investment Policy Group. He is also chairman of Bernstein's Proxy Voting Committee. Mr. Phillips earned a BA from Hamilton College and an MBA from Harvard University. He has also earned the right to use the Chartered Financial Analyst designation. SUB-ADVISOR: Columbus Circle Investors ("CCI") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. CCI was founded in 1975. Its address is Metro Center, One Station Place, Stamford, CT 06902. As of December 31, 2005, CCI had approximately $5.9 billion in assets under management. Principal Variable Contracts Fund 87 www.principal.com The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Growth Anthony Rizza
ANTHONY RIZZA, CFA . Mr. Rizza, portfolio manager, joined CCI in 1991. He received a BS in Business from the University of Connecticut. Mr. Rizza has earned the right to use the Chartered Financial Analyst designation and is a member of the Hartford Society of Security Analysts. SUB-ADVISOR: Emerald Advisers, Inc. ("Emerald") is a wholly-owned subsidiary of Emerald Asset Management. Emerald provides professional investment advisory services to institutional investors, high net worth individuals and the general public. As of December 31, 2005, Emerald managed approximately $2.36 billion in assets. Emerald's offices are located at 1703 Oregon Pike Road, Suite 101, Lancaster, Pennsylvania 17601.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ SmallCap Growth Joseph W. Garner Kenneth G. Mertz Stacey L. Sears
The portfolio management and strategy team have long tenures at Emerald, with Ms. Sears joining Emerald in 1991, Mr. Mertz in 1992 and Mr. Garner in 1994. JOSEPH W. GARNER . Mr. Garner joined Emerald in 1994 and serves as Director of Emerald Research and Portfolio Manager. Prior to joining Emerald, Mr. Garner was the Program Manager of the Pennsylvania Economic Development Financing Authority (PEDFA); an Economic Development Analyst with the PA Department of Commerce's Office of Technology Development; and an Industry Research Analyst with the Pittsburgh High Technology Council. Mr. Garner earned an MBA from the Katz Graduate School of Business, University of Pittsburgh, and graduated magna cum laude with a BA in Economics from Millersville University. KENNETH G. MERTZ II, CFA. . Mr. Mertz joined Emerald in 1992 and serves as President of Emerald Advisers, Inc. Formerly he served as Past Trustee, Vice President of the Emerald Mutual Funds (1992-2005) and Chief Investment Officer of the Pennsylvania State Employees' Retirement System (1985-1992). He earned a BA in Economics from Millersville University. Mr. Mertz supervises the entire portfolio management and trading process. As Chief Investment Officer, he has full discretion over all portfolios. Mr. Mertz, Ms. Sears and Mr. Garner work as a team developing strategy. STACEY L. SEARS . Ms. Sears joined Emerald in 1991 and serves as Senior Vice President and Portfolio Manager of Emerald Advisers, Inc. She is co-manager of the Forward Emerald Growth Fund and a member of the Portfolio Management team. Additionally, Ms. Sears maintains research coverage of retail, apparel, consumer goods and consumer technology companies. Ms. Sears earned a BS in Business Administration from Millersville University and an MBA from Villanova University. SUB-ADVISOR: Grantham, Mayo, Van Otterloo & Co. LLC ("GMO") is a privately held global investment management firm servicing clients in the corporate, public, endowment and foundation marketplace located at 40 88 Principal Variable Contracts Fund 1-800-247-4123 Rowes Wharf, Boston, MA 02110. As of December 31, 2005, GMO managed $111 billion in client assets.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ LargeCap Growth Equity Sam Wilderman
Day-to-day management of the LargeCap Growth Equity Account is the responsibility of GMO's U.S. Quantitative Division. The Division's members work collaboratively to manage the Account's portfolio, and no one person is primarily responsible for day-to-day management. The individual responsible for managing the implementation and monitoring of the overall portfolio management of the Account is Sam Wilderman. Mr. Wilderman allocates responsibility for portions of the Account's portfolio to various members of the Division, oversees the implementation of trades, reviews the overall composition of the Account's portfolio, including compliance with stated investment objectives and strategies and monitors cash flows. Mr. Wilderman is a member (partner) of GMO and is Director of GMO's U.S. Quantitative Division. Mr. Wilderman served as co-director of U.S. equity management in 2005. Prior to this position, he was responsible for research and portfolio management for the GMO Emerging Markets Fund, the GMO Emerging Countries Fund and the GMO Emerging Markets Quality Fund. He joined GMO in 1996 following the completion of his B.A. in Economics from Yale University. The SAI contains other information about how GMO determines the compensation of the Division's senior member, other accounts managed by the team's senior member, and ownership of shares of the Account by the Division's senior member. SUB-ADVISOR: J.P. Morgan Investment Management Inc. ("Morgan"), 522 Fifth Avenue, New York, NY 10036 is an indirect wholly-owned subsidiary of JPMorgan Chase & Co. ("JPMorgan"), a bank holding company. Morgan offers a wide range of services to governmental, institutional, corporate and individual customers and acts as investment advisor to individual and institutional clients. As of December 31, 2005, Morgan had total combined assets under management of approximately $847 billion. The portfolio managers operate as a team, sharing responsibility for the day-to-day management of the portfolio, each strategy does, however, have lead portfolio managers with responsibility for implementing the insight of the team into individual portfolios. The Statement of Additional Information provides additional information about the portfolio managers' compensation, other accounts managed by the portfolio managers and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ SmallCap Value Christopher T. Blum Dennis S. Ruhl
CHRISTOPHER T. BLUM, CFA . Managing Director of Morgan. Mr. Blum is a portfolio manager in the U.S. Small Cap Equity Group. He rejoined the firm in 2001. Previously, he spent two years as a research analyst responsible for the valuation and acquisition of private equity assets at Pomona Capital. Prior to that, Mr. Blum spent over three years with Morgan where he focused on structured small-cap core and small-cap value accounts. He earned his BBA in Finance at the Bernard M. Baruch School for Business and is a holder of the CFA designation. DENNIS S. RUHL, CFA . Mr. Ruhl, Vice President of Morgan, joined the company in 1999. He is a portfolio manager in the U.S. Small Cap Equity Group. His current responsibilities include managing structured small cap core and value Principal Variable Contracts Fund 89 www.principal.com accounts. Previously, he worked on quantitative equity research (focusing on trading) as well as business development. Mr. Ruhl earned Bachelor's degrees in Mathematics and Computer Science and a Master's degree in Computer Science, all from MIT. He has earned the right to use the Chartered Financial Analyst designation. SUB-ADVISOR: Mellon Equity Associates, LLP ("Mellon Equity"), 500 Grant Street, Suite 4200, Pittsburgh, PA 15258. Mellon Equity is a wholly owned subsidiary of Mellon Financial Corporation ("Mellon"). Mellon has approximately $4.7 trillion in assets under management, administration or custody, including $781 billion under management. As of December 31, 2005, Mellon Equity managed approximately $21.3 billion in assets. The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ MidCap Growth Adam T. Logan John O'Toole SmallCap Value Ronald P. Gala Peter D. Goslin
RONALD P. GALA, CFA . Mr. Gala is a portfolio manager of Dreyfus and a Senior Vice President and a principal of Mellon Equity. Mr. Gala has 20 years experience managing equity portfolios, and he is a past president of the Pittsburgh Society of Financial Analysts. Mr. Gala earned his MBA in Finance from the University of Pittsburgh and his BS in Business Administration from Duquesne University. He is a Chartered Financial Analyst. PETER D. GOSLIN, CFA . Mr. Goslin is a Vice President and Portfolio Manager with Mellon Equity. Before joining Mellon Equity in 1999, Mr. Goslin spent over four years with Merrill Lynch. During his tenure with Merrill, he worked as a NASDAQ market maker and an equity index options proprietary trader. Prior to that, he ran Merrill's S&P options desk at the Chicago Mercantile Exchange. Mr. Goslin earned his MBA in Finance at the University of Notre Dame Graduate School of Business following a BS in Finance from St. Vincent College. He has earned the right to use the Chartered Financial Analyst designation. ADAM T. LOGAN, CFA . Joining the company in 1998, Mr. Logan is a portfolio manager and Vice President of Mellon Equity. Previously, he performed duties as a financial analyst in Mellon Financial Corporation's corporate finance department. He is currently responsible for the management of client portfolios with a specific focus on mid and small capitalization securities. He earned a BA in Finance from Westminster College and an MBA from the Katz Graduate School of Business at the University of Pittsburgh. He has earned the right to use the Chartered Financial Analyst designation. JOHN O'TOOLE, CFA . Senior Vice President of Mellon Equity since 1990. Mr. O'Toole holds an MBA in Finance from the University of Chicago and a BA in Economics from the University of Pennsylvania. He is a member of the Association for Investment Management and Research, and the Pittsburgh Society of Financial Analysts. He is a Chartered Financial Analyst. SUB-ADVISOR: Morgan Stanley Investment Management Inc. ("MSIM Inc."), doing business in certain instances (including its role as sub-advisor to the Asset Allocation Account) under the name "Van Kampen," is a registered investment adviser, located at 1221 Avenue of the Americas, New York, New York, 10020, and is a direct subsidiary of Morgan Stanley. As of December 31, 2005, Van Kampen, together with its affiliated asset management companies, had approximately $434.0 billion in asset under management. 90 Principal Variable Contracts Fund 1-800-247-4123 The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Asset Allocation Francine J. Bovich
FRANCINE J. BOVICH . Ms. Bovich is Managing Director of Morgan Stanley and Morgan Stanley & Co. Incorporated since 1997. Principal 1993-1996. Ms. Bovich holds a BA in Economics from Connecticut College, and an MBA in Finance from New York University. Ms. Bovich is co-head of Morgan Stanley's Global Tactical Asset Allocation Team. Ms. Bovich is responsible for the overall allocation of the Fund's assets among equities, bonds and money market instruments. SUB-ADVISOR: Neuberger Berman Management, Inc. ("Neuberger Berman") is an affiliate of Neuberger Berman, LLC. Neuberger Berman, LLC is located at 605 Third Avenue, 2nd Floor, New York, NY 10158-0180. Together with Neuberger Berman, the firms manage more than $105.9 billion in total assets (as of December 31, 2005) and continue an asset management history that began in 1939. Neuberger Berman Management, Inc. is an indirect, wholly owned subsidiary of Lehman Brothers Holdings, Inc. Lehman Brothers is located at 745 Seventh Avenue, New York, NY 10019. The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ MidCap Value S. Basu Mullick
S. BASU MULLICK . Mr. Mullick, Managing Director, Portfolio Manager, joined Neuberger Berman in 1998. He is manager of mid- to large-cap value Partners Fund and mid-cap value strategy totaling $5.4 billion in assets. Prior to joining the company, Mr. Mullick was a portfolio manager at Ark Asset Management. He earned a BA in Economics from the Presidency College, India. He also earned a MA in Economics and a Ph.D., ABD Finance from Rutgers University. SUB-ADVISOR: Principal Global Investors, LLC ("Principal") is an indirectly wholly-owned subsidiary of Principal Life Insurance Company and an affiliate of the Manager. Principal manages equity, fixed-income and real estate investments primarily for institutional investors, including Principal Life. As of December 31, 2005, Principal, together with its affiliated asset management companies, had approximately $159 billion in asset under management. Principal Global Investor's headquarters address is 801 Grand Avenue, Des Moines, Iowa 50392 and has other primary asset management offices in New York, London, Sydney and Singapore. The day-to-day portfolio management for some of the Accounts listed below is shared by two or more portfolio managers. In each such case, except where noted below, the portfolio managers operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio with no limitation on the authority of one portfolio manager in relation to another. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account. Principal Variable Contracts Fund 91 www.principal.com
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Balanced Dirk Laschanzky Bond William C. Armstrong Timothy R. Warrick Capital Value John Pihlblad Diversified International Paul H. Blankenhagen Juliet Cohn Christopher Ibach Equity Income Dirk Laschanzky Government & High Quality Bond Brad Fredericks Lisa Stange International Emerging Markets Michael A. Marusiak Michael L. Reynal International SmallCap Brian W. Pattinson LargeCap Stock Index Dirk Laschanzky Mariateresa Monaco MidCap K. William Nolin Money Market Tracy Reeg Alice Robertson Short-Term Bond Zeid Ayer Craig Dawson Martin J. Schafer SmallCap Thomas Morabito
WILLIAM C. ARMSTRONG, CFA . Mr. Armstrong is a portfolio manager for Principal. He manages multi-sector portfolios that invest in corporate bonds, mortgage-backed securities, commercial mortgage-backed securities, asset-backed securities, sovereigns, and agencies. He jointed the firm in 1992. Previously he served as a commissioned bank examiner at Federal Deposit Insurance Commission. He earned a Master's degree from the University of Iowa and a Bachelor's degree from Kearney State College. He has earned the right to use the Chartered Financial Analyst designation. ZEID AYER, PH.D., CFA . Mr. Ayer is a portfolio manager at Principal. he is a co-manager of the ultra short and short-term bond portfolios. He is also head of the Structured Debt group that covers asset-backed securities (ABS) and non-agency mortgage-backed securities (MBS). He joined Principal in 2001 and is the primary analyst responsible for mortgage-related ABS and non-agency MBS investments. Previously, Mr. Ayer was an assistant vice president at PNC Financial Services Group. He earned a doctorate in Physics from the University of Notre Dame, a master's in Computational Finance from Carnegie Mellon University and a Bachelor's degree in Physics from St. Xavier's College, Bombay University. He has earned the right to use the Chartered Financial Analyst designation. PAUL H. BLANKENHAGEN, CFA . Mr. Blankenhagen joined the firm in 1992 and was named a portfolio manager in 2000. He is responsible for developing portfolio strategy and the ongoing management of core international equity portfolios. He earned a Master's degree from Drake University and a Bachelor's degree in Finance from Iowa State University. He has earned the right to use the Chartered Financial Analyst designation, and is a member of the Association for Investment Management and Research (AIMR) and the Iowa Society of Financial Analysts. JULIET COHN . Ms. Cohn is a portfolio manager at Principal. She co-manages the core international equity portfolios, with an emphasis on Europe and on the health care sector. Prior to joining the firm in 2003, she served as a director and senior portfolio manager at Allianz Dresdner Asset Management, managing both retail and institutional European 92 Principal Variable Contracts Fund 1-800-247-4123 accounts. Prior to that, she was a fund manager at London firms Capel Cure Myers and Robert Fleming. She earned a bachelor's degree in Mathematics from Trinity College, Cambridge England. CRAIG DAWSON, CFA . Mr. Dawson is a portfolio manager at Principal. He is co-manager of the ultra short and short term bond portfolios. He joined the firm in 1998 as a research associate, then moved into a portfolio analyst role before moving into a portfoio manager position in 2002. He earned an MBA and a Bachelor's degree in Finance from the University of Iowa. Mr. Dawson has earned the right to use the Chartered Financial Analyst designation. BRAD FREDERICKS. . Mr. Fredericks is a portfolio manager at Principal. He is responsible for co-managing the government securities accounts. His responsibilities include general portfolio overview and security analysis. He joined the firm in 1998 as a financial accountant and was named a portfolio manager in 2002. Previously, Mr. Fredericks was an assistant trader at Norwest Mortgage. He earned a Bachelor's degree in Finance from Iowa State University. Mr. Fredericks is a Fellow of the Life Management Institute (FLMI). CHRISTOPHER IBACH, CFA . Mr. Ibach is an associate portfolio manager and equity research analyst at Principal. He specializes primarily in the analysis of international technology companies, with a particular emphasis on semi-conductor research. Prior to joining Principal in 2000, he gained six years of related industry experience with Motorola, Inc. Mr. Ibach earned an MBA in Finance and a Bachelor's degree in Electrical Engineering from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. DIRK LASCHANZKY, CFA . Mr. Laschanzky is a portfolio manager for Principal, responsible for portfolio implementation strategies, asset allocation and managing the midcap value and index portfolios. Prior to joining Principal in 1997, he was a portfolio manager and analyst for over seven years at AMR Investment Services. He earned an MBA and BA, both in Finance, from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. MICHAEL A. MARUSIAK . Mr. Marusiak is a portfolio manager for Principal. He specializes in the management of emerging markets portfolios, as well as regional Asian equity portfolios. Prior to joining Principal in 2000, he was an analyst at Trust Company of the West. He earned an MIA in International Finance from the Columbia University School of International and Public Affairs and a BA in Business Administration and Finance from Simon Fraser University of Burnaby, British Columbia. MARIATERESA MONACO . Ms. Monaco is an portfolio manager at Principal. She serves as portfolio manager for the firm's small-cap growth and index portfiols and as a member of the firm's asset allocation policy group. Prior to joining Principal in 2005, she was a quantitative equity analyst at Fidelity Management and Research supporting a family of institutional equity funds. Ms. Monaco earned an MBA from the Sloan School of Management at the Massachusetts Institute of Technology and a Master's degree in Electrical Engineering from Northeastern University. She also earned a Master's degree in Electrical Engineering from Politecnico di Torino, Italy, and a diploma in Piano from the Conservatorio di Torino, Italy. THOMAS MORABITO, CFA . Mr. Morabito leads the small-cap portfolio management team for Principal and is the portfolio manager on the small-cap value portfolios. Prior to joining Principal in 2000, he managed the Structured Small Cap Fund for Invesco Management & Research. He earned an MBA in Finance from Northeastern University and his BA in Economics from State University of New York. He has earned the right to use the Chartered Financial Analyst designation. K. WILLIAM NOLIN, CFA . Mr. Nolin is a portfolio manager for Principal. He serves as the portfolio manager for the firm's international small-cap equity portfolios. He joined the firm in 1994. He earned an MBA from the Yale School of Management and a Bachelor's degree in Finance from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. BRIAN W. PATTINSON, CFA . Mr. Pattinson is a portfolio manager at Principal. He serves as the portfolio manager for the firm's international small-cap equity portfolios. He joined Principal in 1994. Mr. Pattinson earned an MBA and Principal Variable Contracts Fund 93 www.principal.com Bachelor's degree in Finance from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. JOHN PIHLBLAD, CFA . Mr. Pihlblad is a portfolio manager at Principal. He joined the firm in 2000 and led the development of Principal Global Investors' Global Research Platform. He has over 25 years experience in creating and managing quantitative investment systems. Prior to joining Principal, Mr. Pihlblad was a partner and co-founder of GlobeFlex Capital in San Diego where he was responsible for the development and implementation of the investment process for both domestic and international products. He earned a BA from Westminster College. He has earned the right to use the Chartered Financial Analyst designation. TRACY REEG. . Ms. Reeg is a portfolio manager at Principal. She is involved in the portfolio management of money market portfolios. She joined the firm in 1993 and began trading and portfolio management duties in 2000. Ms. Reeg earned a Bachelor's degree in Finance from the University of Northern Iowa. She is a member of the Life Office Management Association (LOMA) and is a Fellow of the Life Management Institute (FLMI). MICHAEL L. REYNAL . Mr. Reynal is a portfolio manager at Principal. He specializes in the management of emerging markets portfolios, as well as regional Asian equity portfolios. Prior to joining Principal in 2001, he was responsible for equity investments in Latin America, the Mediterranean and the Balkans while at Wafra Investment Advisory Group, Inc. in New York. Mr. Reynal earned an MBA from the Amos Tuck School at Dartmouth College, an MA in History from Christ's College at the University of Cambridge and a BA in History from Middlebury College. ALICE ROBERTSON . Ms. Robertson is a trader and portfolio manager for Principal. She is responsible for trading corporate bonds on the fixed income trading desk. In addition, she serves as co-portfolio manager of the money market funds and oversees the short-term trading operation. She joined the firm in 1990 after working as an assistance vice president/commercial paper analyst with Duff & Phelps Credit Company. Ms. Robertson served as a credit analyst for the firm before moving into her current role in 1993. She earned an MBA in Finance and Marketing from DePaul University and her Bachelor's degree in Economics from Northwestern University. MARTIN J. SCHAFER . Mr. Schafer is a portfolio manager for Principal. He specializes in short-term and long duration portfolios, as well as the Inflation Protection Fund and stable value mandates. He also has experience in managing mortgage-backed securities. Mr. Schafer joined the firm in 1977 and in the early 1980s he developed the firm's secondary mortgage marketing operation. In 1984, he assumed portfolio management responsibility for its residential mortgage portfolio. He began managing mutual fund assets in 1985, institutional portfolios in 1992 and stable value portfolios in 2000. He has earned a Bachelor's degree in Accounting and Finance from the University of Iowa. LISA A. STANGE, CFA . Ms. Stange is a portfolio manager and strategist for Principal. She is responsible for managing the government securities portfolios and the mortgage-backed securities (MBS) within the multi-sector portfolios. As a strategies, Ms. Stange is involved in the formulation of broad investment strategy, quantitative research and product development. Previously, she was co-portfolio manager for U.S. multi-sector portfolios. She joined the firm in 1989. Ms. Stange earned an MBA and a Bachelor's degree from the University of Iowa. She has earned the right to use the Chartered Financial Analyst designation. TIMOTHY R. WARRICK, CFA . Mr. Warrick is a portfolio manager at Principal with responsibility for the corporate and U.S. multi-sector portfolios. He also serves as portfolio management team leader with responsibility for overseeing portfolio management function for all total return fixed income products. Prior to his portfolio management responsibilities with the firm, Mr. Warrick was a fixed income credit analyst and extensively involved in product development He joined the firm in 1990. He received an MBA in Finance from Drake University and a Bachelor's degree in Accounting and Economics from Simpson College. He has earned the right to use the Chartered Financial Analyst designation. SUB-ADVISOR: Principal Real Estate Investors, LLC ("Principal - REI"), an indirect wholly-owned subsidiary of Principal Life and an affiliate of the Manager, was founded in 2000. It manages investments for institutional investors, including Principal Life. As of December 31, 2005, Principal - REI, together with its affiliated 94 Principal Variable Contracts Fund 1-800-247-4123 asset management companies, had approximately $32.0 billion in asset under management. Principal - REI's address is 801 Grand Avenue, Des Moines, Iowa 50392. The Statement of Additional Information provides further information about the portfolio manager's compensation, other accounts managed by the portfolio manager, and the portfolio manager's ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Real Estate Securities Kelly D. Rush
KELLY D. RUSH, CFA . Mr. Rush directs the Real Estate Investment Trust (REIT) activity for a member company of the Principal Financial Group. Mr. Rush joined the Principal Financial Group in 1987 and has been dedicated to public real estate investments since 1995. His experience includes the structuring of public real estate transactions that included commercial mortgage loans and the issuance of unsecured bonds. He received his Master's degree and Bachelor's degree in Finance from the University of Iowa. He has earned the right to use the Chartered Financial Analyst designation. SUB-ADVISOR: T. Rowe Price Associates, Inc. ("T. Rowe Price"), a wholly-owned subsidiary of T. Rowe Price Group, Inc., a financial services holding company, has over 68 years of investment management experience. Together with its affiliates, T. Rowe Price had approximately $269.5 billion in assets under management as of December 31, 2005. T. Rowe Price is located at 100 East Pratt Street, Baltimore, MD 21202. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Equity Growth Robert W. Sharps LargeCap Blend William J. Stromberg Richard T. Whitney
ROBERT W. SHARPS, CFA, CPA . Mr. Sharps is a Vice President of T. Rowe Price Group, Inc., and T. Rowe Price. He is also the lead Portfolio Manager with the Large-Cap Growth Strategy Team in the Equity Division. Prior to joining the firm in 1997, Mr. Sharps was a Senior Consultant at KPMG Peat Marwick. He earned a BS, summa cum laude, in Accounting from Towson University and an MBA in Finance from the Wharton School, University of Pennsylvania. He has also earned the Chartered Financial Analyst and Certified Public Accountant accreditations. WILLIAM J. STROMBERG, CFA . Mr. Stromberg is a Vice President of T. Rowe Price Group, Inc., and T. Rowe Price, Director of Global Equity Research, and Co-Director of Equities for T. Rowe Price. Prior to joining the firm in 1987, he was employed as a Systems Engineer for the Westinghouse Defense and Electronics Center. He earned a BA from Johns Hopkins University and an MBA from Tuck School of Business at Dartmouth College. He has earned the right to use the Chartered Financial Analyst designation. Mr. Stromberg serves as a portfolio coordinator for the Account. Instead of making stock selection decisions, he is responsible for ensuring adherence to portfolio constraints and risk controls, along with managing inter-analyst activity. As the lead portfolio coordinator, Mr. Stromberg has ultimate accountability for the Account. Principal Variable Contracts Fund 95 www.principal.com RICHARD T. WHITNEY, CFA . Mr. Whitney is a Vice President of T. Rowe Price Group, Inc. and T. Rowe Price, Director of the firm's Quantitative Equity Group and member of the Equity Steering Committee and Brokerage Control Committee. Prior to joining the firm in 1985, Mr. Whitney was employed by the Chicago Board of Trade and IBM. He earned a BS and an MEE in Electrical Engineering from Rice University and an MBA from the University of Chicago. He has earned the right to use the Chartered Financial Analyst designation. Mr. Whitney serves as a portfolio coordinator for the Fund. Instead of making stock selection decisions, he, along with Mr. Stromberg, is responsible for ensuring adherence to portfolio constraints and risk controls, as well as managing inter-analyst activity. SUB-ADVISOR: UBS Global Asset Management (Americas) Inc., a Delaware corporation located at One North Wacker, Chicago, IL 60606 ("UBS Global AM"), is a registered investment advisor. UBS Global AM, a subsidiary of UBS AG, is a member of the UBS Global Asset Management business group (the "Group") of UBS AG. As of December 31, 2005, UBS Global AM managed approximately $66.12 billion in assets and the Group managed approximately $581.49 billion in assets. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ SmallCap Growth Paul A. Graham, Jr. David N. Wabnik
PAUL A. GRAHAM, JR., CFA . Mr. Graham joined UBS Global AM in 1994 and has had portfolio management responsibilities since 1994. Mr. Graham is Managing Director, Head of Growth Investors and Co-Head of U.S. Small Cap Growth Equity. For eight years prior to joining the firm, he served as a small cap portfolio manager and research analyst at Value Line Asset Management. Mr. Graham received his BA from Dartmouth College. He has earned the right to use the Chartered Financial Analyst designation and is a member of the New York Society of Security Analysts. DAVID N. WABNIK . Mr. Wabnik joined UBS Global AM in 1995 and has been a portfolio manager since 1995. Mr. Wabnik is Executive Director, Co-Head of U.S. SmallCap Growth Equity. For four years prior to joining the firm, he served as a small cap portfolio manager/senior research analyst at Value Line Asset Management. Mr. Wabnik received his BS from Binghamton University and his MBA from Columbia Business School. He has completed the Certified Financial Analyst Level I exam. THE SUB-SUB-ADVISORS Principal Global Investors, LLC ("Principal") has entered into sub-sub-advisory agreements for various Accounts. Under these agreements, each sub-sub-advisor has agreed to assume the obligations of Principal for a certain portion of the Account's assets. The sub-sub-advisor is paid a fee by Principal. Principal is the sub-advisor for the Bond Account. Day-to-day management decisions concerning a portion of the Bond Account's portfolio are made by Spectrum Asset Management, Inc. ("Spectrum"), and Post Advisory Group, LLC ("Post") each of which serves as sub-sub-advisor. Principal is the sub-advisor for the Equity Income Account. Day-to-day management decisions concerning a portion of the Equity Income Account's portfolio are made by Principal Real Estate Investors LLC ("Principal - REI"), and Spectrum each of which serves as sub-sub-advisor. 96 Principal Variable Contracts Fund 1-800-247-4123 See the discussion regarding Principal - REI provided in connection with the Real Estate Securities Account for a description of the firm and the individual who serves as portfolio manager. SUB-ADVISOR: Post Advisory Group, LLC ("Post") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. Post was founded in April 1992. Its address is 11755 Wilshire Boulevard, Los Angeles, CA 90025. As of December 31, 2005, Post had $8.1 billion in asset under management. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account. LAWRENCE A. POST . Mr. Post is a chief executive office and chief investment officer for Post, an affiliate of Principal. He has over 35 years experience in the investment business, including 25 years in the high yield bond market. Prior to founding Post Advisory Group in 1992, he founded the high yield bond department at Smith Barney, and subsequently served as director of high yield research at Salomon Brothers and co-director of research and senior trader at Drexel Burnham Lambert. He earned an MBA in business administration from the University of Pennsylvania's Wharton School of Business and a Bachelor's degree from Lehigh University. ALLAN SCHWEITZER . Mr. Schweitzer is a Managing Director at Post. Prior to joining Post in 2000, he was a senior high yield analyst at Trust Company of the West ("TCW"). Prior to TCW, he was a high yield research analyst at Putnam Investments. Mr. Schweitzer earned a Bachelor's degree in Business Administration from Washington University at St. Louis and a Master's in Business Administration from the University of Chicago with a concentration in analytical finance and international economics. SUB-ADVISOR: Spectrum Asset Management, Inc. ("Spectrum") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. Spectrum was founded in 1987. Its address is 4 High Ridge Park, Stamford, CT 06905. As of December 31, 2005, Spectrum, together with its affiliated asset management companies, had approximately $13.2 billion in asset under management. The portfolio managers listed below operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account. FERNANDO DIAZ. . Mr. Diaz is a vice president and assistant portfolio manager for Spectrum. Prior to joining Spectrum in 2000, Mr. Diaz was head of preferred trading at Spear, Leeds & Kellogg and Pershing, a division of DLJ, where he initiated preferred trading operations at both firms. Mr. Diaz has also worked at Goldman Sachs as an analyst in the Investment Banking division and in the Preferred Stock division as a trader and product analyst. L. PHILLIP JACOBY. . Mr. Jacoby is Sr. Vice President and Portfolio Manager for Spectrum and chairman of Spectrum's Investment Committee. Prior to joining Spectrum in 1995, he was a senior investment officer as USL Capital Corporation, a subsidiary of Ford Motor Corporate, and co-managed a $600 million preferred stock portfolio. He earned a earned a his BS in Finance from Boston University. BERNARD M. SUSSMAN. . Mr. Sussman is Chief Investment Officer of Spectrum and Chair of its Investment Committee. Prior to joining Spectrum in 1995, Mr. Sussman was a general partner and heard of the Preferred Stock area of Goldman Sachs & Co. He was responsible for sales, trading and underwriting for all preferred products and was instrumental in the development of the hybrid (MIPS) market. He earned both an MBA in Finance and a Bachelor's degree in Industrial Relations from Cornell University. Principal Variable Contracts Fund 97 www.principal.com JOSEPH J. URCIUOLI. . Mr. Urciuoli is a senior vice president and director of research for Spectrum and is responsible for all credit research supporting the client portfolios. He is also a portfolio manager. He joined Spectrum in 1998 from Presidential Life Insurance Company where he served as a fixed income analyst and assistant portfolio manager of a $2 billion portfolio. Mr. Urciuoli earned an MBA in Finance and a Bachelor's degree in finance from Long Island University. DUTIES OF THE MANAGER AND SUB-ADVISOR The Manager or Sub-Advisor provides the Directors of the Fund with a recommended investment program. The program must be consistent with the Account's investment objective and policies. Within the scope of the approved investment program, the Sub-Advisor advises the Account on its investment policy and determines which securities are bought or sold, and in what amounts. FEES PAID TO THE MANAGER The Manager is paid a fee by each Account for its services, which includes any fee paid to the Sub-Advisor. The fee paid by each Account (as a percentage of the average daily net assets) for the fiscal year ended December 31, 2005 was:
Asset Allocation 0.80% LargeCap Growth Equity 1.00% Balanced 0.59% LargeCap Stock Index 0.35% Bond 0.45% LargeCap Value 0.75% Capital Value 0.60% MidCap 0.57% Diversified International 0.85% MidCap Growth 0.90% Equity Growth 0.76% MidCap Value 1.05% Equity Income 0.60% Money Market 0.49% Government & High Quality Real Estate Securities Bond 0.44% 0.88% Growth 0.60% Short-Term Bond 0.50% International Emerging SmallCap Markets 1.25% 0.85% International SmallCap 1.19% SmallCap Growth 1.00% LargeCap Blend 0.75% SmallCap Value 1.09%
FEES PAID TO THE SUB-ADVISOR The Sub-Advisor fee paid by each Account (as a percentage of the average daily net assets) for the fiscal year ended December 31, 2005 was:
Asset Allocation 0.36% LargeCap Growth Equity 0.38% Balanced 0.10% LargeCap Stock Index 0.01% Bond 0.10% LargeCap Value 0.21% Capital Value 0.14% MidCap 0.14% Diversified International 0.10% MidCap Growth 0.36% Equity Growth 0.34% MidCap Value 0.46% Equity Income 0.17% Money Market 0.07% Government & High Quality Real Estate Securities Bond 0.10% 0.54% Growth 0.13% Short-Term Bond 0.10% International Emerging SmallCap Markets 0.48% 0.19% International SmallCap 0.48% SmallCap Growth 0.54% LargeCap Blend 0.30% SmallCap Value 0.49%
98 Principal Variable Contracts Fund 1-800-247-4123 The Fund and the Manager, under an order received from the SEC, may enter into and materially amend agreements with Sub-Advisors, other than those affiliated with the Manager, without obtaining shareholder approval. For any Account that is relying on that order, the Manager may: . hire one or more Sub-Advisors; . change Sub-Advisors; and . reallocate management fees between itself and Sub-Advisors. The Manager will continue to have the ultimate responsibility for the investment performance of these Accounts due to its responsibility to oversee Sub-Advisors and recommend their hiring, termination and replacement. No Account will rely on the order until it receives approval from its shareholders or, in the case of a new Account, the Account's sole initial shareholder before the Account is available to the other purchasers, and the Account states in its prospectus that it intends to rely on the order. The Asset Allocation, Equity Growth, LargeCap Blend, LargeCap Growth Equity, LargeCap Value, MidCap Growth, MidCap Value, SmallCap Growth and SmallCap Value Accounts have received the necessary shareholder approval and intend to rely on the order. Principal Variable Contracts Fund 99 www.principal.com GENERAL INFORMATION ABOUT AN ACCOUNT FREQUENT TRADING AND MARKET-TIMING (ABUSIVE TRADING PRACTICES) The Accounts of the Principal Variable Contracts Fund are not designed for frequent trading or market timing activity. The Fund has adopted fair valuation procedures to be used in the case of significant events, including broad market movements, occurring after the close of a foreign market in which securities are traded. The procedures will be followed if the Manager believes the events will impact the value of the foreign securities. These procedures are intended to discourage market timing transactions in shares of the Accounts. The Accounts do not knowingly accommodate frequent purchases and redemptions ("excessive trading") of Fund shares by investors. If you intend to trade frequently and/or use market timing investment strategies, do not purchase these Accounts. The Fund does not knowingly accommodate excessive trading. The Principal Variable Contracts Fund considers frequent trading and market timing activities to be abusive trading practices because they may: . Disrupt the management of the Accounts by; . forcing the Account to hold short-term (liquid) assets rather than investing for long term growth, which results in lost investment opportunities for the Account; and . causing unplanned portfolio turnover; . Hurt the portfolio performance of the Account; and . Increase expenses of the Account due to; . increased broker-dealer commissions; and . increased recordkeeping and related costs. If we are not able to identify such excessive trading practices, The Accounts may be negatively impacted and may cause investors to suffer the harms described. Certain Accounts may be at greater risk for abusive trading practices. For example, those Accounts that invest in foreign securities may appeal to investors attempting to take advantage of time-zone arbitrage. This risk is particularly relevant to the Diversified International, International Emerging Markets and International SmallCap Accounts but does apply to the purchase of foreign securities by any Account. As the Accounts of the Principal Variable Contracts Fund are only available through variable annuity or variable life contracts, the Principal Variable Contracts Fund must rely on Principal Life (as sponsor of the variable contract) to monitor customer trading activity to identify and take action against excessive trading. There can be no certainty that Principal Life will identify and prevent excessive trading in all instances. When Principal Life identifies excessive trading, Principal Life will act to curtail such trading in a fair and uniform manner. If Principal Life, or the Principal Variable Contracts Fund, deem excessive trading practices to be occurring, Principal Life will take action that may include, but is not limited to: . Rejecting exchange instructions from shareholder or other person authorized by the shareholder to direct exchanges; . Restricting submission of exchange requests by, for example, allowing exchange requests to be submitted by 1st class U.S. mail only and disallowing requests made via the internet, by facsimile, by overnight courier or by telephone; . Limiting the dollar amount of an exchange and/or the number of exchanges during a year; . Requiring a holding period of a minimum of 30 days before permitting exchanges among the Accounts where there is evidence of at least one round-trip exchange (exchange or redemption of shares that were purchased within 30 days of the exchange/redemption); and . Taking such other action as directed by the Principal Variable Contracts Fund. The Principal Variable Contracts Fund has reserved the right to accept or reject, without prior written notice, any exchange requests. In some instances, an exchange may be completed prior to a determination of abusive trading. In those instances, Principal Life will reverse an exchange (within three business days of the exchange) and return the account holdings to the positions held prior to the exchange. Principal Life will give you notice in writing in this instance. 100 Principal Variable Contracts Fund 1-800-247-4123 ELIGIBLE PURCHASERS Only certain eligible purchasers may buy shares of the Accounts. Eligible purchasers are limited to 1) separate accounts of Principal Life or of other insurance companies, 2) Principal Life or any of its subsidiaries or affiliates, 3) trustees of other managers of any qualified profit sharing, incentive or bonus plan established by Principal Life or any of its subsidiaries or affiliates for employees of such company, subsidiary or affiliate. Such trustees or managers may buy Account shares only in their capacities as trustees or managers and not for their personal accounts. The Board of Directors of the Fund reserves the right to broaden or limit the designation of eligible purchaser. Each Account serves as the underlying investment vehicle for variable annuity contracts and variable life insurance policies that are funded through separate accounts established by Principal Life. It is possible that in the future, it may not be advantageous for variable life insurance separate accounts and variable annuity separate accounts to invest in the Accounts at the same time. Although neither Principal Life nor the Fund currently foresees any such disadvantage, the Fund's Board of Directors monitors events in order to identify any material conflicts between such policy owners and contract holders. Material conflict could result from, for example, 1) changes in state insurance laws, 2) changes in Federal income tax law, 3) changes in the investment management of an Account, or 4) differences in voting instructions between those given by policy owners and those given by contract holders. Should it be necessary, the Board would determine what action, if any, should be taken. Such action could include the sale of Account shares by one or more of the separate accounts which could have adverse consequences. SHAREHOLDER RIGHTS The following information applies to each Account of the Principal Variable Contracts Fund, Inc. Each Account share is eligible to vote, either in person or by proxy, at all shareholder meetings for that Account. This includes the right to vote on the election of directors, selection of independent auditors and other matters submitted to meetings of shareholders of the Account. Each share has equal rights with every other share of the Account as to dividends, earnings, voting, assets and redemption. Shares are fully paid, non-assessable and have no preemptive or conversion rights. Shares of an Account are issued as full or fractional shares. Each fractional share has proportionately the same rights including voting as are provided for a full share. Shareholders of the Fund may remove any director with or without cause by the vote of a majority of the votes entitled to be case at a meeting of all Account shareholders. The bylaws of the Fund provide that the Board of Directors of the Fund may increase or decrease the aggregate number of shares that the Fund has the authority to issue, without a shareholder vote. The bylaws of the Fund also provide that the Fund does not need to hold an annual meeting of shareholders unless one of the following is required to be acted upon by shareholders under the Investment Company Act of 1940: election of directors; approval of an investment advisory agreement; ratification of the selection of independent auditors; and approval of the distribution agreement. The Fund intends to hold shareholder meetings only when required by law and at such other times when the Board of Directors deems it to be appropriate. Shareholder inquiries should be directed to: Principal Variable Contracts Fund, Inc., Principal Financial Group, Des Moines, Iowa 50392-2080. NON-CUMULATIVE VOTING The Fund's shares have non-cumulative voting rights. This means that the holders of more than 50% of the shares voting for the election of directors of the Fund can elect 100% of the directors if they choose to do so. In such event, the holders of the remaining shares voting for the election of directors will not be able to elect any directors. Principal Life votes each Account's shares allocated to each of its separate accounts registered under the Investment Company Act of 1940 and attributable to variable annuity contracts or variable life insurance policies participating in the separate accounts. The shares are voted in accordance with instructions received from contract holders, policy owners, participants and annuitants. Other shares of each Account held by each separate account, including shares for which no timely voting instructions are received, are voted in proportion to the instructions that are received with respect to contracts or policies participating that separate account. Shares of each of the Accounts held in the general account of Principal Life or in the unregistered separate accounts are voted in proportion to the instructions that are received with respect to contracts and policies participating in its registered and unregistered separate accounts. If Principal Life determines, under applicable law, that an Account's shares held in one or more separate accounts or in Principal Variable Contracts Fund 101 www.principal.com its general account need not be voted according to the instructions that are received, it may vote those Account shares in its own right. PURCHASE OF ACCOUNT SHARES Shares are purchased from Princor Financial Services Corporation, the Fund's principal underwriter. There are no sales charges on shares of the Accounts, however, your variable contract may impose a charge. There are no restrictions on amounts to be invested in shares of the Accounts. Shareholder accounts for each Account are maintained under an open account system. Under this system, an account is opened and maintained for each investor. Each investment is confirmed by sending the investor a statement of account showing the current purchase and the total number of shares owned. The statement of account is treated by each Account as evidence of ownership of Account shares. Share certificates are not issued. SALE OF ACCOUNT SHARES This section applies to eligible purchasers other than the separate accounts of Principal Life and its subsidiaries. Each Account sells its shares upon request. There is no charge for the sale. A shareholder sends a written request to the Account requesting the sale of any part or all of the shares. The letter must be signed exactly as the account is registered. If payment is to be made to the registered shareholder or joint shareholder, the Account does not require a signature guarantee. If payment is to be made to another party, the shareholder's signature(s) must be guaranteed by a commercial bank, trust company, credit union, savings and loan association, national securities exchange member or brokerage firm. Shares are redeemed at the net asset value per share next computed after the request is received by the Account in proper and complete form. Sales proceeds are generally sent within three business days after the request is received in proper form. However, the right to sell shares may be suspended during any period when 1) trading on the NYSE is restricted as determined by the SEC or when the NYSE is closed for other than weekends and holidays, or 2) an emergency exists, as determined by the SEC, as a result of which a) disposal by a fund of securities owned by it is not reasonably practicable, b) it is not reasonably practicable for a fund to fairly determine the value of its net assets, or c) the SEC permits suspension for the protection of security holders. If payments are delayed and the instruction is not canceled by the shareholder's written instruction, the amount of the transaction is determined as of the first valuation date following the expiration of the permitted delay. The transaction occurs within five days thereafter. In addition, payments on surrenders attributable to a premium payment made by check may be delayed up to 15 days. This permits payment to be collected on the check. RESTRICTED TRANSFERS Shares of each of the Accounts may be transferred to an eligible purchaser. However, if an Account is requested to transfer shares to other than an eligible purchaser, the Account has the right, at its election, to purchase the shares at the net asset value next calculated after the receipt of the transfer request. However, the Account must give written notification to the transferee(s) of the shares of the election to buy the shares within seven days of the request. Settlement for the shares shall be made within the seven-day period. FINANCIAL STATEMENTS You will receive an annual financial statement for the Fund, audited by the Fund's independent registered public accounting firm, Ernst & Young LLP. That report is a part of this prospectus. You will also receive a semiannual financial statement that is unaudited. FINANCIAL HIGHLIGHTS The following financial highlights tables are intended to help you understand the Fund's financial performance for the periods shown. Certain information reflects results for a single Fund share. The total returns in each table represent the 102 Principal Variable Contracts Fund 1-800-247-4123 rate that an investor would have earned or lost each period on an investment in the Fund (assuming reinvestment of all distributions). The financial statements for the Fund were audited by Ernst & Young LLP, whose report, along with the financial statements, is included in the most recent annual report for the Fund. To receive a copy of the latest annual or semiannual report for the Fund, you may telephone 1-800-247-4123. FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- ASSET ALLOCATION ACCOUNT ------------------------ Net Asset Value, Beginning of Period.. $12.28 $11.70 $9.82 $11.28 $12.02 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.19 0.14 0.15 0.20 0.24 Net Realized and Unrealized Gain (Loss) on Investments......... 0.51 0.82 1.92 (1.66) (0.71) ---- ---- ---- ----- ----- Total From Investment Operations 0.70 0.96 2.07 (1.46) (0.47) Less Dividends and Distributions: Dividends from Net Investment Income... (0.20) (0.38) (0.19) -- (0.24) Distributions from Realized Gains...... -- -- -- -- (0.03) ---- ----- Total Dividends and Distributions (0.20) (0.38) (0.19) -- (0.27) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $12.78 $12.28 $11.70 $9.82 $11.28 ====== ====== ====== ===== ====== Total Return /(a)/ ... 5.79% 8.49% 21.61% (12.94)% (3.92)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $100,637 $103,131 $98,006 $82,409 $101,904 Ratio of Expenses to Average Net Assets.. 0.86% 0.84% 0.85% 0.84% 0.85% Ratio of Net Investment Income to Average Net Assets.. 1.53% 1.19% 1.49% 1.79% 2.23% Portfolio Turnover Rate................ 83.5% 127.0% 186.0% 255.3% 182.4% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- BALANCED ACCOUNT ---------------- Net Asset Value, Beginning of Period.. $14.34 $13.31 $11.56 $13.73 $15.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.31 0.31 0.27 0.34 0.40/(c)/ Net Realized and Unrealized Gain (Loss) on Investments......... 0.64 1.00 1.83 (2.11) (1.42)/(c)/ ---- ---- ---- ----- ----- Total From Investment Operations 0.95 1.31 2.10 (1.77) (1.02) Less Dividends and Distributions: Dividends from Net Investment Income... (0.36) (0.28) (0.35) (0.40) (0.47) Distributions from Realized Gains...... -- -- -- -- (0.21) ---- ----- Total Dividends and Distributions (0.36) (0.28) (0.35) (0.40) (0.68) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $14.93 $14.34 $13.31 $11.56 $13.73 ====== ====== ====== ====== ====== Total Return /(a)/ ... 6.79% 10.05% 18.82% (13.18)% (6.96)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $116,927 $126,548 $124,735 $110,545 $144,214 Ratio of Expenses to Average Net Assets.. 0.64% 0.63% 0.65% 0.61% 0.61% Ratio of Gross Expenses to Average Net Assets.......... -- 0.63%/(b)/ 0.65%/(b)/ 0.62%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 2.19% 2.32% 2.23% 2.52% 2.73%/(c)/ Portfolio Turnover Rate................ 115.3% 128.3% 114.3% 87.8% 114.3%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. /(c) /Effective January 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies. The effect of this change for the year ended December 31, 2001 was to decrease net investment income per share by $.01, increase net realized and unrealized gains/losses per share by $.01, and decrease the ratio of net investment income to average net assets by .08%. Financial highlights for prior periods have not been restated to reflect this change in presentation. 67 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- BOND ACCOUNT ------------ Net Asset Value, Beginning of Period.. $12.31 $12.31 $12.32 $11.84 $11.78 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.50 0.51 0.52 0.51 0.56/(c)/ Net Realized and Unrealized Gain (Loss) on Investments......... (0.20) 0.08 0.02 0.54 0.35/(c)/ ----- ---- ---- ---- ---- Total From Investment Operations 0.30 0.59 0.54 1.05 0.91 Less Dividends and Distributions: Dividends from Net Investment Income... (0.57) (0.59) (0.55) (0.57) (0.85) ----- ----- ----- ----- ----- Total Dividends and Distributions (0.57) (0.59) (0.55) (0.57) (0.85) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $12.04 $12.31 $12.31 $12.32 $11.84 ====== ====== ====== ====== ====== Total Return /(a)/ ... 2.50% 4.98% 4.59% 9.26% 8.12% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $338,044 $286,684 $263,435 $232,839 $166,658 Ratio of Expenses to Average Net Assets.. 0.47% 0.47% 0.47% 0.49% 0.50% Ratio of Net Investment Income to Average Net Assets.. 4.21% 4.23% 4.32% 5.02% 5.73%/(c)/ Portfolio Turnover Rate................ 176.2% 143.6% 82.1% 63.3% 146.1% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- CAPITAL VALUE ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $32.39 $29.23 $23.60 $27.78 $30.72 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.54 0.44 0.38 0.39 0.34 Net Realized and Unrealized Gain (Loss) on Investments......... 1.66 3.17 5.63 (4.18) (2.80) ---- ---- ---- ----- ----- Total From Investment Operations 2.20 3.61 6.01 (3.79) (2.46) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.45) (0.38) (0.39) (0.34) Distributions from Realized Gains...... -- -- -- -- (0.14) ----- ----- Total Dividends and Distributions -- (0.45) (0.38) (0.39) (0.48) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $34.59 $32.39 $29.23 $23.60 $27.78 ====== ====== ====== ====== ====== Total Return /(a)/ ... 6.80% 12.36% 25.49% (13.66)% (8.05)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $258,490 $265,580 $248,253 $206,541 $254,484 Ratio of Expenses to Average Net Assets.. 0.61% 0.60% 0.61% 0.61% 0.61% Ratio of Gross Expenses to Average Net Assets.......... -- 0.60%/(b)/ 0.61%/(b)/ 0.61%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.62% 1.47% 1.47% 1.45% 1.20% Portfolio Turnover Rate................ 120.9% 183.3% 125.7% 142.6% 91.7%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. /(c) /Effective January 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies. The effect of this change for the year ended December 31, 2001 was to decrease net investment income per share by $.01, increase net realized and unrealized gains/losses per share by $.01, and decrease the ratio of net investment income to average net assets by .08%. Financial highlights for prior periods have not been restated to reflect this change in presentation. 68 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- DIVERSIFIED INTERNATIONAL ACCOUNT --------------------------------- Net Asset Value, Beginning of Period /(a)/ ............... $13.75 $11.48 $8.78 $10.51 $13.90 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.18 0.17 0.13 0.10 0.09 Net Realized and Unrealized Gain (Loss) on Investments......... 3.05 2.22 2.67 (1.78) (3.46) ---- ---- ---- ----- ----- Total From Investment Operations 3.23 2.39 2.80 (1.68) (3.37) Less Dividends and Distributions: Dividends from Net Investment Income... (0.15) (0.12) (0.10) (0.05) (0.02) ----- ----- ----- ----- ----- Total Dividends and Distributions (0.15) (0.12) (0.10) (0.05) (0.02) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $16.83 $13.75 $11.48 $8.78 $10.51 ====== ====== ====== ===== ====== Total Return /(b)/ ... 23.79% 21.03% 32.33% (16.07)% (24.27)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $293,647 $226,753 $167,726 $119,222 $145,848 Ratio of Expenses to Average Net Assets.. 0.97% 0.96% 0.92% 0.92% 0.92% Ratio of Gross Expenses to Average Net Assets.......... 0.97%/(c)/ 0.97%/(d)/ 0.93%/(d)/ 0.93%/(d)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.27% 1.39% 1.33% 1.03% 0.78% Portfolio Turnover Rate................ 121.2% 170.1% 111.5% 82.2% 84.3% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- EQUITY GROWTH ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $16.02 $14.73 $11.74 $16.29 $20.37 Income from Investment Operations: Net Investment Income (Operating Loss).... -- 0.09 0.06 0.03 0.01 Net Realized and Unrealized Gain (Loss) on Investments......... 1.21 1.28 2.99 (4.54) (2.82) ---- ---- ---- ----- ----- Total From Investment Operations 1.21 1.37 3.05 (4.51) (2.81) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.08) (0.06) (0.04) (0.02) Distributions from Realized Gains...... -- -- -- -- (1.25) ---- ----- Total Dividends and Distributions -- (0.08) (0.06) (0.04) (1.27) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $17.23 $16.02 $14.73 $11.74 $16.29 ====== ====== ====== ====== ====== Total Return /(b)/ ... 7.55% 9.33% 25.95% (27.72)% (14.86)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $274,192 $280,700 $272,831 $219,044 $334,401 Ratio of Expenses to Average Net Assets.. 0.77% 0.72% 0.74% 0.77% 0.75% Ratio of Gross Expenses to Average Net Assets.......... -- 0.77%/(e)/ 0.77%/(e)/ -- -- Ratio of Net Investment Income to Average Net Assets.. 0.00% 0.59% 0.47% 0.19% 0.06% Portfolio Turnover Rate................ 51.6% 147.7% 130.9% 138.8% 88.8%
/(a) /Effective May 1, 2005, International Account changed its name to Diversified International Account. /(b) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(c) /Expense ratio without custodian credits. /(d) /Expense ratio without commission rebates and custodian credits. /(e) /Expense ratio without commission rebates. 69 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- EQUITY INCOME ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $9.01 $7.93 $7.26 $8.73 $12.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.37 0.34 0.34 0.37 0.25 Net Realized and Unrealized Gain (Loss) on Investments......... 0.41 1.05 0.66 (1.47) (3.70) ---- ---- ---- ----- ----- Total From Investment Operations 0.78 1.39 1.00 (1.10) (3.45) Less Dividends and Distributions: Dividends from Net Investment Income... (0.01) (0.31) (0.33) (0.37) (0.25) ---- Total Dividends and Distributions (0.01) (0.31) (0.33) (0.37) (0.25) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $9.78 $9.01 $7.93 $7.26 $8.73 ===== ===== ===== ===== ===== Total Return /(b)/ ... 8.67% 17.60% 13.83% (12.61)% (27.70)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $91,489 $44,572 $30,255 $25,079 $33,802 Ratio of Expenses to Average Net Assets.. 0.66% 0.62% 0.61% 0.62% 0.62% Ratio of Net Investment Income to Average Net Assets.. 3.93% 4.13% 4.54% 4.40% 2.22% Portfolio Turnover Rate................ 84.7% 137.2% 22.5% 66.4% 104.2% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- GOVERNMENT & HIGH QUALITY BOND ACCOUNT /(A)/ -------------------------------------- Net Asset Value, Beginning of Period.. $11.64 $11.77 $12.00 $11.58 $11.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.44 0.44 0.45 0.43 0.51 Net Realized and Unrealized Gain (Loss) on Investments......... (0.21) (0.04) (0.24) 0.55 0.32 ---- ----- ----- ---- ---- Total From Investment Operations 0.23 0.40 0.21 0.98 0.83 Less Dividends and Distributions: Dividends from Net Investment Income... (0.51) (0.53) (0.44) (0.52) (0.68) Distributions from Realized Gains...... -- -- -- (0.04) -- ---- ----- Total Dividends and Distributions (0.51) (0.53) (0.44) (0.56) (0.68) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $11.36 $11.64 $11.77 $12.00 $11.58 ====== ====== ====== ====== ====== Total Return /(b)/ ... 2.01% 3.56% 1.84% 8.80% 7.61% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $316,047 $334,034 $368,564 $342,001 $193,254 Ratio of Expenses to Average Net Assets.. 0.46% 0.44% 0.44% 0.47% 0.49% Ratio of Net Investment Income to Average Net Assets.. 3.88% 3.82% 3.83% 4.87% 5.63% Portfolio Turnover Rate................ 262.1% 67.2% 110.4% 33.8% 45.9%
/(a) /Effective November 19, 2005, Government Securities Account changed its name to Government & High Quality Bond Account. /(b) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. 70 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- GROWTH ACCOUNT -------------- Net Asset Value, Beginning of Period.. $11.94 $10.95 $8.68 $12.24 $16.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.03 0.07 0.03 0.02 -- Net Realized and Unrealized Gain (Loss) on Investments......... 1.40 0.95 2.26 (3.58) (4.19) ---- ---- ---- ----- ----- Total From Investment Operations 1.43 1.02 2.29 (3.56) (4.19) Less Dividends and Distributions: Dividends from Net Investment Income... (0.08) (0.03) (0.02) -- -- ---- Total Dividends and Distributions (0.08) (0.03) (0.02) -- -- ---- ----- ----- ----- Net Asset Value, End of Period............ $13.29 $11.94 $10.95 $8.68 $12.24 ====== ====== ====== ===== ====== Total Return /(b)/ ... 12.09% 9.38% 26.46% (29.07)% (25.50)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $124,254 $134,956 $141,107 $124,079 $209,879 Ratio of Expenses to Average Net Assets.. 0.62% 0.60% 0.61% 0.61% 0.61% Ratio of Gross Expenses to Average Net Assets.......... -- 0.60%/(f)/ 0.61%/(f)/ 0.61%/(f)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.26% 0.67% 0.35% 0.18% 0.02% Portfolio Turnover Rate................ 78.3% 122.4% 40.8% 27.3% 39.0% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- INTERNATIONAL EMERGING MARKETS ACCOUNT -------------------------------------- Net Asset Value, Beginning of Period.. $14.78 $12.86 $8.24 $8.93 $9.37 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.22 0.12 0.11 0.02 0.08 Net Realized and Unrealized Gain (Loss) on Investments......... 4.46 3.04 4.60 (0.70) (0.48) ---- ---- ---- ----- ----- Total From Investment Operations 4.68 3.16 4.71 (0.68) (0.40) Less Dividends and Distributions: Dividends from Net Investment Income... (0.17) (0.10) (0.08) -- (0.04) Distributions from Realized Gains...... (3.27) (1.14) -- -- -- Tax Return of Capital Distributions /(a)/. -- -- (0.01) (0.01) -- ----- ----- ----- Total Dividends and Distributions (3.44) (1.24) (0.09) (0.01) (0.04) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $16.02 $14.78 $12.86 $8.24 $8.93 ====== ====== ====== ===== ===== Total Return /(b)/ ... 34.29% 24.89% 57.20% (7.63)% (4.24)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $71,639 $43,502 $23,972 $10,835 $6,964 Ratio of Expenses to Average Net Assets.. 1.60% 1.53% 1.71% 1.60% 1.35% Ratio of Gross Expenses to Average Net Assets /(c)/ ... 1.60%/(d)/ 1.55%/(e)/ 1.84%/(e)/ 2.26%/(e)/ 2.33% Ratio of Net Investment Income to Average Net Assets.. 1.45% 0.87% 1.16% 0.39% 0.97% Portfolio Turnover Rate................ 169.6% 171.0% 112.4% 147.7% 137.4%
/(a) /See "Dividends and Distributions to Shareholders" in Notes to Financial Statements. /(b) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(c) /Expense ratio without the Manager's voluntary expense limit. The expense limit was increased on May 1, 2002, and May 1, 2003, and ceased on May 1, 2004. /(d) /Expense ratio without custodian credits. /(e) /Expense ratio without commission rebates and custodian credits. /(f) /Expense ratio without commission rebates. 72 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- INTERNATIONAL SMALLCAP ACCOUNT ------------------------------ Net Asset Value, Beginning of Period.. $17.72 $13.73 $9.06 $10.84 $13.87 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.12 0.11 0.10 0.08 0.04 Net Realized and Unrealized Gain (Loss) on Investments......... 4.96 4.00 4.72 (1.83) (3.07) ---- ---- ---- ----- ----- Total From Investment Operations 5.08 4.11 4.82 (1.75) (3.03) Less Dividends and Distributions: Dividends from Net Investment Income... (0.11) (0.12) (0.15) (0.03) -- Distributions from Realized Gains...... (0.19) -- -- -- -- ---- ----- Total Dividends and Distributions (0.30) (0.12) (0.15) (0.03) -- ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $22.50 $17.72 $13.73 $9.06 $10.84 ====== ====== ====== ===== ====== Total Return /(a)/ ... 29.12% 30.20% 54.15% (16.20)% (21.85)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $143,454 $99,833 $66,242 $38,912 $43,674 Ratio of Expenses to Average Net Assets.. 1.33% 1.30% 1.33% 1.31% 1.41% Ratio of Gross Expenses to Average Net Assets.......... 1.33%/(d)/ 1.31%/(e)/ 1.33%/(e)/ 1.32%/(e)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.63% 0.75% 1.00% 0.77% 0.32% Portfolio Turnover Rate................ 132.3% 140.6% 128.9% 73.6% 123.8% 2005 2004 2003 2002/(F)/ ---- ---- ---- ---- LARGECAP BLEND ACCOUNT ---------------------- Net Asset Value, Beginning of Period.. $10.73 $10.37 $8.43 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.10 0.13 0.10 0.02 Net Realized and Unrealized Gain (Loss) on Investments......... 0.40 0.92 1.90 (1.57) ---- ---- ---- ----- Total From Investment Operations 0.50 1.05 2.00 (1.55) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.11) (0.06) (0.02) Distributions from Realized Gains...... (0.04) (0.58) -- -- ---- ----- ----- Total Dividends and Distributions (0.04) (0.69) (0.06) (0.02) ----- ----- ----- ----- Net Asset Value, End of Period............ $11.19 $10.73 $10.37 $8.43 ====== ====== ====== ===== Total Return /(a)/ ... 4.74% 10.36% 23.76% (15.47)%/(g)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $135,072 $90,751 $54,632 $13,927 Ratio of Expenses to Average Net Assets.. 0.78% 0.76% 0.80% 1.00%/(h)/ Ratio of Gross Expenses to Average Net Assets /(b)/ ... -- 0.78%/(c)/ 0.83%/(c)/ 1.10%/(h)(c)/ Ratio of Net Investment Income to Average Net Assets.. 0.96% 1.23% 1.08% 0.86%/(h)/ Portfolio Turnover Rate................ 44.1% 75.6% 56.2% 49.1%/(h)/
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on May 1, 2004. /(c) /Expense ratio without commission rebates. /(d) /Expense ratio without custodian credits. /(e) /Expense ratio without commission rebates and custodian credits. /(f) /Period from May 1, 2002, date operations commenced, through December 31, 2002. /(g) /Total return amounts have not been annualized. /(h) /Computed on an annualized basis. 73 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- LARGECAP GROWTH EQUITY ACCOUNT ------------------------------ Net Asset Value, Beginning of Period.. $4.60 $4.47 $3.63 $5.44 $7.78 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.01 0.01 -- (0.02) (0.03) Net Realized and Unrealized Gain (Loss) on Investments......... 0.16 0.13 0.84 (1.79) (2.31) ---- ---- ---- ----- ----- Total From Investment Operations 0.17 0.14 0.84 (1.81) (2.34) Less Dividends and Distributions: Dividends from Net Investment Income... (0.01) (0.01) -- -- -- ----- ----- ----- Total Dividends and Distributions (0.01) (0.01) -- -- -- ----- ----- ----- Net Asset Value, End of Period............ $4.76 $4.60 $4.47 $3.63 $5.44 ===== ===== ===== ===== ===== Total Return /(a)/ ... 3.63% 3.16% 23.14% (33.27)% (30.08)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $36,912 $31,179 $24,677 $5,572 $5,172 Ratio of Expenses to Average Net Assets.. 1.09% 1.04% 1.16% 1.05% 1.10% Ratio of Gross Expenses to Average Net Assets /(b)/ ... -- 1.05%/(d)/ 1.19%/(d)/ 1.09%/(d)/ 1.11% Ratio of Net Investment Income to Average Net Assets.. 0.18% 0.28% (0.13)% (0.49)% (0.62)% Portfolio Turnover Rate................ 91.2% 141.8% 51.1% 183.8% 121.2% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- LARGECAP STOCK INDEX ACCOUNT ---------------------------- Net Asset Value, Beginning of Period.. $8.77 $8.06 $6.35 $8.29 $9.52 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.13 0.14 0.10 0.08 0.08 Net Realized and Unrealized Gain (Loss) on Investments......... 0.26 0.70 1.70 (1.94) (1.23) ---- ---- ---- ----- ----- Total From Investment Operations 0.39 0.84 1.80 (1.86) (1.15) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.13) (0.09) (0.08) (0.08) ----- Total Dividends and Distributions -- (0.13) (0.09) (0.08) (0.08) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $9.16 $8.77 $8.06 $6.35 $8.29 ===== ===== ===== ===== ===== Total Return /(a)/ ... 4.47% 10.39% 28.32% (22.44)% (12.10)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $179,143 $158,237 $118,638 $72,949 $73,881 Ratio of Expenses to Average Net Assets.. 0.38% 0.37% 0.39% 0.39% 0.40% Ratio of Gross Expenses to Average Net Assets /(c)/ ... 0.38% 0.37% 0.39% 0.39% 0.41% Ratio of Net Investment Income to Average Net Assets.. 1.52% 1.64% 1.42% 1.22% 1.05% Portfolio Turnover Rate................ 13.1% 20.5% 15.7% 15.1% 10.8%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on May 1, 2002. /(c) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on April 29, 2005. /(d) /Expense ratio without commission rebates. 73 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002/(C)/ ---- ---- ---- ---- LARGECAP VALUE ACCOUNT ---------------------- Net Asset Value, Beginning of Period.. $11.88 $10.80 $8.52 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.18 0.19 0.16 0.06 Net Realized and Unrealized Gain (Loss) on Investments......... 0.46 1.22 2.23 (1.48) ---- ---- ---- ----- Total From Investment Operations 0.64 1.41 2.39 (1.42) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.16) (0.11) (0.06) Distributions from Realized Gains...... (0.07) (0.17) -- -- ----- ----- ----- Total Dividends and Distributions (0.07) (0.33) (0.11) (0.06) ----- ----- ----- ----- Net Asset Value, End of Period............ $12.45 $11.88 $10.80 $8.52 ====== ====== ====== ===== Total Return /(a)/ ... 5.44% 13.09% 28.05% (14.24)%/(d)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $122,221 $80,721 $47,221 $13,186 Ratio of Expenses to Average Net Assets.. 0.77% 0.75% 0.74% 0.96%/(e)/ Ratio of Gross Expenses to Average Net Assets /(b)/ ... -- 0.76%/(f)/ 0.79%/(f)/ 1.00%/(e)(f)/ Ratio of Net Investment Income to Average Net Assets.. 1.52% 1.65% 1.77% 1.79%/(e)/ Portfolio Turnover Rate................ 19.7% 23.2% 17.1% 5.9%/(e)/ 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MIDCAP ACCOUNT -------------- Net Asset Value, Beginning of Period.. $39.63 $37.56 $28.54 $32.09 $34.47 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.45 0.39 0.35 0.30 0.24 Net Realized and Unrealized Gain (Loss) on Investments......... 3.12 6.05 9.01 (3.08) (1.50) ---- ---- ---- ----- ----- Total From Investment Operations 3.57 6.44 9.36 (2.78) (1.26) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.39) (0.34) (0.30) (0.24) Distributions from Realized Gains...... (0.66) (3.98) -- (0.47) (0.88) ---- ----- ----- ----- ----- Total Dividends and Distributions (0.66) (4.37) (0.34) (0.77) (1.12) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $42.54 $39.63 $37.56 $28.54 $32.09 ====== ====== ====== ====== ====== Total Return /(a)/ ... 9.21% 17.76% 32.81% (8.75)% (3.71)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $420,812 $395,304 $334,204 $248,986 $278,707 Ratio of Expenses to Average Net Assets.. 0.58% 0.59% 0.61% 0.62% 0.62% Ratio of Gross Expenses to Average Net Assets.......... -- 0.59%/(f)/ 0.61%/(f)/ 0.62%/(f)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.13% 1.02% 1.09% 0.98% 0.77% Portfolio Turnover Rate................ 49.9% 38.9% 44.9% 67.9% 73.6%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on May 1, 2004. /(c) /Period from May 1, 2002, date operations commenced, through December 31, 2002. /(d) /Total return amounts have not been annualized. /(e) /Computed on an annualized basis. /(f) /Expense ratio without commission rebates. 74 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MIDCAP GROWTH ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $9.84 $8.80 $6.26 $8.49 $10.46 Income from Investment Operations: Net Investment Income (Operating Loss).... (0.02) (0.03) (0.03) (0.04) (0.05) Net Realized and Unrealized Gain (Loss) on Investments......... 1.37 1.07 2.57 (2.19) (1.68) ---- ---- ---- ----- ----- Total From Investment Operations 1.35 1.04 2.54 (2.23) (1.73) Less Dividends and Distributions: Distributions from Realized Gains...... -- -- -- -- (0.24) ---- ----- Total Dividends and Distributions -- -- -- -- (0.24) ---- ----- Net Asset Value, End of Period............ $11.19 $9.84 $8.80 $6.26 $8.49 ====== ===== ===== ===== ===== Total Return /(a)/ ... 13.72% 11.82% 40.58% (26.27)% (16.92)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $68,471 $59,674 $54,288 $21,934 $27,838 Ratio of Expenses to Average Net Assets.. 0.92% 0.86% 0.91% 0.91% 0.97% Ratio of Gross Expenses to Average Net Assets.......... -- 0.92%/(b)/ 0.94%/(b)/ 0.92%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. (0.15)% (0.30)% (0.39)% (0.55)% (0.66)% Portfolio Turnover Rate................ 97.0% 47.7% 67.5% 43.1% 55.2% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MIDCAP VALUE ACCOUNT -------------------- Net Asset Value, Beginning of Period.. $15.38 $14.13 $10.48 $11.68 $12.57 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.05 0.02 0.01 -- 0.01 Net Realized and Unrealized Gain (Loss) on Investments......... 1.53 3.10 3.81 (1.16) (0.35) ---- ---- ---- ----- ----- Total From Investment Operations 1.58 3.12 3.82 (1.16) (0.34) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.01) (0.01) -- (0.01) Distributions from Realized Gains...... (0.39) (1.86) (0.16) (0.04) (0.54) ----- ----- ----- ----- ----- Total Dividends and Distributions (0.39) (1.87) (0.17) (0.04) (0.55) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $16.57 $15.38 $14.13 $10.48 $11.68 ====== ====== ====== ====== ====== Total Return /(a)/ ... 10.55% 22.67% 36.49% (9.96)% (2.58)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $112,437 $78,166 $52,054 $24,766 $11,778 Ratio of Expenses to Average Net Assets.. 1.07% 1.05% 1.05% 1.04% 1.36% Ratio of Gross Expenses to Average Net Assets.......... -- 1.08%/(b)/ 1.08%/(b)/ 1.10%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.32% 0.11% 0.11% 0.03% 0.12% Portfolio Turnover Rate................ 90.6% 59.2% 55.5% 75.3% 208.8%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. 75 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MONEY MARKET ACCOUNT -------------------- Net Asset Value, Beginning of Period.. $1.000 $1.000 $1.000 $1.000 $1.000 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.027 0.009 0.007 0.014 0.039 ----- ----- ----- ----- ----- Total From Investment Operations 0.027 0.009 0.007 0.014 0.039 Less Dividends and Distributions: Dividends from Net Investment Income... (0.027) (0.009) (0.007) (0.014) (0.039) ------ ------ ------ ------ ------ Total Dividends and Distributions (0.027) (0.009) (0.007) (0.014) (0.039) ------ ------ ------ ------ ------ Net Asset Value, End of Period............ $1.000 $1.000 $1.000 $1.000 $1.000 ====== ====== ====== ====== ====== Total Return /(a)/ ... 2.69% 0.92% 0.74% 1.42% 3.92% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $150,653 $140,553 $151,545 $201,455 $180,923 Ratio of Expenses to Average Net Assets.. 0.61% 0.49% 0.49% 0.49% 0.50% Ratio of Net Investment Income to Average Net Assets.. 2.66% 0.91% 0.74% 1.40% 3.70% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- REAL ESTATE SECURITIES ACCOUNT ------------------------------ Net Asset Value, Beginning of Period.. $17.88 $14.90 $11.24 $10.77 $10.29 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.40 0.39 0.49 0.35 0.42 Net Realized and Unrealized Gain (Loss) on Investments......... 2.39 4.66 3.87 0.48 0.47 ---- ---- ---- ---- ---- Total From Investment Operations 2.79 5.05 4.36 0.83 0.89 Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.35) (0.42) (0.35) (0.41) Distributions from Realized Gains...... (0.16) (1.72) (0.28) (0.01) -- ---- ----- ----- ----- ----- Total Dividends and Distributions (0.16) (2.07) (0.70) (0.36) (0.41) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $20.51 $17.88 $14.90 $11.24 $10.77 ====== ====== ====== ====== ====== Total Return /(a)/ ... 15.85% 34.53% 38.91% 7.72% 8.75% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $178,922 $146,022 $93,018 $46,358 $22,457 Ratio of Expenses to Average Net Assets.. 0.89% 0.90% 0.91% 0.92% 0.92% Ratio of Gross Expenses to Average Net Assets ......... -- 0.90% 0.92% -- -- Ratio of Net Investment Income to Average Net Assets.. 2.16% 2.37% 3.83% 3.99% 4.55% Portfolio Turnover Rate................ 23.6% 58.8% 53.9% 54.4% 92.4%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. 80 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003/(D)/ ---- ---- ---- SHORT-TERM BOND ACCOUNT ----------------------- Net Asset Value, Beginning of Period /(c)/ ............... $10.12 $9.99 $10.00 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.33 0.25 0.13 Net Realized and Unrealized Gain (Loss) on Investments......... (0.15) (0.12) (0.05) ----- ----- ----- Total From Investment Operations 0.18 0.13 0.08 Less Dividends and Distributions: Dividends from Net Investment Income... (0.19) -- (0.09) ---- ----- ----- Total Dividends and Distributions (0.19) -- (0.09) ---- ----- ----- Net Asset Value, End of Period............ $10.11 $10.12 $9.99 ====== ====== ===== Total Return /(a)/ ... 1.80% 1.30% 0.78%/(e)/ Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $83,822 $56,241 $20,552 Ratio of Expenses to Average Net Assets.. 0.57% 0.53% 0.57%/(f)/ Ratio of Gross Expenses to Average Net Assets/(b)/..... -- -- 0.57%/(f)/ Ratio of Net Investment Income to Average Net Assets.. 3.26% 2.53% 2.15%/(f)/ Portfolio Turnover Rate................ 74.3% 34.8% 5.0%/(f)/ 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- SMALLCAP ACCOUNT ---------------- Net Asset Value, Beginning of Period.. $9.55 $7.97 $5.83 $8.03 $7.83 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.02 -- 0.01 0.01 -- Net Realized and Unrealized Gain (Loss) on Investments......... 0.65 1.58 2.14 (2.20) 0.20 ---- ---- ---- ----- ---- Total From Investment Operations 0.67 1.58 2.15 (2.19) 0.20 Less Dividends and Distributions: Dividends from Net Investment Income... -- -- (0.01) (0.01) -- ---- ----- ----- Total Dividends and Distributions -- -- (0.01) (0.01) -- ---- ----- ----- Net Asset Value, End of Period............ $10.22 $9.55 $7.97 $5.83 $8.03 ====== ===== ===== ===== ===== Total Return /(a)/ ... 7.04% 19.82% 36.82% (27.33)% 2.55% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $94,476 $85,115 $65,285 $32,201 $36,493 Ratio of Expenses to Average Net Assets.. 0.88% 0.86% 0.95% 0.97% 1.00% Ratio of Gross Expenses to Average Net Assets.......... -- 0.86%/(g)/ 0.95%/(g)/ 0.97%/(g)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.17% 0.03% 0.09% 0.12% (0.06)% Portfolio Turnover Rate................ 125.8% 188.7% 162.9% 215.5% 154.5%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without the Manager's voluntary expense limit. The expense limit ceased on May 1, 2004. /(c) /Effective November 19, 2005, Limited Term Bond Account changed its name to Short-Term Bond Account. /(d) /Period from May 1, 2003, date operations commenced, through December 31, 2003. /(e) /Total return amounts have not been annualized. /(f) /Computed on an annualized basis. /(g) /Expense ratio without commission rebates. 80 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- SMALLCAP GROWTH ACCOUNT ----------------------- Net Asset Value, Beginning of Period.. $9.30 $8.36 $5.74 $10.60 $15.59 Income from Investment Operations: Net Investment Income (Operating Loss).... (0.07) (0.06) (0.04) (0.05) (0.10) Net Realized and Unrealized Gain (Loss) on Investments......... 0.69 1.00 2.66 (4.81) (4.89) ---- ---- ---- ----- ----- Total From Investment Operations 0.62 0.94 2.62 (4.86) (4.99) ---- ---- ---- ----- ----- Net Asset Value, End of Period............ $9.92 $9.30 $8.36 $5.74 $10.60 ===== ===== ===== ===== ====== Total Return /(a)/ ... 6.67% 11.24% 45.64% (45.85)% (32.01)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $66,656 $63,453 $55,628 $32,754 $55,966 Ratio of Expenses to Average Net Assets.. 1.05% 0.99% 0.99% 0.95% 1.05% Ratio of Gross Expenses to Average Net Assets ......... -- 1.01%/(b)/ 1.02%/(b)/ 1.06%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. (0.77)% (0.70)% (0.64)% (0.68)% (0.92)% Portfolio Turnover Rate................ 68.2% 43.3% 54.1% 287.9% 152.2% 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- SMALLCAP VALUE ACCOUNT ---------------------- Net Asset Value, Beginning of Period.. $16.83 $15.04 $10.30 $11.37 $11.26 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.07 0.03 0.06 0.06 0.09 Net Realized and Unrealized Gain (Loss) on Investments......... 0.96 3.37 5.14 (1.07) 0.60 ---- ---- ---- ----- ---- Total From Investment Operations 1.03 3.40 5.20 (1.01) 0.69 Less Dividends and Distributions: Dividends from Net Investment Income... (0.01) (0.03) (0.05) (0.06) (0.09) Distributions from Realized Gains...... (0.24) (1.58) (0.41) -- (0.49) ---- ----- ----- ----- ----- Total Dividends and Distributions (0.25) (1.61) (0.46) (0.06) (0.58) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $17.61 $16.83 $15.04 $10.30 $11.37 ====== ====== ====== ====== ====== Total Return /(a)/ ... 6.22% 23.08% 50.61% (8.86)% 6.25% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $132,035 $107,206 $82,135 $44,217 $30,888 Ratio of Expenses to Average Net Assets.. 1.13% 1.12% 1.16% 1.28% 1.24% Ratio of Gross Expenses to Average Net Assets.......... -- 1.13%/(b)/ 1.18%/(b)/ 1.29%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 0.38% 0.21% 0.50% 0.68% 0.95% Portfolio Turnover Rate................ 45.3% 38.0% 54.0% 77.4% 67.8%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. 82 ADDITIONAL INFORMATION Additional information about the Fund (including the Fund's policy regarding the disclosure of portfolio securities) is available in the Statement of Additional Information dated May 1, 2006 which is incorporated by reference into this prospectus. Additional information about the Funds' investments is available in the Fund's annual and semiannual reports to shareholders. In the Funds' annual report, you will find a discussion of the market conditions and investment strategies that significantly affected the Funds' performance during the last fiscal year. The Statement of Additional Information and the Fund's annual and semi-annual reports can be obtained free of charge by writing or telephoning Princor Financial Services Corporation, P.O. Box 10423, Des Moines, IA 50306. In addition, the Fund makes its Statement of Additional Information and annual and semi-annual reports available, free of charge, on http:// www.principal.com. To request this and other information about the Fund and to make shareholder inquiries, telephone 1-800-247-4123. Information about the Fund (including the Statement of Additional Information) can be reviewed and copied at the Commission's Public Reference Room in Washington, D.C. Information on the operation of the Public Reference Room may be obtained by calling the Commission at 1-202-942-8090. Reports and other information about the Fund are available on the EDGAR Database on the Commission's internet site at http://www.sec.gov. Copies of this information may be obtained, upon payment of a duplicating fee, by electronic request at the following E-mail address: publicinfo@sec.gov, or by writing the Commission's Public Reference Section, Washington, D.C. 20549-0102. The U.S. government does not insure or guarantee an investment in any of the Accounts. There can be no assurance that the Money Market Account will be able to maintain a stable share price of $1.00 per share. Shares of the Accounts are not deposits or obligations of, or guaranteed or endorsed by, any financial institution, nor are shares of the Accounts federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other agency. Principal Variable Contracts Fund, Inc. SEC File 811-01944 104 Principal Variable Contracts Fund 1-800-247-4123 PRINCIPAL VARIABLE CONTRACTS FUND, INC.
ACCOUNTS OF THE FUND -------------------- CAPITAL VALUE ACCOUNT MONEY MARKET ACCOUNT GOVERNMENT & HIGH QUALITY BOND ACCOUNT
This Prospectus describes a mutual fund organized by Principal Life Insurance Company/(R)/ ("Principal Life"). The Fund provides a choice of investment objectives through the Accounts listed above. The date of this Prospectus is May 1, 2006. As with all mutual funds, neither the Securities and Exchange Commission ("SEC") nor any State Securities Commission has approved or disapproved of these securities or determined if this prospectus is accurate or complete. It is a criminal offense to represent otherwise. TABLE OF CONTENTS ACCOUNT DESCRIPTIONS....................................................3 Capital Value Account.................................................5 Government & High Quality Bond Account................................8 Money Market Account..................................................11 CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.........................14 PRICING OF ACCOUNT SHARES...............................................19 DIVIDENDS AND DISTRIBUTIONS.............................................19 MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE..........................20 The Manager...........................................................20 The Sub-Advisors......................................................20 Duties of the Manager and Sub-Advisors................................21 Fees Paid to the Manager..............................................21 GENERAL INFORMATION ABOUT AN ACCOUNT....................................22 Eligible Purchasers...................................................23 Shareholder Rights....................................................23 Non-Cumulative Voting.................................................24 Purchase of Account Shares............................................24 Sale of Account Shares................................................24 Restricted Transfers..................................................25 Financial Statements..................................................25 FINANCIAL HIGHLIGHTS....................................................25 ADDITIONAL INFORMATION..................................................29 2 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 ACCOUNT DESCRIPTIONS The Principal Variable Contracts Fund (the "Fund") is made up of Accounts. Each Account has its own investment objective. Principal Management Corporation*, the "Manager" of the Fund, has selected a Sub-Advisor for the Accounts based on the Sub-Advisor's experience with the investment strategy for which it was selected. The Manager seeks to provide a wide range of investment approaches through the Fund. The Sub-Advisor of the Accounts is Principal Global Investors, LLC ("Principal"). Principal, Principal Management Corporation and Princor Financial Services Corporation ("Princor" are affiliates of Principal Life Insurance Company and with it are subsidiaries of Principal Financial Group, Inc. and members of the Principal Financial Group/(R)/ . In the description for each Account, there is important information about the Account's: MAIN STRATEGIES AND RISKS These sections describe each Account's investment objective and summarize how each Account intends to achieve its investment objective. The Board of Directors may change an Account's objective or the investment strategies without a shareholder vote if it determines such a change is in the best interests of the Account. If there is a material change to the Account's investment objective or investment strategies, you should consider whether the Account remains an appropriate investment for you. There is no guarantee that an Account will meet its objective. The sections also describe each Account's primary investment strategies (including the type or types of securities in which the Account invests), any policy of the Account to concentrate in securities of issuers in a particular industry or group of industries and the main risks associated with an investment in the Account. A fuller discussion of risks appears later in the Prospectus under the caption "Certain Investment Strategies and Related Risks." Each Account may invest up to 100% of its assets in cash and cash equivalents for temporary defensive purposes in response to adverse market, economic or political condition as more fully described under the caption "Certain Investment Strategies and Related Risks-Temporary Defensive Measures." Each Account is designed to be a portion of an investor's portfolio. None of the Accounts is intended to be a complete investment program. You should consider the risks of each Account before making an investment and be prepared to maintain the investment during periods of adverse market conditions. INVESTMENT RESULTS A bar chart and a table are included with each Account that has annual returns for a full calendar year. They show the Account's annual returns and its long-term performance. The chart shows how the Account's performance has varied from year-to-year. The table compares the Account's performance over time to that of: . a broad-based securities market index (An index measures the market price of a specific group of securities in a particular market or securities in a market sector. You cannot invest directly in an index. An index does not have an investment advisor and does not pay any commissions or expenses. If an index had expenses, its performance would be lower.); and . an average of mutual funds with a similar investment objective and management style. The averages used are prepared by independent statistical services. An Account's past performance is not necessarily an indication of how the Account will perform in the future. Call the Principal Variable Contracts Fund at 1-800-247-4123 to get the current 7-day yield for the Money Market Account. FEES AND EXPENSES The annual operating expenses for each Account are deducted from that Account's assets. Each Account's operating expenses are shown with the description of the Account and are stated as a percentage of Account assets. A discussion of fees and expenses appears later in the Prospectus under the caption "The Costs of Investing." The fees and expenses shown do not include the effect of any separate account expenses or other contract level expenses. If such charges were included, overall expenses would be higher and would lower performance. PRINCIPAL VARIABLE CONTRACTS FUND 3 www.principal.com The description of each Account includes examples of the costs associated with investing in the Account. The examples are intended to help you compare the cost of investing in a particular Account with the cost of investing in other mutual funds. The examples assume you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The examples also assume that your investment has a 5% total return each year and that the Account's operating expenses remain the same. Your actual costs of investing in a particular Account may be higher or lower than the costs assumed for purposes of the examples. NOTES: . No salesperson, dealer or other person is authorized to give information or make representations about an Account other than those contained in this Prospectus. Information or representations not contained in this Prospectus may not be relied upon as having been made by the Principal Variable Contracts Fund, an Account, the Manager, any Sub-Advisor or Princor. . Investments in these Accounts are not deposits of a bank and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. 4 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 CAPITAL VALUE ACCOUNT The Account seeks to provide long-term capital appreciation and secondarily growth of investment income. MAIN STRATEGIES The Account invests primarily in common stock and other equity securities of large capitalization companies. Under normal market conditions, the Account invests at least 80% of its assets in common stocks of companies with large market capitalizations (those with market capitalizations similar to companies in the Russell 1000/(R)// /Value Index (as of March 31, 2006 this range was between approximately $688 million and $387.4 billion) at the time of purchase. Market capitalization is defined as total current market value of a company's outstanding common stock. Up to 25% of Account assets may be invested in foreign securities. The Account invests in stocks that, in the opinion of the Sub-Advisor, Principal, are undervalued in the marketplace at the time of purchase. Value stocks are often characterized by below average price/earnings ratios (P/E) and above average dividend yields relative to the overall market. Securities for the Account are selected by consideration of the quality and price of individual issuers rather than forecasting stock market trends. The selection process focuses on four key elements: . determination that a stock is selling below its fair market value; . early recognition of changes in a company's underlying fundamentals; . evaluation of the sustainability of fundamental changes; and . by monitoring a stock's behavior in the market, evaluation of the timeliness of the investment. Principal believes that superior stock selection is the key to consistent out-performance. Principal seeks to achieve superior stock selection by systematically evaluating company fundamentals and in-depth original research. Principal focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. Principal focuses its stock selections on established companies that it believes have a sustainable competitive advantage. Principal constructs a portfolio that is "benchmark aware" in that it is sensitive to the sector (companies with similar characteristics) and security weightings of its benchmark. However, the Account is actively managed and prepared to over- and/or under-weight sectors and industries differently from the benchmark. MAIN RISKS The Account is subject to the risk that its principal market segment, large capitalization value stocks, may underperform compared to other market segments or to the equity markets as a whole. The value of the Account's securities may fluctuate on a daily basis. As with all mutual funds, as the values of the Account's assets rise or fall, the Account's share price changes. If you sell your shares when their value is less than the price you paid, you will lose money. As with any security, the securities in which the Account invests have associated risks. These include risks of: STOCK MARKET VOLATILITY . The net asset value of the Account's shares is effected by changes in the value of the securities it owns. The prices of equity securities held by the Account may decline in response to certain events including those directly involving issuers of these securities, adverse conditions affecting the general economy, or overall market declines. In the short term, stock prices can fluctuate dramatically in response to these factors. VALUE STOCKS . Investment in value stocks carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. FOREIGN INVESTING . Foreign markets may not perform as well as U.S. markets. Political and economic uncertainty in foreign countries, as well as less public information about foreign investments may negatively impact the Account's portfolio. Dividends and other income payable on foreign securities may be subject to foreign taxes. Some investments may be made in currencies other than the U.S. dollar that will fluctuate in value as a result of changes in the currency exchange rate. PRINCIPAL VARIABLE CONTRACTS FUND 5 www.principal.com ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading costs, which may have an adverse impact on the Account's performance and may increase taxable distributions. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 120.9%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking long-term growth of capital and willing to accept the risks of investing in common stocks, but who prefer investing in companies that appear to be considered undervalued relative to similar companies. 6 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"23.5 "1997"28.53 "1998"13.58 "1999"-4.29 "2000"2.16 "2001"-8.05 "2002"-13.66 "2003"25.49 "2004"12.36 The Account's highest/lowest quarterly returns "2005"6.8 during this time period were: HIGHEST Q2 '03 15.52% LOWEST Q3 '02 -15.10% LOGO The year-to-date return as of March 31, 2006 is 6.07%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT CAPITAL VALUE ACCOUNT 6.80 3.64 7.74 11.92* Russell 1000 Value Index................. 7.05 5.28 10.94 14.32** Morningstar Large Value Category Average 5.88 3.96 8.85 13.21** Index performance does not reflect deductions for fees, expenses or taxes. * Lifetime results are measured from the date the Account was first sold (May 13, 1970). ** Lifetime results are measured from December 31, 1978 (earliest date for which information is available).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.60% Other Expenses................... 0.01% ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.61%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 CAPITAL VALUE ACCOUNT $62 $195 $340 $762
PRINCIPAL VARIABLE CONTRACTS FUND 7 www.principal.com GOVERNMENT & HIGH QUALITY BOND ACCOUNT F/K/A GOVERNMENT SECURITIES ACCOUNT The Account seeks a high level of current income, liquidity and safety of principal. MAIN STRATEGIES The Account seeks to achieve its investment objective by investing primarily (at least 80% of its assets) in securities that are issued by the U.S. Government, its agencies or instrumentalities. The Account may invest in mortgage-backed securities representing an interest in a pool of mortgage loans. These securities are rated AAA by Standard & Poor's Corporation or Aaa by Moody's Investor Services, Inc. or, if unrated, determined by the Sub-Advisor, Principal, to be of equivalent quality. The Account relies on the professional judgment of Principal to make decisions about the Account's portfolio securities. The basic investment philosophy of Principal is to seek undervalued securities that represent good long-term investment opportunities. Securities may be sold when Principal believes they no longer represent good long-term value. The Account may also hold cash and cash equivalents. The size of the Account's cash position depends on various factors, including market conditions and purchases and redemptions of Account shares. A large cash position could impact the ability of the Account to achieve its objective but it also would reduce the Account's exposure in the event of a market downturn and provide liquidity to make additional investments or to meet redemptions. The Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income. Under a reverse repurchase agreement, the Account sells securities and agrees to repurchase them at a specified date and price. The Account pays interest on this "secured financing" and attempts to make money on the difference between the financing rate and the interest it earns by investing the proceeds of the financing. While a reverse repurchase agreement is outstanding, the Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account may lend its portfolio securities to brokers, dealers and other financial institutions. In connection with such loans, the Account remains the owner of the loaned securities and continues to be entitled to payments in amounts equal to the interest, dividends or other distributions payable on the loaned securities. Loans of portfolio securities may not exceed 33 1/3% of the value of the Account's total assets (including the value of all assets received as collateral for loan). In connection with such loans the Account will receive collateral from the borrower equal to at least 100% of the value of the loaned securities. MAIN RISKS As with any security, the securities in which the Account invests have associated risks. These include risks of: U.S. GOVERNMENT SECURITIES . U.S. Government securities do not involve the degree of credit risk associated with investments in lower quality fixed-income securities. As a result, the yields available from U.S. Government securities are generally lower than the yields available from many other fixed-income securities. Like other fixed-income securities, the values of U.S. Government securities change as interest rates fluctuate. Fluctuations in the value of the Account's securities do not affect interest income on securities already held by the Account, but are reflected in the Account's price per share. Since the magnitude of these fluctuations generally is greater at times when the Account's average maturity is longer, under certain market conditions the Account may invest in short-term investments yielding lower current income rather than investing in higher yielding longer term securities. INTEREST RATE CHANGES . The value of fixed-income securities held by the Account may be affected by factors such as changing interest rates. When interest rates rise, the value of fixed-income securities will generally fall. Conversely, a drop in interest rates will generally cause an increase in the value of fixed-income securities. Some fixed-income investments give the issuer the option to call, or redeem, its securities before their maturity date. If an issuer calls its security during a time of declining interest rates, the Account may have to reinvest the proceeds in securities with lower rates. In addition, the Account's appreciation may be limited by issuer call options having more value during times of declining interest rates. 8 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater credit risk and price fluctuations than higher quality and shorter maturity bonds. Bonds held by the Account may be affected by unfavorable political, economic, or governmental developments that could affect the repayment of principal or the payment of interest. U.S. GOVERNMENT SPONSORED SECURITIES . The Account may invest in debt and mortgage-backed securities issued by government-sponsored enterprises such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Banks. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to prepayment risk. Prepayments, unscheduled principal payments, may result from voluntary prepayment, refinancing or foreclosure of the underlying mortgage. When interest rates decline, significant unscheduled prepayments may result. These prepayments must then be reinvested at lower rates. Prepayments may also shorten the effective maturities of these securities, especially during periods of declining interest rates. On the other hand, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to the risk of decline in market value in response to rising interest rates and potentially increasing the volatility of the Account. In addition, prepayments may cause losses on securities purchased at a premium (dollar amount by which the price of the bond exceeds its face value). At times, mortgage-backed securities may have higher than market interest rates and are purchased at a premium. Unscheduled prepayments are made at par and cause the Account to experience a loss of some or all of the premium. DERIVATIVE INSTRUMENTS . The use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. Derivatives are subject to a number of risks including liquidity, interest rate, market, and credit risk. They also involve the risk of mispricing or improper valuation, the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index, and the risk of default or bankruptcy of the other party to the agreement. Gains or losses involving some futures, options, swaps, and other derivatives may be substantial - in part because a relatively small price movement in these securities may result in an immediate and substantial gain or loss for the Account. HEDGING STRATEGIES . The Account may use futures, options, swaps and other derivative instruments to "hedge" or protect the portfolio from adverse movements in securities prices and interest rates. The Account may also use a variety of currency hedging techniques, including forward currency contracts, to manage exchange rate risk. The Sub-Advisor believes the use of these instruments will benefit the Account. However, the Account's performance could be worse than if the Account had not used such instruments if the Sub-Advisor's judgment proves incorrect. Futures contracts and options may not always be successful hedges; their prices can be highly volatile; using them could lower Account total return; and the potential loss from the use of futures can exceed a Account's initial investment in such contracts. REVERSE REPURCHASE AGREEMENTS. . This strategy involves the risk that interest costs on money borrowed may exceed the return on securities purchased with the borrowed money. In addition, reverse repurchase agreements may increase the volatility of the Fund. LENDING OF SECURITIES . If the Account lends its portfolio securities and the borrower of the securities fail financially, the Account may experience delays in recovering the loaned securities or exercising its rights in the collateral. The Account lends its securities only to borrowers that the Sub-Advisor determines are creditworthy. PORTFOLIO DURATION . The average portfolio duration of the Account normally varies within a three- to six-year time frame based on Sub-Advisor's forecast for interest rates. Duration is a measure of the expected life of a fixed-income security that is used to determine the sensitivity of a security's price to changes in interest rates. For example, if the portfolio duration of the Account is three years, a change of 1% in the market's yield results in a change of approximately 3% in the value of the Account's securities. The longer a security's duration, the more sensitive it is to changes in interest rates. An Account with a longer average portfolio duration will be more sensitive to changes in interest rates than an Account with a shorter average portfolio duration. PRINCIPAL VARIABLE CONTRACTS FUND 9 www.principal.com ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an attempt to achieve its investment objective. The financial highlights table at the end of this Prospectus shows the Account's turnover rate during recent fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to the Account buying and selling all of its securities two times during the course of the year. A high turnover rate may increase the Account's trading cost which may have an adverse impact on the Account's performance. The annualized portfolio turnover rate for the Account for the twelve month period ended December 31, 2005 was 262.1%. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking diversification by investing in a fixed-income mutual fund. 10 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year and showing how the Account's average annual returns compare with those of a broad measure of market performance. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"3.35 "1997"10.39 "1998"8.27 "1999"-0.29 "2000"11.4 "2001"7.61 "2002"8.8 "2003"1.84 "2004"3.56 The Account's highest/lowest quarterly returns "2005"2.01 during this time period were: HIGHEST Q2 '97 4.52% LOWEST Q1 '96 -1.90% LOGO The year-to-date return as of March 31, 2006 is -0.45%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* GOVERNMENT & HIGH QUALITY BOND ACCOUNT . 2.01 4.72 5.62 7.30 Lehman Brothers Government/Mortgage Index................. 2.63 5.40 6.01 7.56 Morningstar Intermediate Government Category Average .............. 1.90 4.62 5.12 6.67 Index performance does not reflect deductions for fees, expenses or taxes. *Lifetime results are measured from the date the Account was first sold (April 9, 1987).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.44% Other Expenses................... 0.02 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.46%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 GOVERNMENT & HIGH QUALITY BOND ACCOUNT $47 $148 $258 $579
PRINCIPAL VARIABLE CONTRACTS FUND 11 www.principal.com MONEY MARKET ACCOUNT The Account has an investment objective of as high a level of current income available from investments in short-term securities as is consistent with preservation of principal and maintenance of liquidity. MAIN STRATEGIES The Account invests its assets in a portfolio of high quality, short-term money market instruments. The investments are U.S. dollar denominated securities which the Sub-Advisor, Principal, believes present minimal credit risks. At the time the Account purchases each security, it is an "eligible security" as defined in the regulations issued under the Investment Company Act of 1940, as amended. The Account maintains a dollar weighted average portfolio maturity of 90 days or less. It intends to hold its investments until maturity. However, the Account may sell a security before it matures: . to take advantage of market variations; . to generate cash to cover sales of Account shares by its shareholders; or . upon revised credit opinions of the security's issuer. The sale of a security by the Account before maturity may not be in the best interest of the Account. The sale of portfolio securities is usually a taxable event. The Account does have an ability to borrow money to cover the redemption of Account shares. It is the policy of the Account to be as fully invested as possible to maximize current income. Securities in which the Account invests include: . securities issued or guaranteed by the U.S. government, including treasury bills, notes and bonds; . securities issued or guaranteed by agencies or instrumentalities of the U.S. government. These are backed either by the full faith and credit of the U.S. government or by the credit of the particular agency or instrumentality; . bank obligations including: . certificates of deposit which generally are negotiable certificates against funds deposited in a commercial bank; or . bankers acceptances which are time drafts drawn on a commercial bank, usually in connection with international commercial transactions. . commercial paper which is short-term promissory notes issued by U.S. or foreign corporations primarily to finance short-term credit needs; . corporate debt consisting of notes, bonds or debentures which at the time of purchase by the Account has 397 days or less remaining to maturity; . repurchase agreements under which securities are purchased with an agreement by the seller to repurchase the security at the same price plus interest at a specified rate. Generally these have a short maturity (less than a week) but may also have a longer maturity; and . taxable municipal obligations which are short-term obligations issued or guaranteed by state and municipal issuers which generate taxable income. Among the certificates of deposit typically held by the Account are Eurodollar and Yankee obligations which are issued in U.S. dollars by foreign banks and foreign branches of U.S. banks. Before the Sub-Advisor selects a Eurodollar or Yankee obligation, however, the foreign issuer undergoes the same credit-quality analysis and tests of financial strength as an issuer of domestic securities. MAIN RISKS As with all mutual funds, the value of the Account's assets may rise or fall. Although the Account seeks to preserve the value of an investment at $1.00 per share, it is possible to lose money by investing in the Account. An investment in the Account is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. As with any security, the securities in which the Account invests have associated risks. These include risks of: CREDIT RISK . Credit risk pertains to the issuer's ability to make scheduled principal or interest payments. This may reduce the Account's stream of income and decrease the Account's yield. 12 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 INTEREST RATE RISK . The value of the Account's shares is directly impacted by trends in interest rates. If interest rates rise, the value of debt securities generally will fall. REPURCHASE AGREEMENTS . The Account may invest in repurchase agreements with commercial banks, brokers and dealers considered by the Sub-Advisor to be creditworthy. Default or insolvency of the other party is a potential risk to the Account. U.S. GOVERNMENT SPONSORED ENTERPRISES . The Account may invest in securities issued by government-sponsored enterprises. Although the issuing agency, instrumentality or corporation may be chartered or sponsored by the United States government, their securities are neither issued nor guaranteed by the United States Treasury. EURODOLLAR AND YANKEE OBLIGATIONS . Eurodollar and Yankee obligations have risks similar to U.S. money market instruments, such as income risk and credit risk. Other risks of Eurodollar and Yankee obligations include the possibilities that: a foreign government will not let U.S. dollar-denominated assets leave the country; the banks that issue Eurodollar obligations may not be subject to the same regulations as U.S. banks; and adverse political or economic developments will affect investments in a foreign country. INVESTOR PROFILE The Account may be an appropriate investment for investors seeking monthly dividends without incurring much principal risk. PRINCIPAL VARIABLE CONTRACTS FUND 13 www.principal.com Principal has been the Account's Sub-Advisor since its inception. The bar chart and tables provide some indication of the risks of investing in the Account by showing changes in performance from year to year. The Account's past performance is not necessarily an indication of how the Account will perform in the future. Annual operating expenses do not include any separate account expenses, cost of insurance or other contract-level expenses. Total returns would be lower if such expenses were included. YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
"1996"5.07 "1997"5.04 "1998"5.2 "1999"4.84 "2000"6.07 "2001"3.92 "2002"1.42 "2003"0.74 "2004"0.92 "2005"2.69 TO OBTAIN THE ACCOUNT'S CURRENT YIELD INFORMATION, PLEASE CALL 1-800-247-4123 LOGO The year-to-date return as of March 31, 2006 is 1.00%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2005
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT* Money Market Account . 2.69 1.93 3.60 3.15 *Lifetime results are measured from the date the Account was first sold (March 18, 1983).
FEES AND EXPENSES OF THE ACCOUNT (These fees and expenses do not include the effect of any sales charge, separate account expenses or other contract level expenses which may be applied at the variable life insurance or variable annuity product level. If such charges or - fees were included, overall expenses would be higher and would lower the Account's performance.) ANNUAL ACCOUNT OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM ACCOUNT ASSETS) AS OF DECEMBER 31, 2005
Management Fees.................. 0.49% Other Expenses................... 0.12 ---- TOTAL ANNUAL ACCOUNT OPERATING EXPENSES 0.61%
EXAMPLE This Example is intended to help you compare the cost of investing in the Account with the cost of investing in other mutual funds. The Example assumes that you invest $10,000 in the Account for the time periods indicated and then redeem all of your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Account's operating expenses remain the same. If separate account expenses and contract level expenses were included, expenses would be higher. Although your actual costs may be higher or lower, based on these assumptions your cost would be:
NUMBER OF YEARS YOU OWN YOUR SHARES ----------------------------------------------------------------------------------------------------------------------------------- 1 3 5 10 MONEY MARKET ACCOUNT $62 $195 $340 $762
14 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS The Statement of Additional Information (SAI) contains additional information about investment strategies and their related risks. SECURITIES AND INVESTMENT PRACTICES MARKET VOLATILITY . Equity securities include common stocks, preferred stocks, convertible securities, depositary receipts, rights and warrants. Common stocks, the most familiar type, represent an equity (ownership) interest in a corporation. The value of a company's stock may fall as a result of factors directly relating to that company, such as decisions made by its management or lower demand for the company's products or services. A stock's value may also fall because of factors affecting not just the company, but also companies in the same industry or in a number of different industries, such as increases in production costs. The value of a company's stock may also be affected by changes in financial markets that are relatively unrelated to the company or its industry, such as changes in interest rates or currency exchange rates. In addition, a company's stock generally pays dividends only after the company invests in its own business and makes required payments to holders of its bonds and other debt. For this reason, the value of a company's stock will usually react more strongly than its bonds and other debt to actual or perceived changes in the company's financial condition or prospects. Stocks of smaller companies may be more vulnerable to adverse developments than those of larger companies. Fixed-income securities include bonds and other debt instruments that are used by issuers to borrow money from investors. The issuer generally pays the investor a fixed, variable or floating rate of interest. The amount borrowed must be repaid at maturity. Some debt securities, such as zero coupon bonds, do not pay current interest, but are sold at a discount from their face values. INTEREST RATE CHANGES . Fixed-income securities are sensitive to changes in interest rates. In general, fixed-income security prices rise when interest rates fall and fall when interest rates rise. Longer term bonds and zero coupon bonds are generally more sensitive to interest rate changes. CREDIT RISK . Fixed-income security prices are also affected by the credit quality of the issuer. Investment grade debt securities are medium and high quality securities. Some bonds, such as lower grade or "junk" bonds, may have speculative characteristics and may be particularly sensitive to economic conditions and the financial condition of the issuers. REPURCHASE AGREEMENTS AND LOANED SECURITIES Although not a principal investment strategy, each of the Accounts may invest a portion of its assets in repurchase agreements. Repurchase agreements typically involve the purchase of debt securities from a financial institution such as a bank, savings and loan association or broker-dealer. A repurchase agreement provides that the Account sells back to the seller and that the seller repurchases the underlying securities at a specified price on a specific date. Repurchase agreements may be viewed as loans by an Account collateralized by the underlying securities. This arrangement results in a fixed rate of return that is not subject to market fluctuation while the Account holds the security. In the event of a default or bankruptcy by a selling financial institution, the affected Account bears a risk of loss. To minimize such risks, the Account enters into repurchase agreements only with large, well-capitalized and well-established financial institutions. In addition, the value of the securities collateralizing the repurchase agreement is, and during the entire term of the repurchase agreement remains, at least equal to the repurchase price, including accrued interest. Each of the Accounts may lend its portfolio securities to unaffiliated broker-dealers and other unaffiliated qualified financial institutions. REVERSE REPURCHASE AGREEMENTS An Account may use reverse repurchase agreements to obtain cash to satisfy unusually heavy redemption requests or for other temporary or emergency purposes without the necessity of selling portfolio securities, or to earn additional income on portfolio securities, such as Treasury bills or notes. In a reverse repurchase agreement, an Account sells a portfolio security to another party, such as a bank or broker-dealer, in return for cash and agrees to repurchase the instrument at a particular price and time. While a reverse repurchase agreement is outstanding, an Account will PRINCIPAL VARIABLE CONTRACTS FUND 15 www.principal.com maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account will enter into reverse repurchase agreements only with parties that the Sub-Advisor deems creditworthy. Using reverse repurchase agreements to earn additional income involves the risk that the interest earned on the invested proceeds is less than the expense of the reverse repurchase agreement transaction. This technique may also have a leveraging effect on the Account, although the Account's intent to segregate assets in the amount of the repurchase agreement minimizes this effect. CURRENCY CONTRACTS The Accounts may enter into forward currency contracts, currency futures contracts and options, and options on currencies for hedging purposes and not as a principal investment strategy. A forward currency contract involves a privately negotiated obligation to purchase or sell a specific currency at a future date at a price set in the contract. An Account will not hedge currency exposure to an extent greater than the aggregate market value of the securities held or to be purchased by the Account (denominated or generally quoted or currently convertible into the currency). Hedging is a technique used in an attempt to reduce risk. If an Account's Sub-Advisor hedges market conditions incorrectly or employs a strategy that does not correlate well with the Account's investment, these techniques could result in a loss. These techniques may increase the volatility of an Account and may involve a small investment of cash relative to the magnitude of the risk assumed. In addition, these techniques could result in a loss if the other party to the transaction does not perform as promised. There is also a risk of government action through exchange controls that would restrict the ability of the Account to deliver or receive currency. FORWARD COMMITMENTS Although not a principal investment strategy, each of the Accounts may enter into forward commitment agreements. These agreements call for the Account to purchase or sell a security on a future date at a fixed price. Each of the Accounts may also enter into contracts to sell its investments either on demand or at a specific interval. WARRANTS Each of the Accounts may invest in warrants though may not use such investments as a principal investment strategy. A warrant is a certificate granting its owner the right to purchase securities from the issuer at a specified price, normally higher than the current market price. INITIAL PUBLIC OFFERINGS ("IPOS") The Capital Value Account may invest in IPOs. An IPO is a company's first offering of stock to the public. IPO risk is that the market value of IPO shares will fluctuate considerably due to factors such as the absence of a prior public market, unseasoned trading, the small number of shares available for trading and limited information about the issuer. The purchase of IPO shares may involve high transaction costs. IPO shares are subject to market risk and liquidity risk. In addition, the market for IPO shares can be speculative and/or inactive for extended periods of time. The limited number of shares available for trading in some IPOs may make it more difficult for the Account to buy or sell significant amounts of shares without an unfavorable impact on prevailing prices. Investors in IPO shares can be affected by substantial dilution in the value of their shares by sales of additional shares and by concentration of control in existing management and principal shareholders. When the Account's asset base is small, a significant portion of the Account's performance could be attributable to investments in IPOs because such investments would have a magnified impact on the Account. As the Account's assets grow, the effect of the Account's investments in IPOs on the Account's performance probably will decline, which could reduce the Account's performance. Because of the price volatility of IPO shares, the Account may choose to hold IPO shares for a very short period of time. This may increase the turnover of the Account's portfolio and lead to increased expenses to the Account, such as commissions and transaction costs. By selling IPO shares, the Account may realize taxable gains it will subsequently distribute to shareholders. DERIVATIVES To the extent permitted by its investment objectives and policies, each of the Accounts (except Money Market) may invest in securities that are commonly referred to as derivative securities. Generally, a derivative is a financial arrangement, the value of which is derived from, or based on, a traditional security, asset, or market index. Certain derivative securities are described more accurately as index/structured securities. Index/structured securities are 16 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 derivative securities whose value or performance is linked to other equity securities (such as depositary receipts), currencies, interest rates, indices or other financial indicators (reference indices). Some derivatives, such as mortgage-related and other asset-backed securities, are in many respects like any other investment, although they may be more volatile or less liquid than more traditional debt securities. There are many different types of derivatives and many different ways to use them. Futures and options are commonly used for traditional hedging purposes to attempt to protect an Account from exposure to changing interest rates, securities prices, or currency exchange rates and for cash management purposes as a low-cost method of gaining exposure to a particular securities market without investing directly in those securities. The Accounts may enter into put or call options, future contracts, options on futures contracts and over-the-counter swap contracts (e.g., interest rate swaps, total return swaps and credit default swaps) for both hedging and non-hedging purposes. Generally, no Account may invest in a derivative security unless the reference index or the instrument to which it relates is an eligible investment for the Account. The return on a derivative security may increase or decrease, depending upon changes in the reference index or instrument to which it relates. The risks associated with derivative investments include: . the risk that the underlying security, interest rate, market index or other financial asset will not move in the direction the Manager or Sub-Advisor anticipated; . the possibility that there may be no liquid secondary market which may make it difficult or impossible to close out a position when desired; . the risk that adverse price movements in an instrument can result in a loss substantially greater than an Account's initial investment; and . the counterparty may fail to perform its obligations. EXCHANGE TRADED FUNDS (ETFS) These are a type of index fund bought and sold on a securities exchange. An ETF trades like common stock and represents a fixed portfolio of securities designed to rack a particular market index. The Accounts could purchase an ETF to temporarily gain exposure to a portion of the U.S. or a foreign market while awaiting purchase of underlying securities. The risks of owning an ETF generally reflect the risks of owning the underlying securities they are designed to track, although ETFs have management fees that increase their costs. CONVERTIBLE SECURITIES Convertible securities are fixed-income securities that an Account has the right to exchange for equity securities at a specified conversion price. The option allows the Account to realize additional returns if the market price of the equity securities exceeds the conversion price. For example, the Account may hold fixed-income securities that are convertible into shares of common stock at a conversion price of $10 per share. If the market value of the shares of common stock reached $12, the Account could realize an additional $2 per share by converting its fixed-income securities. Convertible securities have lower yields than comparable fixed-income securities. In addition, at the time a convertible security is issued the conversion price exceeds the market value of the underlying equity securities. Thus, convertible securities may provide lower returns than non-convertible fixed-income securities or equity securities depending upon changes in the price of the underlying equity securities. However, convertible securities permit the Account to realize some of the potential appreciation of the underlying equity securities with less risk of losing its initial investment. The Accounts treat convertible securities as both fixed-income and equity securities for purposes of investment policies and limitations because of their unique characteristics. The Accounts may invest in convertible securities without regard to their ratings. FOREIGN INVESTING The Capital Value and Money Market Accounts may invest in securities of foreign companies but not as a principal investment strategy. For the purpose of this restriction, foreign companies are: . companies with their principal place of business or principal office outside the U.S.; and . companies for which the principal securities trading market is outside the U.S. PRINCIPAL VARIABLE CONTRACTS FUND 17 www.principal.com Foreign companies may not be subject to the same uniform accounting, auditing and financial reporting practices as are required of U.S. companies. In addition, there may be less publicly available information about a foreign company than about a U.S. company. Securities of many foreign companies are less liquid and more volatile than securities of comparable U.S. companies. Commissions on foreign securities exchanges may be generally higher than those on U.S. exchanges, although each Account seeks the most favorable net results on its portfolio transactions. Foreign markets also have different clearance and settlement procedures than those in U.S. markets. In certain markets there have been times when settlements have been unable to keep pace with the volume of securities transactions, making it difficult to conduct these transactions. Delays in settlement could result in temporary periods when a portion of Account assets is not invested and earning no return. If an Account is unable to make intended security purchases due to settlement problems, the Account may miss attractive investment opportunities. In addition, an Account may incur a loss as a result of a decline in the value of its portfolio if it is unable to sell a security. With respect to certain foreign countries, there is the possibility of expropriation or confiscatory taxation, political or social instability, or diplomatic developments that could affect an Account's investments in those countries. In addition, an Account may also suffer losses due to nationalization, expropriation or differing accounting practices and treatments. Investments in foreign securities are subject to laws of the foreign country that may limit the amount and types of foreign investments. Changes of governments or of economic or monetary policies, in the U.S. or abroad, changes in dealings between nations, currency convertibility or exchange rates could result in investment losses for an Account. Finally, even though certain currencies may be convertible into U.S. dollars, the conversion rates may be artificial relative to the actual market values and may be unfavorable to Account investors. Foreign securities are often traded with less frequency and volume, and therefore may have greater price volatility, than is the case with many U.S. securities. Brokerage commissions, custodial services, and other costs relating to investment in foreign countries are generally more expensive than in the U.S. Though the Accounts intend to acquire the securities of foreign issuers where there are public trading markets, economic or political turmoil in a country in which an Account has a significant portion of its assets or deterioration of the relationship between the U.S. and a foreign country may negatively impact the liquidity of an Account's portfolio. An Account may have difficulty meeting a large number of redemption requests. Furthermore, there may be difficulties in obtaining or enforcing judgments against foreign issuers. An Account may choose to invest in a foreign company by purchasing depositary receipts. Depositary receipts are certificates of ownership of shares in a foreign-based issuer held by a bank or other financial institution. They are alternatives to purchasing the underlying security but are subject to the foreign securities to which they relate. Investments in companies of developing countries may be subject to higher risks than investments in companies in more developed countries. These risks include: . increased social, political and economic instability; . a smaller market for these securities and low or nonexistent volume of trading that results in a lack of liquidity and in greater price volatility; . lack of publicly available information, including reports of payments of dividends or interest on outstanding securities; . foreign government policies that may restrict opportunities, including restrictions on investment in issuers or industries deemed sensitive to national interests; . relatively new capital market structure or market-oriented economy; . the possibility that recent favorable economic developments may be slowed or reversed by unanticipated political or social events in these countries; . restrictions that may make it difficult or impossible for the Account to vote proxies, exercise shareholder rights, pursue legal remedies, and obtain judgments in foreign courts; and . possible losses through the holding of securities in domestic and foreign custodial banks and depositories. In addition, many developing countries have experienced substantial, and in some periods, extremely high rates of inflation for many years. Inflation and rapid fluctuations in inflation rates have had and may continue to have negative effects on the economies and securities markets of those countries. 18 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 Repatriation of investment income, capital and proceeds of sales by foreign investors may require governmental registration and/or approval in some developing countries. An Account could be adversely affected by delays in or a refusal to grant any required governmental registration or approval for repatriation. Further, the economies of developing countries generally are heavily dependent upon international trade and, accordingly, have been and may continue to be adversely affected by trade barriers, exchange controls, managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries with which they trade. SMALL AND MEDIUM CAPITALIZATION COMPANIES The Capital Value Account may hold securities of small and medium capitalization companies but not as a principal investment strategy. Market capitalization is defined as total current market value of a company's outstanding common stock. Investments in companies with smaller market capitalizations may involve greater risks and price volatility (wide, rapid fluctuations) than investments in larger, more mature companies. Small companies may be less significant within their industries and may be at a competitive disadvantage relative to their larger competitors. While smaller companies may be subject to these additional risks, they may also realize more substantial growth than larger or more established companies. Smaller companies may be less mature than larger companies. At this earlier stage of development, the companies may have limited product lines, reduced market liquidity for their shares, limited financial resources or less depth in management than larger or more established companies. Unseasoned issuers are companies with a record of less than three years continuous operation, including the operation of predecessors and parents. Unseasoned issuers by their nature have only a limited operating history that can be used for evaluating the company's growth prospects. As a result, investment decisions for these securities may place a greater emphasis on current or planned product lines and the reputation and experience of the company's management and less emphasis on fundamental valuation factors than would be the case for more mature growth companies. TEMPORARY DEFENSIVE MEASURES From time to time, as part of its investment strategy, each Account (other than the Money Market Account which may invest in high quality money market securities at any time) may invest without limit in cash and cash equivalents for temporary defensive purposes in response to adverse market, economic or political conditions. To the extent that the Account is in a defensive position, it may lose the benefit of upswings and limit its ability to meet its investment objective. For this purpose, cash equivalents include: bank notes, bank certificates of deposit, bankers' acceptances, repurchase agreements, commercial paper, and commercial paper master notes which are floating rate debt instruments without a fixed maturity. In addition, an Account may purchase U.S. government securities, preferred stocks and debt securities, whether or not convertible into or carrying rights for common stock. PORTFOLIO TURNOVER "Portfolio Turnover" is the term used in the industry for measuring the amount of trading that occurs in an Account's portfolio during the year. For example, a 100% turnover rate means that on average every security in the portfolio has been replaced once during the year. Accounts with high turnover rates (more than 100%) often have higher transaction costs (which are paid by the Account) and may have an adverse impact on the Account's performance. No turnover rate can be calculated for the Money Market Account because of the short maturities of the securities in which it invests. Turnover rates for each of the other Accounts may be found in the Account's Financial Highlights table. Please consider all the factors when you compare the turnover rates of different funds. A fund with consistently higher total returns and higher turnover rates than another fund may actually be achieving better performance precisely because the managers are active traders. You should also be aware that the "total return" line in the Financial Highlights section already includes portfolio turnover costs. PRINCIPAL VARIABLE CONTRACTS FUND 19 www.principal.com PRICING OF ACCOUNT SHARES Each Account's shares are bought and sold at the current share price. The share price of each Account is calculated each day the New York Stock Exchange ("NYSE") is open (shares are not priced on the days on which the NYSE is closed for trading). The share price is determined at the close of business of the NYSE (normally 3:00 p.m. Central time). When an order to buy or sell shares is received, the share price used to fill the order is the next price calculated after the order is received. For all Accounts, except the Money Market Account, the share price is calculated by: . taking the current market value of the total assets of the Account . subtracting liabilities of the Account . dividing the remainder by the total number of shares owned by the Account. The securities of the Money Market Account are valued at amortized cost. The calculation procedure is described in the SAI. The Money Market Account reserves the right to determine a share price more than once each day. NOTES: . If current market values are not readily available for a security owned by an Account, its fair value is determined using a policy adopted by the Directors. . An Account's securities may be traded on foreign securities markets that generally complete trading at various times during the day prior to the close of the NYSE. Generally, the values of foreign securities used in computing a Fund's NAV are determined at the time the foreign market closes. Foreign securities and currencies are converted to U.S. dollars using the exchange rate in effect at the close of the London Exchange (generally 11:00 a.m. Eastern Time). Occasionally, events affecting the value of foreign securities occur when the foreign market is closed and the NYSE is open. The Account has adopted policies and procedures to "fair value" some or all securities held by an Account if significant events occur after the close of the market on which the foreign securities are traded but before the Account's NAV is calculated. Significant events can be specific to a single security or can include events that affect a particular foreign market or markets. A significant event can also include a general market movement in the U.S. securities markets. If the Manager believes that the market value of any or all of the foreign securities is materially affected by such an event, the securities will be valued, and the Account's NAV will be calculated, using the policy adopted by the Account. These fair valuation procedures are intended to discourage shareholders from investing in the Account for the purpose of engaging in market timing or arbitrage transactions. The trading of foreign securities generally or in a particular country or countries may not take place on all days the NYSE is open, or may trade on days the NYSE is closed. Thus, the value of the foreign securities held by the Account may change on days when shareholders are unable to purchase or redeem shares. . Certain securities issued by companies in emerging market countries may have more than one quoted valuation at any point in time. These may be referred to as local price and premium price. The premium price is often a negotiated price that may not consistently represent a price at which a specific transaction can be effected. The Fund has a policy to value such securities at a price at which the Sub-Advisor expects the securities may be sold. DIVIDENDS AND DISTRIBUTIONS The Accounts earn dividends, interest and other income from investments and distribute this income (less expenses) as dividends. The Accounts also realize capital gains from investments and distribute these gains (less any losses) as capital gain distributions. The Accounts normally make dividends and capital gain distributions at least annually, in February. Dividends and capital gain distributions are automatically reinvested in additional shares of the Account making the distribution. 20 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE THE MANAGER Principal Management Corporation serves as the manager for the Fund. In its handling of the business affairs of the Fund, the Manager provides clerical, recordkeeping and bookkeeping services, and keeps the required financial and accounting records. THE SUB-ADVISORS The Manager has signed a contract with a Sub-Advisor under which the Sub-Advisor agrees to assume the obligations of the Manager to provide investment advisory service for the Account. For these services, the Sub-Advisor is paid a fee by the Manager. Information regarding Sub-Advisors and individual portfolio managers is set forth below. The Statement of Additional Information provides additional information about each portfolio manager's compensation, other accounts managed by the portfolio manager and the portfolio manager's ownership of securities in the Account. MANAGER: The Manager is an indirect subsidiary of Principal Financial Services, Inc. and has managed mutual funds since 1969. As of December 31, 2005, the mutual funds it manages had assets of approximately $28.6 billion. The Manager's address is Principal Financial Group, Des Moines, Iowa 50392-2080. SUB-ADVISOR: Principal Global Investors, LLC ("Principal") is an indirectly wholly-owned subsidiary of Principal Life Insurance Company and an affiliate of the Manager. Principal manages equity, fixed-income and real estate investments primarily for institutional investors, including Principal Life. As of December 31, 2005, Principal, together with its affiliated asset management companies, had approximately $159 billion in asset under management. Principal Global Investor's headquarters address is 801 Grand Avenue, Des Moines, Iowa 50392 and has other primary asset management offices in New York, London, Sydney and Singapore. The day-to-day portfolio management for some of the Accounts listed below is shared by two or more portfolio managers. In each such case, except where noted below, the portfolio managers operate as a team, sharing authority and responsibility for research and the day-to-day management of the portfolio with no limitation on the authority of one portfolio manager in relation to another. The Statement of Additional Information provides further information about the portfolio managers' compensation, other accounts managed by the portfolio managers, and the portfolio managers' ownership of shares of the Account.
DAY-TO-DAY ACCOUNT ACCOUNT MANAGEMENT ------- ------------------ Capital Value John Pihlblad Government & High Quality Bond Brad Fredericks Lisa Stange Money Market Tracy Reeg Alice Robertson
BRAD FREDERICKS. . Mr. Fredericks is a portfolio manager at Principal. He is responsible for co-managing the government securities accounts. His responsibilities include general portfolio overview and security analysis. He joined the firm in 1998 as a financial accountant and was named a portfolio manager in 2002. Previously, Mr. Fredericks was an assistant trader at Norwest Mortgage. He earned a Bachelor's degree in Finance from Iowa State University. Mr. Fredericks is a Fellow of the Life Management Institute (FLMI). PRINCIPAL VARIABLE CONTRACTS FUND 21 www.principal.com JOHN PIHLBLAD, CFA . Mr. Pihlblad is a portfolio manager at Principal. He joined the firm in 2000 and led the development of Principal Global Investors' Global Research Platform. He has over 25 years experience in creating and managing quantitative investment systems. Prior to joining Principal, Mr. Pihlblad was a partner and co-founder of GlobeFlex Capital in San Diego where he was responsible for the development and implementation of the investment process for both domestic and international products. He earned a BA from Westminster College. He has earned the right to use the Chartered Financial Analyst designation. TRACY REEG. . Ms. Reeg is a portfolio manager at Principal. She is involved in the portfolio management of money market portfolios. She joined the firm in 1993 and began trading and portfolio management duties in 2000. Ms. Reeg earned a Bachelor's degree in Finance from the University of Northern Iowa. She is a member of the Life Office Management Association (LOMA) and is a Fellow of the Life Management Institute (FLMI). ALICE ROBERTSON . Ms. Robertson is a trader and portfolio manager for Principal. She is responsible for trading corporate bonds on the fixed income trading desk. In addition, she serves as co-portfolio manager of the money market funds and oversees the short-term trading operation. She joined the firm in 1990 after working as an assistance vice president/commercial paper analyst with Duff & Phelps Credit Company. Ms. Robertson served as a credit analyst for the firm before moving into her current role in 1993. She earned an MBA in Finance and Marketing from DePaul University and her Bachelor's degree in Economics from Northwestern University. LISA A. STANGE, CFA . Ms. Stange is a portfolio manager and strategist for Principal. She is responsible for managing the government securities portfolios and the mortgage-backed securities (MBS) within the multi-sector portfolios. As a strategies, Ms. Stange is involved in the formulation of broad investment strategy, quantitative research and product development. Previously, she was co-portfolio manager for U.S. multi-sector portfolios. She joined the firm in 1989. Ms. Stange earned an MBA and a Bachelor's degree from the University of Iowa. She has earned the right to use the Chartered Financial Analyst designation. DUTIES OF THE MANAGER AND SUB-ADVISOR The Manager or Sub-Advisor provides the Directors of the Fund with a recommended investment program. The program must be consistent with the Account's investment objective and policies. Within the scope of the approved investment program, the Sub-Advisor advises the Account on its investment policy and determines which securities are bought or sold, and in what amounts. FEES PAID TO THE MANAGER The Manager is paid a fee by each Account for its services, which includes any fee paid to the Sub-Advisor. The fee paid by each Account (as a percentage of the average daily net assets) for the fiscal year ended December 31, 2005 was:
Capital Value 0.60% Government & High Quality Bond 0.44% Money Market 0.49%
FEES PAID TO THE SUB-ADVISOR The Sub-Advisor fee paid by each Account (as a percentage of the average daily net assets) for the fiscal year ended December 31, 2005 was:
Capital Value 0.14% Government & High Quality Bond 0.10% Money Market 0.07%
22 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 The Fund and the Manager, under an order received from the SEC, may enter into and materially amend agreements with Sub-Advisors, other than those affiliated with the Manager, without obtaining shareholder approval. For any Account that is relying on that order, the Manager may: . hire one or more Sub-Advisors; . change Sub-Advisors; and . reallocate management fees between itself and Sub-Advisors. The Manager will continue to have the ultimate responsibility for the investment performance of these Accounts due to its responsibility to oversee Sub-Advisors and recommend their hiring, termination and replacement. No Account will rely on the order until it receives approval from its shareholders or, in the case of a new Account, the Account's sole initial shareholder before the Account is available to the other purchasers, and the Account states in its prospectus that it intends to rely on the order. PRINCIPAL VARIABLE CONTRACTS FUND 23 www.principal.com GENERAL INFORMATION ABOUT AN ACCOUNT FREQUENT TRADING AND MARKET-TIMING (ABUSIVE TRADING PRACTICES) The Accounts of the Principal Variable Contracts Fund are not designed for frequent trading or market timing activity. The Fund has adopted fair valuation procedures to be used in the case of significant events, including broad market movements, occurring after the close of a foreign market in which securities are traded. The procedures will be followed if the Manager believes the events will impact the value of the foreign securities. These procedures are intended to discourage market timing transactions in shares of the Accounts. The Accounts do not knowingly accommodate frequent purchases and redemptions ("excessive trading") of Fund shares by investors. If you intend to trade frequently and/or use market timing investment strategies, do not purchase these Accounts. The Fund does not knowingly accommodate excessive trading. The Principal Variable Contracts Fund considers frequent trading and market timing activities to be abusive trading practices because they may: . Disrupt the management of the Accounts by; . forcing the Account to hold short-term (liquid) assets rather than investing for long term growth, which results in lost investment opportunities for the Account; and . causing unplanned portfolio turnover; . Hurt the portfolio performance of the Account; and . Increase expenses of the Account due to; . increased broker-dealer commissions; and . increased recordkeeping and related costs. If we are not able to identify such excessive trading practices, The Accounts may be negatively impacted and may cause investors to suffer the harms described. Certain Accounts may be at greater risk for abusive trading practices. For example, those Accounts that invest in foreign securities may appeal to investors attempting to take advantage of time-zone arbitrage. This risk is particularly relevant to the Diversified International, International Emerging Markets and International SmallCap Accounts but does apply to the purchase of foreign securities by any Account. As the Accounts of the Principal Variable Contracts Fund are only available through variable annuity or variable life contracts, the Principal Variable Contracts Fund must rely on Principal Life (as sponsor of the variable contract) to monitor customer trading activity to identify and take action against excessive trading. There can be no certainty that Principal Life will identify and prevent excessive trading in all instances. When Principal Life identifies excessive trading, Principal Life will act to curtail such trading in a fair and uniform manner. If Principal Life, or the Principal Variable Contracts Fund, deem excessive trading practices to be occurring, Principal Life will take action that may include, but is not limited to: . Rejecting exchange instructions from shareholder or other person authorized by the shareholder to direct exchanges; . Restricting submission of exchange requests by, for example, allowing exchange requests to be submitted by 1st class U.S. mail only and disallowing requests made via the internet, by facsimile, by overnight courier or by telephone; . Limiting the dollar amount of an exchange and/or the number of exchanges during a year; . Requiring a holding period of a minimum of 30 days before permitting exchanges among the Accounts where there is evidence of at least one round-trip exchange (exchange or redemption of shares that were purchased within 30 days of the exchange/redemption); and . Taking such other action as directed by the Principal Variable Contracts Fund. The Principal Variable Contracts Fund has reserved the right to accept or reject, without prior written notice, any exchange requests. In some instances, an exchange may be completed prior to a determination of abusive trading. In those instances, Principal Life will reverse an exchange (within three business days of the exchange) and return the account holdings to the positions held prior to the exchange. Principal Life will give you notice in writing in this instance. 24 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 ELIGIBLE PURCHASERS Only certain eligible purchasers may buy shares of the Accounts. Eligible purchasers are limited to 1) separate accounts of Principal Life or of other insurance companies, 2) Principal Life or any of its subsidiaries or affiliates, 3) trustees of other managers of any qualified profit sharing, incentive or bonus plan established by Principal Life or any of its subsidiaries or affiliates for employees of such company, subsidiary or affiliate. Such trustees or managers may buy Account shares only in their capacities as trustees or managers and not for their personal accounts. The Board of Directors of the Fund reserves the right to broaden or limit the designation of eligible purchaser. Each Account serves as the underlying investment vehicle for variable annuity contracts and variable life insurance policies that are funded through separate accounts established by Principal Life. It is possible that in the future, it may not be advantageous for variable life insurance separate accounts and variable annuity separate accounts to invest in the Accounts at the same time. Although neither Principal Life nor the Fund currently foresees any such disadvantage, the Fund's Board of Directors monitors events in order to identify any material conflicts between such policy owners and contract holders. Material conflict could result from, for example, 1) changes in state insurance laws, 2) changes in Federal income tax law, 3) changes in the investment management of an Account, or 4) differences in voting instructions between those given by policy owners and those given by contract holders. Should it be necessary, the Board would determine what action, if any, should be taken. Such action could include the sale of Account shares by one or more of the separate accounts which could have adverse consequences. SHAREHOLDER RIGHTS The following information applies to each Account of the Principal Variable Contracts Fund, Inc. Each Account share is eligible to vote, either in person or by proxy, at all shareholder meetings for that Account. This includes the right to vote on the election of directors, selection of independent auditors and other matters submitted to meetings of shareholders of the Account. Each share has equal rights with every other share of the Account as to dividends, earnings, voting, assets and redemption. Shares are fully paid, non-assessable and have no preemptive or conversion rights. Shares of an Account are issued as full or fractional shares. Each fractional share has proportionately the same rights including voting as are provided for a full share. Shareholders of the Fund may remove any director with or without cause by the vote of a majority of the votes entitled to be case at a meeting of all Account shareholders. The bylaws of the Fund provide that the Board of Directors of the Fund may increase or decrease the aggregate number of shares that the Fund has the authority to issue, without a shareholder vote. The bylaws of the Fund also provide that the Fund does not need to hold an annual meeting of shareholders unless one of the following is required to be acted upon by shareholders under the Investment Company Act of 1940: election of directors; approval of an investment advisory agreement; ratification of the selection of independent auditors; and approval of the distribution agreement. The Fund intends to hold shareholder meetings only when required by law and at such other times when the Board of Directors deems it to be appropriate. Shareholder inquiries should be directed to: Principal Variable Contracts Fund, Inc., Principal Financial Group, Des Moines, Iowa 50392-2080. NON-CUMULATIVE VOTING The Fund's shares have non-cumulative voting rights. This means that the holders of more than 50% of the shares voting for the election of directors of the Fund can elect 100% of the directors if they choose to do so. In such event, the holders of the remaining shares voting for the election of directors will not be able to elect any directors. Principal Life votes each Account's shares allocated to each of its separate accounts registered under the Investment Company Act of 1940 and attributable to variable annuity contracts or variable life insurance policies participating in the separate accounts. The shares are voted in accordance with instructions received from contract holders, policy owners, participants and annuitants. Other shares of each Account held by each separate account, including shares for which no timely voting instructions are received, are voted in proportion to the instructions that are received with respect to contracts or policies participating that separate account. Shares of each of the Accounts held in the general account of Principal Life or in the unregistered separate accounts are voted in proportion to the instructions that are received with respect to contracts and policies participating in its registered and unregistered separate accounts. If Principal Life determines, under applicable law, that an Account's shares held in one or more separate accounts or in PRINCIPAL VARIABLE CONTRACTS FUND 25 www.principal.com its general account need not be voted according to the instructions that are received, it may vote those Account shares in its own right. PURCHASE OF ACCOUNT SHARES Shares are purchased from Princor Financial Services Corporation, the Fund's principal underwriter. There are no sales charges on shares of the Accounts, however, your variable contract may impose a charge. There are no restrictions on amounts to be invested in shares of the Accounts. Shareholder accounts for each Account are maintained under an open account system. Under this system, an account is opened and maintained for each investor. Each investment is confirmed by sending the investor a statement of account showing the current purchase and the total number of shares owned. The statement of account is treated by each Account as evidence of ownership of Account shares. Share certificates are not issued. SALE OF ACCOUNT SHARES This section applies to eligible purchasers other than the separate accounts of Principal Life and its subsidiaries. Each Account sells its shares upon request. There is no charge for the sale. A shareholder sends a written request to the Account requesting the sale of any part or all of the shares. The letter must be signed exactly as the account is registered. If payment is to be made to the registered shareholder or joint shareholder, the Account does not require a signature guarantee. If payment is to be made to another party, the shareholder's signature(s) must be guaranteed by a commercial bank, trust company, credit union, savings and loan association, national securities exchange member or brokerage firm. Shares are redeemed at the net asset value per share next computed after the request is received by the Account in proper and complete form. Sales proceeds are generally sent within three business days after the request is received in proper form. However, the right to sell shares may be suspended during any period when 1) trading on the NYSE is restricted as determined by the SEC or when the NYSE is closed for other than weekends and holidays, or 2) an emergency exists, as determined by the SEC, as a result of which a) disposal by a fund of securities owned by it is not reasonably practicable, b) it is not reasonably practicable for a fund to fairly determine the value of its net assets, or c) the SEC permits suspension for the protection of security holders. If payments are delayed and the instruction is not canceled by the shareholder's written instruction, the amount of the transaction is determined as of the first valuation date following the expiration of the permitted delay. The transaction occurs within five days thereafter. In addition, payments on surrenders attributable to a premium payment made by check may be delayed up to 15 days. This permits payment to be collected on the check. RESTRICTED TRANSFERS Shares of each of the Accounts may be transferred to an eligible purchaser. However, if an Account is requested to transfer shares to other than an eligible purchaser, the Account has the right, at its election, to purchase the shares at the net asset value next calculated after the receipt of the transfer request. However, the Account must give written notification to the transferee(s) of the shares of the election to buy the shares within seven days of the request. Settlement for the shares shall be made within the seven-day period. FINANCIAL STATEMENTS You will receive an annual financial statement for the Fund, audited by the Fund's independent registered public accounting firm, Ernst & Young LLP. That report is a part of this prospectus. You will also receive a semiannual financial statement that is unaudited. FINANCIAL HIGHLIGHTS The following financial highlights tables are intended to help you understand the Fund's financial performance for the periods shown. Certain information reflects results for a single Fund share. The total returns in each table represent the 26 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 rate that an investor would have earned or lost each period on an investment in the Fund (assuming reinvestment of all distributions). The financial statements for the Fund were audited by Ernst & Young LLP, whose report, along with the financial statements, is included in the most recent annual report for the Fund. To receive a copy of the latest annual or semiannual report for the Fund, you may telephone 1-800-247-4123. FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- CAPITAL VALUE ACCOUNT --------------------- Net Asset Value, Beginning of Period.. $32.39 $29.23 $23.60 $27.78 $30.72 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.54 0.44 0.38 0.39 0.34 Net Realized and Unrealized Gain (Loss) on Investments......... 1.66 3.17 5.63 (4.18) (2.80) ---- ---- ---- ----- ----- Total From Investment Operations 2.20 3.61 6.01 (3.79) (2.46) Less Dividends and Distributions: Dividends from Net Investment Income... -- (0.45) (0.38) (0.39) (0.34) Distributions from Realized Gains...... -- -- -- -- (0.14) ----- ----- Total Dividends and Distributions -- (0.45) (0.38) (0.39) (0.48) ---- ----- ----- ----- ----- Net Asset Value, End of Period............ $34.59 $32.39 $29.23 $23.60 $27.78 ====== ====== ====== ====== ====== Total Return /(a)/ ... 6.80% 12.36% 25.49% (13.66)% (8.05)% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $258,490 $265,580 $248,253 $206,541 $254,484 Ratio of Expenses to Average Net Assets.. 0.61% 0.60% 0.61% 0.61% 0.61% Ratio of Gross Expenses to Average Net Assets.......... -- 0.60%/(b)/ 0.61%/(b)/ 0.61%/(b)/ -- Ratio of Net Investment Income to Average Net Assets.. 1.62% 1.47% 1.47% 1.45% 1.20% Portfolio Turnover Rate................ 120.9% 183.3% 125.7% 142.6% 91.7%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. /(b) /Expense ratio without commission rebates. 68 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- GOVERNMENT & HIGH QUALITY BOND ACCOUNT /(//A//)/ -------------------------------------- Net Asset Value, Beginning of Period.. $11.64 $11.77 $12.00 $11.58 $11.43 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.44 0.44 0.45 0.43 0.51 Net Realized and Unrealized Gain (Loss) on Investments......... (0.21) (0.04) (0.24) 0.55 0.32 ---- ----- ----- ---- ---- Total From Investment Operations 0.23 0.40 0.21 0.98 0.83 Less Dividends and Distributions: Dividends from Net Investment Income... (0.51) (0.53) (0.44) (0.52) (0.68) Distributions from Realized Gains...... -- -- -- (0.04) -- ---- ----- Total Dividends and Distributions (0.51) (0.53) (0.44) (0.56) (0.68) ----- ----- ----- ----- ----- Net Asset Value, End of Period............ $11.36 $11.64 $11.77 $12.00 $11.58 ====== ====== ====== ====== ====== Total Return /(//b//)/ 2.01% 3.56% 1.84% 8.80% 7.61% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $316,047 $334,034 $368,564 $342,001 $193,254 Ratio of Expenses to Average Net Assets.. 0.46% 0.44% 0.44% 0.47% 0.49% Ratio of Net Investment Income to Average Net Assets.. 3.88% 3.82% 3.83% 4.87% 5.63% Portfolio Turnover Rate................ 262.1% 67.2% 110.4% 33.8% 45.9%
/(a) /Effective November 19, 2005, Government Securities Account changed its name to Government & High Quality Bond Account. /(b) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. 69 FINANCIAL HIGHLIGHTS PRINCIPAL VARIABLE CONTRACTS FUND, INC. ------------------------------------------------------------------------------- SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31 (EXCEPT AS NOTED):
2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- MONEY MARKET ACCOUNT -------------------- Net Asset Value, Beginning of Period.. $1.000 $1.000 $1.000 $1.000 $1.000 Income from Investment Operations: Net Investment Income (Operating Loss).... 0.027 0.009 0.007 0.014 0.039 ----- ----- ----- ----- ----- Total From Investment Operations 0.027 0.009 0.007 0.014 0.039 Less Dividends and Distributions: Dividends from Net Investment Income... (0.027) (0.009) (0.007) (0.014) (0.039) ------ ------ ------ ------ ------ Total Dividends and Distributions (0.027) (0.009) (0.007) (0.014) (0.039) ------ ------ ------ ------ ------ Net Asset Value, End of Period............ $1.000 $1.000 $1.000 $1.000 $1.000 ====== ====== ====== ====== ====== Total Return /(a)/ ... 2.69% 0.92% 0.74% 1.42% 3.92% Ratio/Supplemental Data: Net Assets, End of Period (in thousands).......... $150,653 $140,553 $151,545 $201,455 $180,923 Ratio of Expenses to Average Net Assets.. 0.61% 0.49% 0.49% 0.49% 0.50% Ratio of Net Investment Income to Average Net Assets.. 2.66% 0.91% 0.74% 1.40% 3.70%
/(a) /Total return does not reflect charges attributable to Principal Life Insurance Company's separate account. Inclusion of these charges would reduce the amounts shown. 76 ADDITIONAL INFORMATION Additional information about the Fund (including the Fund's policy regarding the disclosure of portfolio securities) is available in the Statement of Additional Information dated May 1, 2006 which is incorporated by reference into this prospectus. Additional information about the Funds' investments is available in the Fund's annual and semiannual reports to shareholders. In the Funds' annual report, you will find a discussion of the market conditions and investment strategies that significantly affected the Funds' performance during the last fiscal year. The Statement of Additional Information and the Fund's annual and semi-annual reports can be obtained free of charge by writing or telephoning Princor Financial Services Corporation, P.O. Box 10423, Des Moines, IA 50306. In addition, the Fund makes its Statement of Additional Information and annual and semi-annual reports available, free of charge, on http:// www.principal.com. To request this and other information about the Fund and to make shareholder inquiries, telephone 1-800-247-4123. Information about the Fund (including the Statement of Additional Information) can be reviewed and copied at the Commission's Public Reference Room in Washington, D.C. Information on the operation of the Public Reference Room may be obtained by calling the Commission at 1-202-942-8090. Reports and other information about the Fund are available on the EDGAR Database on the Commission's internet site at http://www.sec.gov. Copies of this information may be obtained, upon payment of a duplicating fee, by electronic request at the following E-mail address: publicinfo@sec.gov, or by writing the Commission's Public Reference Section, Washington, D.C. 20549-0102. The U.S. government does not insure or guarantee an investment in any of the Accounts. There can be no assurance that the Money Market Account will be able to maintain a stable share price of $1.00 per share. Shares of the Accounts are not deposits or obligations of, or guaranteed or endorsed by, any financial institution, nor are shares of the Accounts federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other agency. Principal Variable Contracts Fund, Inc. SEC File 811-01944 28 PRINCIPAL VARIABLE CONTRACTS FUND 1-800-247-4123 PRINCIPAL VARIABLE CONTRACTS FUND, INC. STATEMENT OF ADDITIONAL INFORMATION dated May 1, 2006 This Statement of Additional Information (SAI) is not a prospectus. It contains information in addition to the information in the Fund's prospectuses. The Fund's prospectuses, dated May 1, 2006, which we may amend from time to time, contain the basic information you should know before investing in the Fund. You should read this SAI together with the Fund's prospectus. The audited financial statements, schedules of investments and auditor's report included in the Fund's Annual Report to Shareholders, for the fiscal year ended December 31, 2005 are hereby incorporated by reference into and are legally a part of this SAI. For a free copy of the current prospectus or annual report, call 1-800-247-4123 or write: Principal Variable Contracts Fund, Inc. Principal Financial Group Des Moines IA 50392-2080 TABLE OF CONTENTS Fund History............................................................3 Description of the Fund's Investments and Risks.........................3 Management..............................................................22 Control Persons and Principal Holders of Securities.....................27 Investment Advisory and Other Services..................................29 Cost of Manager's Services..............................................32 Brokerage Allocation and Other Practices................................38 Pricing of Shares.......................................................52 Calculation of Performance Data.........................................53 Tax Status..............................................................55 General Information.....................................................56 Portfolio Holdings Disclosure...........................................56 Financial Statements....................................................57 Appendix A - Description of Bond Ratings ...............................58 Appendix B - Proxy Voting Policies......................................61 Appendix C - Portfolio Manager Disclosures..............................130 FUND HISTORY The Principal Variable Contracts Fund is a registered, open-end management investment company, commonly called a mutual fund. It was organized on May 27, 1997 as a Maryland corporation. The Articles of Incorporation have been amended as follows: . February 13, 1998 to add the International SmallCap; MidCap Growth, Real Estate; SmallCap; SmallCap Growth; SmallCap Value and Utilities Accounts; . February 1, 1999 to add the MidCap Value and Stock Index 500 Accounts; . July 27, 2000 to add the International Emerging Markets, LargeCap Growth Equity and MidCap Growth Equity Accounts and change the name of the Stock Index 500 Account to the LargeCap Stock Index Account; . May 1, 2001 to change the name of the Aggressive Growth Account to the Equity Growth Account; . February 1, 2002 to add the LargeCap Blend and LargeCap Value Accounts; and . February 4, 2003 to add the Limited Term Bond Account. . March 1, 2004 to change the name of the Real Estate Account to Real Estate Securities Account and the Utilities Account to the Equity Income Account. . October 12, 2004 to add the Equity Value, LifeTime 2010, LifeTime 2020, LifeTime 2030, LifeTime 2040, LifeTime 2050 and LifeTime Strategic Income Accounts. . April 11, 2005 to change the name of the International Account to Diversified International Account. . September 30, 2005 to change the name of the Government Securities Account to Government & High Quality Bond Account and to change the name of the Limited Term Bond Account to Short-Term Bond Account. Principal Management Corporation is the Manager of the Fund. DESCRIPTION OF THE FUND'S INVESTMENTS AND RISKS FUND POLICIES The investment objectives, investment strategies and the main risks of each Account are described in the Prospectus. This Statement of Additional Information ("SAI") contains supplemental information about those strategies and risks and the types of securities the Sub-Advisor can select for each Account. Additional information is also provided about the strategies that the Account may use to try to achieve its objective. The composition of each Account and the techniques and strategies that the Sub-Advisor may use in selecting securities will vary over time. An Account is not required to use all of the investment techniques and strategies available to it in seeking its goals. Unless otherwise indicated, with the exception of the percentage limitations on borrowing, the restrictions apply at the time transactions are entered into. Accordingly, any later increase or decrease beyond the specified limitation, resulting from market fluctuations or in a rating by a rating service, does not require elimination of any security from the portfolio. Except as described below as "Fundamental Restrictions," the investment strategies described in this SAI and the prospectuses are not fundamental and may be changed by the Board of Directors without shareholder approval. The Fundamental Restrictions may not be changed without a vote of a majority of the outstanding voting securities of the affected Account. The Investment Company Act of 1940, as amended ("1940 Act") provides that "a vote of a majority of the outstanding voting securities" of an Account means the affirmative vote of the lesser of 1) more than 50% of the outstanding shares, or 2) 67% or more of the shares present at a meeting if more than 50% of the outstanding Account shares are represented at the meeting in person or by proxy. Each share has one vote, with fractional shares voting proportionately. With the exception of the diversification test required by the Internal Revenue Code, the Accounts will not consider collateral held in connection with securities lending activities when applying any of the following fundamental restrictions or any other investment restriction set forth in each Account's prospectus or Statement of Additional Information. FUND INVESTMENT LIMITATIONS Asset Allocation Account, Balanced Account, Bond Account, Capital Value Account, Diversified International Account, Equity Growth Account, Equity Income Account, Equity Value Account, Government & High Quality Bond Account, Growth Account, International Emerging Markets Account, International SmallCap Account, LargeCap Blend Account, LargeCap Growth Equity Account, LargeCap Stock Index Account, LargeCap Value Account, MidCap Account, MidCap Growth Account, MidCap Value Account, Money Market Account, Real Estate Securities Account, Short-Term Bond Account, SmallCap Account, SmallCap Growth Account and SmallCap Value Account FUNDAMENTAL RESTRICTIONS Each of the following numbered restrictions for the above-listed Accounts is a matter of fundamental policy and may not be changed without shareholder approval. Each may not: 1) Issue any senior securities as defined in the 1940 Act. Purchasing and selling securities and futures contracts and options thereon and borrowing money in accordance with restrictions described below do not involve the issuance of a senior security. 2) Invest in physical commodities or commodity contracts (other than foreign currencies), but it may purchase and sell financial futures contracts, options on such contracts, swaps and securities backed by physical commodities. 3) Invest in real estate, although it may invest in securities that are secured by real estate and securities of issuers that invest or deal in real estate. 4) The Account may not borrow money, except as permitted under the Investment Company Act of 1940, as amended, and as interpreted, modified or otherwise permitted by regulatory authority having jurisdiction, from time to time. 5) Make loans, except that the Account may a) purchase and hold debt obligations in accordance with its investment objectives and policies; b) enter into repurchase agreements; and c) lend its portfolio securities without limitation against collateral (consisting of cash or liquid assets) equal at all times to not less than 100% of the value of the securities loaned. This limit does not apply to purchases of debt securities or commercial paper. 6) Invest more than 5% of its total assets in the securities of any one issuer (other than obligations issued or guaranteed by the U.S. government or its agencies or instrumentalities) or purchase more than 10% of the outstanding voting securities of any one issuer, except that this limitation shall apply only with respect to 75% of the total assets of the Account. 7) Act as an underwriter of securities, except to the extent that the Account may be deemed to be an underwriter in connection with the sale of securities held in its portfolio. 8) Concentrate its investments in any particular industry, except that the Account may invest up to 25% of the value of its total assets in a single industry, provided that, when the Account has adopted a temporary defensive posture, there shall be no limitation on the purchase of obligations issued or guaranteed by the U.S. government or its agencies or instrumentalities. This restriction applies to the LargeCap Stock Index Account except to the extent that the related Index also is so concentrated. This restriction does not apply to the Real Estate Securities Account. 9) Sell securities short (except where the Fund holds or has the right to obtain at no added cost a long position in the securities sold that equals or exceeds the securities sold short). NON-FUNDAMENTAL RESTRICTIONS Each of these Accounts has also adopted the following restrictions that are not fundamental policies and may be changed without shareholder approval. It is contrary to each Account's present policy to: 1) Invest more than 15% of its net assets in illiquid securities and in repurchase agreements maturing in more than seven days except to the extent permitted by applicable law. 2) Pledge, mortgage or hypothecate its assets, except to secure permitted borrowings. The deposit of underlying securities and other assets in escrow and other collateral arrangements in connection with transactions in put or call options, futures contracts, options on futures contracts and over-the-counter swap contracts are not deemed to be pledges or other encumbrances. 3) Invest in companies for the purpose of exercising control or management. 4) Invest more than 25% of its assets in foreign securities, except that the Diversified International, International Emerging Markets, International SmallCap and Money Market Accounts each may invest up to 100% of its assets in foreign securities. The LargeCap Stock Index Account may invest in foreign securities to the extent that the relevant index is so invested, and the Government & High Quality Bond Account may not invest in foreign securities. 5) Invest more than 5% of its total assets in real estate limited partnership interests (except Real Estate Securities Account). 6) Acquire securities of other investment companies in reliance on Section 12(d)(1)(F) or (G) of the 1940 Act, invest more than 10% of its total assets in securities of other investment companies, invest more than 5% of its total assets in the securities of any one investment company, or acquire more than 3% of the outstanding voting securities of any one investment company except in connection with a merger, consolidation or plan of reorganization. The Account may purchase securities of closed-end investment companies in the open market where no underwriter or dealer's commission or profit, other than a customary broker's commission, is involved. Each Account (except Asset Allocation, Balanced, Capital Value, Diversified International, Equity Income, Growth, and International Emerging Markets) has also adopted the non-fundamental restriction which requires it, under normal circumstances, to invest at least 80% of its net assets in the type of securities, industry or geographic region (as described in the prospectus) as suggested by the name of the Account. The Account will provide 60-days notice to shareholders prior to implementing a change in this policy for the Account. Principal LifeTime 2010, Principal LifeTime 2020, Principal LifeTime 2030, Principal LifeTime 2040, Principal LifeTime 2050 and Principal LifeTime Strategic Income Accounts FUNDAMENTAL RESTRICTIONS Each of the following numbered restrictions for the above-listed Accounts is a matter of fundamental policy and may not be changed without shareholder approval. Each may not: 1) Issue senior securities as defined in the 1940 Act. Purchasing and selling securities and futures contracts and options thereon and borrowing money in accordance with restrictions described below do not involve the issuance of a senior security. 2) Purchase or sell commodities or commodities contracts except that the Account may invest in underlying funds that may purchase or write interest rate, currency and stock and bond index futures contracts and related options thereon. 3) Purchase or sell real estate or interests therein, although the Account may purchase underlying funds which purchase securities of issuers that engage in real estate operations and securities secured by real estate or interests therein. 4) Borrow money, except that it may a) borrow from banks (as defined in the 1940 Act) or other financial institutions in amounts up to 33 1/3% of its total assets (including the amount borrowed) and b) to the extent permitted by applicable law, borrow up to an additional 5% of its total assets for temporary purposes. 5) Make loans, except that the Account may a) purchase underlying funds which purchase and hold debt obligations; and b) enter into repurchase agreements. This limit does not apply to purchases of debt securities or commercial paper by the Account or an underlying fund. For the purpose of this restriction, lending of fund securities by the underlying funds are not deemed to be loans. 6) Act as an underwriter of securities, except to the extent that the Account or an underlying fund may be deemed to be an underwriter in connection with the sale of securities held in its portfolio. 7) Invest 25% or more of the value of its total assets in securities of issuers in any one industry except that the Account will concentrate its investments in the mutual fund industry. This restriction does not apply to the Account's investments in the mutual fund industry by virtue of its investments in the underlying funds. This restriction also does not apply to obligations issued or guaranteed by the U.S. government, its agencies or instrumentalities. 8) Sell securities short. NON-FUNDAMENTAL RESTRICTIONS Each of these Accounts has also adopted the following restrictions that are not fundamental policies and may be changed without shareholder approval. It is contrary to each Account's present policy to: 1) Pledge, mortgage or hypothecate its assets, except to secure permitted borrowings. For the purpose of this restriction, collateral arrangements with respect to the writing of options by the underlying funds and collateral arrangements with respect to initial or variation margin for futures by the underlying funds are not deemed to be pledges of assets. 2) Invest in companies for the purpose of exercising control or management. SECURITY SELECTION Equity Value ---------------- American Century's value team looks for stocks of companies that they believe are undervalued at the time of purchase. The managers use a value investment strategy that looks for companies that are temporarily out of favor in the market. The managers attempt to purchase the stocks of these undervalued companies and hold them until they have returned to favor in the market and their stock prices have gone up. Asset Allocation ---------------- In its selection of securities for Asset Allocation portfolios, Morgan Stanley Investment Management Inc. ("MSIM Inc."), doing business as "Van Kampen" does not utilize any bottom-up security selection. Investment views are derived from top-down decisions and then implemented via baskets of stocks which meet the investment criteria, derivatives or ETFs. For certain asset classes such as Fixed Income, we utilize Van Kampen's internal specialists to generate bottom-up alpha through active security selection. Each active specialist will focus on the relevant criteria for their asset class in identifying securities for selection. LargeCap Growth Equity ---------------------- Grantham, Mayo, Van Otterloo & Co. LLC ("GMO") uses proprietary research and multiple quantitative models to identify stocks it believes have improving fundamentals. GMO then narrows the selection to those stocks it believes have growth characteristics and are undervalued. Generally, these growth stocks are trading at prices below what GMO believes to be their true fundamental value. GMO also uses proprietary techniques to adjust the portfolio for factors such as stock selection discipline (criteria used for selecting stocks), industry and sector weights, and market capitalization. The factors considered and the models used may change over time. LargeCap Stock Index -------------------- Principal Global Investors, LLC ("Principal") allocates Account assets in approximately the same weightings as the relevant index. Principal may omit or remove any stock from the Account if it determines that the stock is not sufficiently liquid. In addition, Principal may exclude or remove a stock from the Account if extraordinary events or financial conditions lead it to believe that such stock should not be a part of the Account's assets. Account assets may be invested in futures and options. MidCap Growth and SmallCap Value -------------------------------- Mellon Equity Associates, LLP ("Mellon Equity") uses valuation models designed to identify common stocks of companies that have demonstrated consistent earnings momentum and delivered superior results relative to market analyst expectations. Other considerations include profit margins, growth in cash flow and other standard balance sheet measures. The securities held are generally characterized by strong earnings growth momentum measures and higher expected earnings per share growth. Once such common stocks are identified, Mellon Equity constructs a portfolio that in the aggregate breakdown and risk profile resembles the Russell Midcap Growth Index, but is weighted toward the most attractive stocks. The valuation model incorporates information about the relevant criteria as of the most recent period for which data are available. Once ranked, the securities are categorized under the headings "buy", "sell" or "hold." The decision to buy, sell or hold is made by Mellon Equity based primarily on output of the valuation model. However, that decision may be modified due to subsequently available or other specific relevant information about the security. SmallCap Value -------------- J.P. Morgan Investment Management Inc. ("Morgan") uses fundamental research, systematic stock valuation and a disciplined portfolio construction process. Morgan seeks to enhance returns and reduce the volatility in the value of the Account relative to that of the U.S. small company value universe. Morgan continuously screens the small company universe to identify for further analysis those companies that exhibit favorable characteristics. Such characteristics include significant and predictable cash flow and high quality management. Based on fundamental research and using a dividend discount model. Morgan ranks these companies within economic sectors according to their relative values. Morgan then selects for purchase the companies it feels to be most attractive within each economic sector. SmallCap Growth --------------- UBS Global Asset Management (Americas) Inc. ("UBS Global AM") seeks to invest in companies with strong business franchises and attractive competitive positions that generate rapidly rising earnings (or profits). In the overall small capitalization universe, UBS Global AM targets companies with earnings growth in the top 60%. The Account may also invest in securities of emerging growth companies which are companies that UBS Global AM expects to experience above average earnings or cash flow growth or meaningful changes in underlying asset values. Investments in equity securities may include common stock and preferred stock. In selecting securities, UBS Global AM seeks to invest in companies that possess dominant market positions or franchises, a major technical edge, or a unique competitive advantage. To this end, UBS Global AM considers earnings revision trends, positive stock price momentum and sales acceleration when selecting securities. The Account may invest in emerging growth companies, which are companies that UBS Global AM expects to experience above-average earnings or cash flow growth or meaningful changes in underling asset values. Selections of equity securities for the other Accounts (except the MidCap Value ------------------------------------------------------------------------------- Account). --------- Such selections are made based on an approach described broadly as "company-by-company" fundamental analysis. Three basic steps are involved in this analysis. . First is the continuing study of basic economic factors in an effort to conclude what the future general economic climate is likely to be over the next one to two years. . Second, given some conviction as to the likely economic climate, the Sub-Advisor attempts to identify the prospects for the major industrial, commercial and financial segments of the economy. By looking at such factors as demand for products, capacity to produce, operating costs, pricing structure, marketing techniques, adequacy of raw materials and components, domestic and foreign competition, and research productivity, the Sub-Advisor evaluates the prospects for each industry for the near and intermediate term. . Finally, determinations are made regarding earnings prospects for individual companies within each industry by considering the same types of factors described above. These earnings prospects are evaluated in relation to the current price of the securities of each company. MidCap Value ------------ Neuberger Berman Management Inc. ("Neuberger Berman"), Sub-Advisor for the MidCap Value Account primarily uses a bottom-up approach although a limited top-down analysis will be used as well. INVESTMENT STRATEGIES AND RISKS Restricted Securities --------------------- Generally, restricted securities are not readily marketable because they are subject to legal or contractual restrictions upon resale. They are sold only in a public offering with an effective registration statement or in a transaction that is exempt from the registration requirements of the Securities Act of 1933. When registration is required, an Account may be obligated to pay all or part of the registration expenses and a considerable period may elapse between the time of the decision to sell and the time the Account may be permitted to sell a security. If adverse market conditions were to develop during such a period, the Account might obtain a less favorable price than existed when it decided to sell. Restricted securities and other securities not readily marketable are priced at fair value as determined in good faith by or under the direction of the Directors. Each of the Accounts (except the Government & High Quality Bond and Money Market Accounts) has adopted investment restrictions that limit its investments in restricted securities or other illiquid securities up to 15% of its net assets (or, in the case of the Money Market Fund, 10%). The Directors have adopted procedures to determine the liquidity of Rule 4(2) short-term paper and of restricted securities under Rule 144A. Securities determined to be liquid under these procedures are excluded from the preceding investment restriction. Foreign Securities ------------------ Foreign companies may not be subject to the same uniform accounting, auditing and financial reporting practices as are required of U.S. companies. In addition, there may be less publicly available information about a foreign company than about a U.S. company. Securities of many foreign companies are less liquid and more volatile than securities of comparable U.S. companies. Commissions on foreign securities exchanges may be generally higher than those on U.S. exchanges, although each Account seeks the most favorable net results on its portfolio transactions. Foreign markets also have different clearance and settlement procedures than those in U.S. markets. In certain markets there have been times when settlements have been unable to keep pace with the volume of securities transactions, making it difficult to conduct these transactions. Delays in settlement could result in temporary periods when a portion of a Account's assets is not invested and are earning no return. If an Account is unable to make intended security purchases due to settlement problems, the Account may miss attractive investment opportunities. In addition, an Account may incur a loss as a result of a decline in the value of its portfolio if it is unable to sell a security. With respect to certain foreign countries, there is the possibility of expropriation or confiscatory taxation, political or social instability, or diplomatic developments that could affect an Account's investments in those countries. In addition, an Account may also suffer losses due to nationalization, expropriation or differing accounting practices and treatments. Investments in foreign securities are subject to laws of the foreign country that may limit the amount and types of foreign investments. Changes of governments or of economic or monetary policies, in the U.S. or abroad, changes in dealings between nations, currency convertibility or exchange rates could result in investment losses for an Account. Finally, even though certain currencies may be convertible into U.S. dollars, the conversion rates may be artificial relative to the actual market values and may be unfavorable to an Account's investors. Foreign securities are often traded with less frequency and volume, and therefore may have greater price volatility, than is the case with many U.S. securities. Brokerage commissions, custodial services, and other costs relating to investment in foreign countries are generally more expensive than in the U.S. Though the Accounts intend to acquire the securities of foreign issuers where there are public trading markets, economic or political turmoil in a country in which an Account has a significant portion of its assets or deterioration of the relationship between the U.S. and a foreign country may negatively impact the liquidity of an Account's portfolio. The Account may have difficulty meeting a large number of redemption requests. Furthermore, there may be difficulties in obtaining or enforcing judgments against foreign issuers. Investments in companies of developing countries may be subject to higher risks than investments in companies in more developed countries. These risks include: . increased social, political and economic instability; . a smaller market for these securities and low or nonexistent volume of trading that results in a lack of liquidity and in greater price volatility; . lack of publicly available information, including reports of payments of dividends or interest on outstanding securities; . foreign government policies that may restrict opportunities, including restrictions on investment in issuers or industries deemed sensitive to national interests; . relatively new capital market structure or market-oriented economy; . the possibility that recent favorable economic developments may be slowed or reversed by unanticipated political or social events in these countries; . restrictions that may make it difficult or impossible for the fund to vote proxies, exercise shareholder rights, pursue legal remedies, and obtain judgments in foreign courts; and . possible losses through the holding of securities in domestic and foreign custodial banks and depositories. In addition, many developing countries have experienced substantial, and in some periods, extremely high rates of inflation for many years. Inflation and rapid fluctuations in inflation rates have had and may continue to have negative effects on the economies and securities markets of those countries. Repatriation of investment income, capital and proceeds of sales by foreign investors may require governmental registration and/or approval in some developing countries. An Account could be adversely affected by delays in or a refusal to grant any required governmental registration or approval for repatriation. Further, the economies of developing countries generally are heavily dependent upon international trade and, accordingly, have been and may continue to be adversely affected by trade barriers, exchange controls, managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries with which they trade. Depositary Receipts ------------------- Depositary Receipts are generally subject to the same sort of risks as direct investments in a foreign country, such as, currency risk, political and economic risk, and market risk, because their values depend on the performance of a foreign security denominated in its home currency. The Accounts that may invest in foreign securities may invest in: . American Depositary Receipts ("ADRs") - receipts issued by an American bank or trust company evidencing ownership of underlying securities issued by a foreign issuer. They are designed for use in U.S. securities markets. . European Depositary Receipts ("EDRs") and Global Depositary Receipts ("GDRs") - receipts typically issued by a foreign financial institution to evidence an arrangement similar to that of ADRs. Depositary Receipts may be issued by sponsored or unsponsored programs. In sponsored programs, an issuer has made arrangements to have its securities traded in the form of Depositary Receipts. In unsponsored programs, the issuer may not be directly involved in the creation of the program. Although regulatory requirements with respect to sponsored and unsponsored programs are generally similar, in some cases it may be easier to obtain financial information from an issuer that has participated in the creation of a sponsored program. Accordingly, there may be less information available regarding issuers of securities of underlying unsponsored programs, and there may not be a correlation between the availability of such information and the market value of the Depositary Receipts. Securities of Smaller Companies ------------------------------- The Accounts may invest in securities of companies with small- or mid-sized market capitalizations. Market capitalization is defined as total current market value of a company's outstanding common stock. Investments in companies with smaller market capitalizations may involve greater risks and price volatility (wide, rapid fluctuations) than investments in larger, more mature companies. Smaller companies may be less mature than older companies. At this earlier stage of development, the companies may have limited product lines, reduced market liquidity for their shares, limited financial resources or less depth in management than larger or more established companies. Small companies also may be less significant within their industries and may be at a competitive disadvantage relative to their larger competitors. While smaller companies may be subject to these additional risks, they may also realize more substantial growth than larger or more established companies. Small company stocks may decline in price as large company stocks rise, or rise in price while larger company stocks decline. Investors should therefore expect the net asset value of the Account that invests a substantial portion of its assets in small company stocks may be more volatile than the shares of an Account that invests solely in larger company stocks. Unseasoned Issuers ------------------ The Accounts may invest in the securities of unseasoned issuers. Unseasoned issuers are companies with a record of less than three years continuous operation, including the operation of predecessors and parents. Unseasoned issuers by their nature have only a limited operating history that can be used for evaluating the companies' growth prospects. As a result, investment decisions for these securities may place a greater emphasis on current or planned product lines and the reputation and experience of the company's management and less emphasis on fundamental valuation factors than would be the case for more mature growth companies. In addition, many unseasoned issuers also may be small companies and involve the risks and price volatility associated with smaller companies. Spread Transactions, Options on Securities and Securities Indices, and Futures ------------------------------------------------------------------------------ Contracts and Options on Futures Contracts ------------------------------------------ The Accounts may each engage in the practices described under this heading. . Spread Transactions. Each Account may purchase covered spread options. Such covered spread options are not presently exchange listed or traded. The purchase of a spread option gives the Account the right to put, or sell, a security that it owns at a fixed dollar spread or fixed yield spread in relationship to another security that the Account does not own, but which is used as a benchmark. The risk to the Account in purchasing covered spread options is the cost of the premium paid for the spread option and any transaction costs. In addition, there is no assurance that closing transactions will be available. The purchase of spread options can be used to protect each Account against adverse changes in prevailing credit quality spreads, i.e., the yield spread between high quality and lower quality securities. The security covering the spread option is maintained in segregated accounts either with the Account's custodian or on the Account's records. The Accounts do not consider a security covered by a spread option to be "pledged" as that term is used in the Account's policy limiting the pledging or mortgaging of assets. . Options on Securities and Securities Indices. Each Account may write (sell) and purchase call and put options on securities in which it invests and on securities indices based on securities in which the Account invests. The Accounts may engage in these transactions to hedge against a decline in the value of securities owned or an increase in the price of securities which the Account plans to purchase, or to generate additional revenue. . Writing Covered Call and Put Options. When an Account writes a call option, it gives the purchaser of the option the right to buy a specific security at a specified price at any time before the option expires. When an Account writes a put option, it gives the purchaser of the option the right to sell to the Account a specific security at a specified price at any time before the option expires. In both situations, the Account receives a premium from the purchaser of the option. The premium received by an Account reflects, among other factors, the current market price of the underlying security, the relationship of the exercise price to the market price, the time period until the expiration of the option and interest rates. The premium generates additional income for the Account if the option expires unexercised or is closed out at a profit. By writing a call, an Account limits its opportunity to profit from any increase in the market value of the underlying security above the exercise price of the option, but it retains the risk of loss if the price of the security should decline. By writing a put, an Account assumes the risk that it may have to purchase the underlying security at a price that may be higher than its market value at time of exercise. The Accounts write only covered options and comply with applicable regulatory and exchange cover requirements. The Accounts usually own the underlying security covered by any outstanding call option. With respect to an outstanding put option, each Account deposits and maintains with its custodian or segregates on the Account's records, cash or other liquid assets with a value at least equal to the exercise price of the option. Once an Account has written an option, it may terminate its obligation before the option is exercised. The Account executes a closing transaction by purchasing an option of the same series as the option previously written. The Account has a gain or loss depending on whether the premium received when the option was written exceeds the closing purchase price plus related transaction costs. . Purchasing Call and Put Options. When an Account purchases a call option, it receives, in return for the premium it pays, the right to buy from the writer of the option the underlying security at a specified price at any time before the option expires. An Account purchases call options in anticipation of an increase in the market value of securities that it intends ultimately to buy. During the life of the call option, the Account is able to buy the underlying security at the exercise price regardless of any increase in the market price of the underlying security. In order for a call option to result in a gain, the market price of the underlying security must exceed the sum of the exercise price, the premium paid and transaction costs. When an Account purchases a put option, it receives, in return for the premium it pays, the right to sell to the writer of the option the underlying security at a specified price at any time before the option expires. An Account purchases put options in anticipation of a decline in the market value of the underlying security. During the life of the put option, the Account is able to sell the underlying security at the exercise price regardless of any decline in the market price of the underlying security. In order for a put option to result in a gain, the market price of the underlying security must decline, during the option period, below the exercise price enough to cover the premium and transaction costs. Once an Account purchases an option, it may close out its position by selling an option of the same series as the option previously purchased. The Account has a gain or loss depending on whether the closing sale price exceeds the initial purchase price plus related transaction costs. . Options on Securities Indices. Each Account may purchase and sell put and call options on any securities index based on securities in which the Account may invest. Securities index options are designed to reflect price fluctuations in a group of securities or segment of the securities market rather than price fluctuations in a single security. Options on securities indices are similar to options on securities, except that the exercise of securities index options requires cash payments and does not involve the actual purchase or sale of securities. The Accounts engage in transactions in put and call options on securities indices for the same purposes as they engage in transactions in options on securities. When an Account writes call options on securities indices, it holds in its portfolio underlying securities which, in the judgment of the Sub-Advisor, correlate closely with the securities index and which have a value at least equal to the aggregate amount of the securities index options. . Risks Associated with Option Transactions. An option position may be closed out only on an exchange that provides a secondary market for an option of the same series. The Accounts generally purchase or write only those options for which there appears to be an active secondary market. However, there is no assurance that a liquid secondary market on an exchange exists for any particular option, or at any particular time. If an Account is unable to effect closing sale transactions in options it has purchased, it has to exercise its options in order to realize any profit and may incur transaction costs upon the purchase or sale of underlying securities. If an Account is unable to effect a closing purchase transaction for a covered option that it has written, it is not able to sell the underlying securities, or dispose of the assets held in a segregated account, until the option expires or is exercised. An Account's ability to terminate option positions established in the over-the-counter market may be more limited than for exchange-traded options and may also involve the risk that broker-dealers participating in such transactions might fail to meet their obligations. . Futures Contracts and Options on Futures Contracts. Each Account may purchase and sell financial futures contracts and options on those contracts. Financial futures contracts are commodities contracts based on financial instruments such as U.S. Treasury bonds or bills or on securities indices such as the S&P 500 Index. Futures contracts, options on futures contracts and the commodity exchanges on which they are traded are regulated by the Commodity Futures Trading Commission ("CFTC"). Through the purchase and sale of futures contracts and related options, an Account may seek to hedge against a decline in the value of securities owned by the Account or an increase in the price of securities that the Account plans to purchase. Each Account may also purchase and sell futures contracts and related options to maintain cash reserves while simulating full investment in securities and to keep substantially all of its assets exposed to the market. Each Account may enter into futures contracts and related options transactions both for hedging and non-hedging purposes. . Futures Contracts. When an Account sells a futures contract based on a financial instrument, the Account is obligated to deliver that kind of instrument at a specified future time for a specified price. When an Account purchases that kind of contract, it is obligated to take delivery of the instrument at a specified time and to pay the specified price. In most instances, these contracts are closed out by entering into an offsetting transaction before the settlement date. The Account realizes a gain or loss depending on whether the price of an offsetting purchase plus transaction costs are less or more than the price of the initial sale or on whether the price of an offsetting sale is more or less than the price of the initial purchase plus transaction costs. Although the Accounts usually liquidate futures contracts on financial instruments in this manner, they may make or take delivery of the underlying securities when it appears economically advantageous to do so. A futures contract based on a securities index provides for the purchase or sale of a group of securities at a specified future time for a specified price. These contracts do not require actual delivery of securities but result in a cash settlement. The amount of the settlement is based on the difference in value of the index between the time the contract was entered into and the time it is liquidated (at its expiration or earlier if it is closed out by entering into an offsetting transaction). When a futures contract is purchased or sold a brokerage commission is paid. Unlike the purchase or sale of a security or option, no price or premium is paid or received. Instead, an amount of cash or other liquid assets (generally about 5% of the contract amount) is deposited by the Account with its custodian for the benefit of the futures commission merchant through which the Account engages in the transaction. This amount is known as "initial margin." It does not involve the borrowing of funds by the Account to finance the transaction. It instead represents a "good faith" deposit assuring the performance of both the purchaser and the seller under the futures contract. It is returned to the Account upon termination of the futures contract if all the Account's contractual obligations have been satisfied. Subsequent payments to and from the broker, known as "variation margin," are required to be made on a daily basis as the price of the futures contract fluctuates, a process known as "marking to market." The fluctuations make the long or short positions in the futures contract more or less valuable. If the position is closed out by taking an opposite position prior to the settlement date of the futures contract, a final determination of variation margin is made. Any additional cash is required to be paid to or released by the broker and the Account realizes a loss or gain. In using futures contracts, the Account may seek to establish more certainly than would otherwise be possible the effective price of or rate of return on portfolio securities or securities that the Account proposes to acquire. An Account, for example, sells futures contracts in anticipation of a rise in interest rates that would cause a decline in the value of its debt investments. When this kind of hedging is successful, the futures contract increases in value when the Account's debt securities decline in value and thereby keeps the Account's net asset value from declining as much as it otherwise would. An Account may also sell futures contracts on securities indices in anticipation of or during a stock market decline in an endeavor to offset a decrease in the market value of its equity investments. When an Account is not fully invested and anticipates an increase in the cost of securities it intends to purchase, it may purchase financial futures contracts. When increases in the prices of equities are expected, an Account may purchase futures contracts on securities indices in order to gain rapid market exposure that may partially or entirely offset increases in the cost of the equity securities it intends to purchase. . Options on Futures Contracts. The Accounts may also purchase and write call and put options on futures contracts. A call option on a futures contract gives the purchaser the right, in return for the premium paid, to purchase a futures contract (assume a long position) at a specified exercise price at any time before the option expires. A put option gives the purchaser the right, in return for the premium paid, to sell a futures contract (assume a short position), for a specified exercise price, at any time before the option expires. Upon the exercise of a call, the writer of the option is obligated to sell the futures contract (to deliver a long position to the option holder) at the option exercise price, which will presumably be lower than the current market price of the contract in the futures market. Upon exercise of a put, the writer of the option is obligated to purchase the futures contract (deliver a short position to the option holder) at the option exercise price, which will presumably be higher than the current market price of the contract in the futures market. However, as with the trading of futures, most options are closed out prior to their expiration by the purchase or sale of an offsetting option at a market price that reflects an increase or a decrease from the premium originally paid. Options on futures can be used to hedge substantially the same risks addressed by the direct purchase or sale of the underlying futures contracts. For example, if an Account anticipates a rise in interest rates and a decline in the market value of the debt securities in its portfolio, it might purchase put options or write call options on futures contracts instead of selling futures contracts. If an Account purchases an option on a futures contract, it may obtain benefits similar to those that would result if it held the futures position itself. But in contrast to a futures transaction, the purchase of an option involves the payment of a premium in addition to transaction costs. In the event of an adverse market movement, however, the Account is not subject to a risk of loss on the option transaction beyond the price of the premium it paid plus its transaction costs. When an Account writes an option on a futures contract, the premium paid by the purchaser is deposited with the Account's custodian. The Account must maintain with its custodian all or a portion of the initial margin requirement on the underlying futures contract. It assumes a risk of adverse movement in the price of the underlying futures contract comparable to that involved in holding a futures position. Subsequent payments to and from the broker, similar to variation margin payments, are made as the premium and the initial margin requirements are marked to market daily. The premium may partially offset an unfavorable change in the value of portfolio securities, if the option is not exercised, or it may reduce the amount of any loss incurred by the Account if the option is exercised. . Risks Associated with Futures Transactions. There are a number of risks associated with transactions in futures contracts and related options. An Account's successful use of futures contracts is subject to the ability of the Sub-Advisor to predict correctly the factors affecting the market values of the Account's portfolio securities. For example, if an Account is hedged against the possibility of an increase in interest rates which would adversely affect debt securities held by the Account and the prices of those debt securities instead increases, the Account loses part or all of the benefit of the increased value of its securities it hedged because it has offsetting losses in its futures positions. Other risks include imperfect correlation between price movements in the financial instrument or securities index underlying the futures contract, on the one hand, and the price movements of either the futures contract itself or the securities held by the Account, on the other hand. If the prices do not move in the same direction or to the same extent, the transaction may result in trading losses. Prior to exercise or expiration, a position in futures may be terminated only by entering into a closing purchase or sale transaction. This requires a secondary market on the relevant contract market. The Account enters into a futures contract or related option only if there appears to be a liquid secondary market. There can be no assurance, however, that such a liquid secondary market exists for any particular futures contract or related option at any specific time. Thus, it may not be possible to close out a futures position once it has been established. Under such circumstances, the Account continues to be required to make daily cash payments of variation margin in the event of adverse price movements. In such situations, if the Account has insufficient cash, it may be required to sell portfolio securities to meet daily variation margin requirements at a time when it may be disadvantageous to do so. In addition, the Account may be required to perform under the terms of the futures contracts it holds. The inability to close out futures positions also could have an adverse impact on the Account's ability effectively to hedge its portfolio. Most United States futures exchanges limit the amount of fluctuation permitted in futures contract prices during a single trading day. This daily limit establishes the maximum amount that the price of a futures contract may vary either up or down from the previous day's settlement price at the end of a trading session. Once the daily limit has been reached in a particular type of contract, no more trades may be made on that day at a price beyond that limit. The daily limit governs only price movements during a particular trading day and therefore does not limit potential losses because the limit may prevent the liquidation of unfavorable positions. Futures contract prices have occasionally moved to the daily limit for several consecutive trading days with little or no trading, thereby preventing prompt liquidation of futures positions and subjecting some futures traders to substantial losses. . Limitations on the Use of Futures and Options on Futures Contracts. Each Account intends to come within an exclusion from the definition of "commodity pool operator" provided by CFTC regulations. Each Account may enter into futures contracts and related options transactions, for hedging purposes and for other appropriate risk management purposes, and to modify the Account's exposure to various currency, equity, or fixed-income markets. Each Account (other than Asset Allocation and Equity Growth) may engage in speculative futures trading. When using futures contracts and options on futures contracts for hedging or risk management purposes, each Account determines that the price fluctuations in the contracts and options are substantially related to price fluctuations in securities held by the Account or which it expects to purchase. In pursuing traditional hedging activities, each Account may sell futures contracts or acquire puts to protect against a decline in the price of securities that the Account owns. Each Account may purchase futures contracts or calls on futures contracts to protect the Account against an increase in the price of securities the Account intends to purchase before it is in a position to do so. When an Account purchases a futures contract, or purchases a call option on a futures contract, it segregates portfolio assets, which must be liquid and marked to the market daily, in a segregated account. The amount so segregated plus the amount of initial margin held for the account of its broker equals the market value of the futures contract. Forward Foreign Currency Exchange Contracts ------------------------------------------- The Accounts may, but are not obligated to, enter into forward foreign currency exchange contracts under various circumstances. Currency transactions include forward currency contracts, exchange listed or over-the-counter options on currencies. A forward currency contract involves a privately negotiated obligation to purchase or sell a specific currency at a specified future date at a price set at the time of the contract. The typical use of a forward contract is to "lock in" the price of a security in U.S. dollars or some other foreign currency which an Account is holding in its portfolio. By entering into a forward contract for the purchase or sale, for a fixed amount of dollars or other currency, of the amount of foreign currency involved in the underlying security transactions, an Account may be able to protect itself against a possible loss resulting from an adverse change in the relationship between the U.S. dollar or other currency which is being used for the security purchase and the foreign currency in which the security is denominated in or exposed to during the period between the date on which the security is purchased or sold and the date on which payment is made or received. The Sub-Advisor also may from time to time utilize forward contracts for other purposes. For example, they may be used to hedge a foreign security held in the portfolio or a security which pays out principal tied to an exchange rate between the U.S. dollar and a foreign currency, against a decline in value of the applicable foreign currency. They also may be used to lock in the current exchange rate of the currency in which those securities anticipated to be purchased are denominated in or exposed to. At times, an Account may enter into "cross-currency" hedging transactions involving currencies other than those in which securities are held or proposed to be purchased are denominated. An Account segregates assets consisting of foreign securities denominated in or exposed to the currency for which the Account has entered into forward contracts under the second circumstance, as set forth above, for the term of the forward contract. It should be noted that the use of forward foreign currency exchange contracts does not eliminate fluctuations in the underlying prices of the securities. It simply establishes a rate of exchange between the currencies that can be achieved at some future point in time. Additionally, although such contracts tend to minimize the risk of loss due to a decline in the value of the hedged currency, they also tend to limit any potential gain that might result if the value of the currency increases. Currency hedging involves some of the same risks and considerations as other transactions with similar instruments. Currency transactions can result in losses to an Account if the currency being hedged fluctuates in value to a degree or in a direction that is not anticipated. Further, the risk exists that the perceived linkage between various currencies may not be present or may not be present during the particular time that an Account is engaging in proxy hedging. Currency transactions are also subject to risks different from those of other portfolio transactions. Because currency control is of great importance to the issuing governments and influences economic planning and policy, purchases and sales of currency and related instruments can be adversely affected by government exchange controls, limitations or restrictions on repatriation of currency, and manipulations or exchange restrictions imposed by governments. These forms of governmental actions can result in losses to an Account if it is unable to deliver or receive currency or monies in settlement of obligations. They could also cause hedges the Account has entered into to be rendered useless, resulting in full currency exposure as well as incurring transaction costs. Currency exchange rates may also fluctuate based on factors extrinsic to a country's economy. Buyers and sellers of currency futures contracts are subject to the same risks that apply to the use of futures contracts generally. Further, settlement of a currency futures contract for the purchase of most currencies must occur at a bank based in the issuing nation. The ability to establish and close out positions on trading options on currency futures contracts is subject to the maintenance of a liquid market that may not always be available. Repurchase and Reverse Repurchase Agreements, Mortgage Dollar Rolls and ----------------------------------------------------------------------- Sale-Buybacks ----------------- The Accounts may invest in repurchase and reverse repurchase agreements. In a repurchase agreement, an Account purchases a security and simultaneously commits to resell that security to the seller at an agreed upon price on an agreed upon date within a number of days (usually not more than seven) from the date of purchase. The resale price consists of the purchase price plus an amount that is unrelated to the coupon rate or maturity of the purchased security. A repurchase agreement involves the obligation of the seller to pay the agreed upon price, which obligation is in effect secured by the value (at least equal to the amount of the agreed upon resale price and marked-to-market daily) of the underlying security or "collateral." A risk associated with repurchase agreements is the failure of the seller to repurchase the securities as agreed, which may cause an Account to suffer a loss if the market value of such securities declines before they can be liquidated on the open market. In the event of bankruptcy or insolvency of the seller, an Account may encounter delays and incur costs in liquidating the underlying security. Repurchase agreements that mature in more than seven days are subject to the 15% limit on illiquid investments. While it is not possible to eliminate all risks from these transactions, it is the policy of the Account to limit repurchase agreements to those parties whose creditworthiness has been reviewed and found satisfactory by the Sub-Advisor. An Account may use reverse repurchase agreements, mortgage dollar rolls, and economically similar transactions to obtain cash to satisfy unusually heavy redemption requests or for other temporary or emergency purposes without the necessity of selling portfolio securities, or to earn additional income on portfolio securities, such as Treasury bills or notes. In a reverse repurchase agreement, an Account sells a portfolio security to another party, such as a bank or broker-dealer, in return for cash and agrees to repurchase the instrument at a particular price and time. While a reverse repurchase agreement is outstanding, an Account will maintain cash and appropriate liquid assets to cover its obligation under the agreement. The Account will enter into reverse repurchase agreements only with parties that the Sub-Advisor deems creditworthy. Using reverse repurchase agreements to earn additional income involves the risk that the interest earned on the invested proceeds is less than the expense of the reverse repurchase agreement transaction. This technique may also have a leveraging effect on the Account, although the Account's intent to segregate assets in the amount of the reverse repurchase agreement minimizes this effect. A "mortgage dollar roll" is similar to a reverse repurchase agreement in certain respects. In a "dollar roll" transaction an Account sells a mortgage-related security, such as a security issued by GNMA, to a dealer and simultaneously agrees to repurchase a similar security (but not the same security) in the future at a pre-determined price. A dollar roll can be viewed, like a reverse repurchase agreement, as a collateralized borrowing in which an Account pledges a mortgage-related security to a dealer to obtain cash. Unlike in the case of reverse repurchase agreements, the dealer with which an Account enters into a dollar roll transaction is not obligated to return the same securities as those originally sold by the Account, but only securities which are "substantially identical." To be considered "substantially identical," the securities returned to an Account generally must: (1) be collateralized by the same types of underlying mortgages; (2) be issued by the same agency and be part of the same program; (3) have a similar original stated maturity; (4) have identical net coupon rates; (5) have similar market yields (and therefore price); and (6) satisfy "good delivery" requirements, meaning that the aggregate principal amounts of the securities delivered and received back must be within 0.1% of the initial amount delivered. An Account's obligations under a dollar roll agreement must be covered by segregated liquid assets equal in value to the securities subject to repurchase by the Account. An Account also may effect simultaneous purchase and sale transactions that are known as "sale-buybacks." A sale-buyback is similar to a reverse repurchase agreement, except that in a sale-buyback, the counterparty who purchases the security is entitled to receive any principal or interest payments made on the underlying security pending settlement of the Account's repurchase of the underlying security. An Account's obligations under a sale-buyback typically would be offset by liquid assets equal in value to the amount of the Account's forward commitment to repurchase the subject security. Swap Agreements and Options on Swap Agreements -------------------------------------------------- Each Account (except Money Market Account) may engage in swap transactions, including, but not limited to, swap agreements on interest rates, security or commodity indexes, specific securities and commodities, and credit and event-linked swaps, to the extent permitted by its investment restrictions. To the extent an Account may invest in foreign currency-denominated securities, it may also invest in currency exchange rate swap agreements. An Account may also enter into options on swap agreements ("swap options"). An Account may enter into swap transactions for any legal purpose consistent with its investment objectives and policies, such as for the purpose of attempting to obtain or preserve a particular return or spread at a lower cost than obtaining a return or spread through purchases and/or sales of instruments in other markets, to protect against currency fluctuations, as a duration management technique, to protect against any increase in the price of securities an Account anticipates purchasing at a later date, or to gain exposure to certain markets in the most economical way possible. Swap agreements are two party contracts entered into primarily by institutional investors for periods ranging from a few weeks to more than one year. In a standard "swap" transaction, two parties agree to exchange the returns (or differentials in rates of return) earned or realized on particular predetermined investments or instruments, which may be adjusted for an interest factor. The gross returns to be exchanged or "swapped" between the parties are generally calculated with respect to a "notional amount," i.e., the return on or increase in value of a particular dollar amount invested at a particular interest rate, in a particular foreign currency, or in a "basket" of securities or commodities representing a particular index. Forms of swap agreements include interest rate caps, under which, in return for a premium, one party agrees to make payments to the other to the extent that interest rates exceed a specified rate, or "cap"; interest rate floors, under which, in return for a premium, one party agrees to make payments to the other to the extent that interest rates fall below a specified rate, or "floor"; and interest rate collars, under which a party sells a cap and purchases a floor or vice versa in an attempt to protect itself against interest rate movements exceeding given minimum or maximum levels. Consistent with an Account's investment objectives and general investment policies, certain of the Accounts may invest in commodity swap agreements. For example, an investment in a commodity swap agreement may involve the exchange of floating-rate interest payments for the total return on a commodity index. In a total return commodity swap, an Account will receive the price appreciation of a commodity index, a portion of the index, or a single commodity in exchange for paying an agreed-upon fee. If the commodity swap is for one period, an Account may pay a fixed fee, established at the outset of the swap. However, if the term of the commodity swap is for more than one period, with interim swap payments, an Account may pay an adjustable or floating fee. With a "floating" rate, the fee may be pegged to a base rate, such as the London Interbank Offered Rate, and is adjusted each period. Therefore, if interest rates increase over the term of the swap contract, an Account may be required to pay a higher fee at each swap reset date. An Account may enter into credit default swap agreements. The "buyer" in a credit default contract is obligated to pay the "seller" a periodic stream of payments over the term of the contract provided that no event of default on an underlying reference obligation has occurred. If an event of default occurs, the seller must pay the buyer the full notional value, or "par value," of the reference obligation in exchange for the reference obligation. An Account may be either the buyer or seller in a credit default swap transaction. If an Account is a buyer and no event of default occurs, the Account will lose its investment and recover nothing. However, if an event of default occurs, the Account (if the buyer) will receive the full notional value of the reference obligation that may have little or no value. As a seller, an Account receives a fixed rate of income throughout the term of the contract, which typically is between six months and three years, provided that there is no default event. If an event of default occurs, the seller must pay the buyer the full notional value of the reference obligation. A swap option is a contract that gives a counterparty the right (but not the obligation) in return for payment of a premium, to enter into a new swap agreement or to shorten, extend, cancel or otherwise modify an existing swap agreement, at some designated future time on specified terms. Each Account (except Money Market Account) may write (sell) and purchase put and call swap options. Most swap agreements entered into by the Accounts would calculate the obligations of the parties to the agreement on a "net basis." Consequently, an Account's current obligations (or rights) under a swap agreement will generally be equal only to the net amount to be paid or received under the agreement based on the relative values of the positions held by each party to the agreement (the "net amount"). An Account's current obligations under a swap agreement will be accrued daily (offset against any amounts owed to the Account) and any accrued but unpaid net amounts owed to a swap counterparty will be covered by the segregation of assets determined to be liquid by the Sub-Advisor in accordance with procedures established by the Board of Directors, to avoid any potential leveraging of the Account's portfolio. Obligations under swap agreements so covered will not be construed to be "senior securities" for purposes of the Account's investment restriction concerning senior securities. Each Account will not enter into a swap agreement with any single party if the net amount owed or to be received under existing contracts with that party would exceed 5% of the Account's total assets. Whether an Account's use of swap agreements or swap options will be successful in furthering its investment objective of total return will depend on the ability of the Account's Sub-Advisor to predict correctly whether certain types of investments are likely to produce greater returns than other investments. Because they are two party contracts and because they may have terms of greater than seven days, swap agreements may be considered to be illiquid. Moreover, an Account bears the risk of loss of the amount expected to be received under a swap agreement in the event of the default or bankruptcy of a swap agreement counterparty. The Accounts will enter into swap agreements only with counterparties that present minimal credit risks, as determined by the Account's Sub-Advisor. Certain restrictions imposed on the Accounts by the Internal Revenue Code may limit the Accounts' ability to use swap agreements. The swaps market is a relatively new market and is largely unregulated. It is possible that developments in the swaps market, including potential government regulation, could adversely affect an Account's ability to terminate existing swap agreements or to realize amounts to be received under such agreements. Depending on the terms of the particular option agreement, an Account will generally incur a greater degree of risk when it writes a swap option than it will incur when it purchases a swap option. When an Account purchases a swap option, it risks losing only the amount of the premium it has paid should it decide to let the option expire unexercised. However, when an Account writes a swap option, upon exercise of the option the Account will become obligated according to the terms of the underlying agreement. Liquidity. Some swap markets have grown substantially in recent years with a large number of banks and investment banking firms acting both as principals and as agents utilizing standardized swap documentation. As a result, these swap markets have become relatively liquid. The liquidity of swap agreements will be determined by the Sub-Advisor based on various factors, including: . the frequency of trades and quotations, . the number of dealers and prospective purchasers in the marketplace, . dealer undertakings to make a market, . the nature of the security (including any demand or tender features, and . the nature of the marketplace for trades (including the ability to assign or offset a portfolio's rights and obligations relating to the investment). Such determination will govern whether a swap will be deemed to be within the 15% restriction on investments in illiquid securities. For purposes of applying the Accounts' investment policies and restrictions (as stated in the Prospectuses and this SAI) swap agreements are generally valued by the Accounts at market value. In the case of a credit default swap sold by an Account (i.e., where the Account is selling credit default protection), however, the Account will value the swap at its notional amount. The manner in which the Accounts value certain securities or other instruments for purposes of applying investment policies and restrictions may differ from the manner in which those investments are valued by other types of investors. High-Yield/High-Risk Bonds -------------------------- The Asset Allocation, Balanced, Bond, MidCap Value and Short-Term Bond Accounts each may invest a portion of its assets in bonds that are rated below investment grade (i.e., bonds rated BB or lower by Standard & Poor's Ratings Services or Ba or lower by Moody's Investors Service, Inc.). Lower rated bonds involve a higher degree of credit risk, which is the risk that the issuer will not make interest or principal payments when due. In the event of an unanticipated default, an Account would experience a reduction in its income and could expect a decline in the market value of the bonds so affected. The Asset Allocation, Balanced and Bond Accounts may also invest in unrated bonds of foreign and domestic issuers. Unrated bonds, while not necessarily of lower quality than rated bonds, may not have as broad a market. Because of the size and perceived demand of the issue, among other factors, certain municipalities may not incur the expense of obtaining a rating. The Sub-Advisor will analyze the creditworthiness of the issuer, as well as any financial institution or other party responsible for payments on the bond, in determining whether to purchase unrated bonds. Unrated bonds will be included in the limitation each Account has with regard to high yield bonds unless the Sub-Advisor deems such securities to be the equivalent of investment grade bonds. Mortgage- and Asset-Backed Securities ------------------------------------- The yield characteristics of the mortgage- and asset-backed securities in which the Asset Allocation, Balanced, Bond and Government & High Quality Bond Accounts may invest differ from those of traditional debt securities. Among the major differences are that the interest and principal payments are made more frequently on mortgage- and asset-backed securities (usually monthly) and that principal may be prepaid at any time because the underlying mortgage loans or other assets generally may be prepaid at any time. As a result, if the Account purchases those securities at a premium, a prepayment rate that is faster than expected will reduce their yield, while a prepayment rate that is slower than expected will have the opposite effect of increasing yield. If the Account purchases these securities at a discount, faster than expected prepayments will increase their yield, while slower than expected prepayments will reduce their yield. Amounts available for reinvestment by the Account are likely to be greater during a period of declining interest rates and, as a result, are likely to be reinvested at lower interest rates than during a period of rising interest rates. In general, the prepayment rate for mortgage-backed securities decreases as interest rates rise and increases as interest rates fall. However, rising interest rates will tend to decrease the value of these securities. In addition, an increase in interest rates may affect the volatility of these securities by effectively changing a security that was considered a short-term security at the time of purchase into a long-term security. Long-term securities generally fluctuate more widely in response to changes in interest rates than short- or medium-term securities. The market for privately issued mortgage- and asset-backed securities is smaller and less liquid than the market for U.S. government mortgage-backed securities. A collateralized mortgage obligation ("CMO") may be structured in a manner that provides a wide variety of investment characteristics (yield, effective maturity and interest rate sensitivity). As market conditions change, and especially during periods of rapid market interest rate changes, the ability of a CMO to provide the anticipated investment characteristics may be greatly diminished. Increased market volatility and/or reduced liquidity may result. Real Estate Investment Trusts ----------------------------- Equity real estate investment trusts own real estate properties, while mortgage real estate investment trusts make construction, development and long-term mortgage loans. Their value may be affected by changes in the underlying property of the trusts, the creditworthiness of the issuer, property taxes, interest rates, and tax and regulatory requirements, such as those relating to the environment. Both types of trusts are dependent upon management skill, are not diversified, and are subject to heavy cash flow dependency, defaults by borrowers, self-liquidation, and the possibility of failing to qualify for tax-free status of income under the Internal Revenue Code and failing to maintain exemption from the 1940 Act. Zero-coupon securities ---------------------- The Accounts may invest in zero-coupon securities. Zero-coupon securities have no stated interest rate and pay only the principal portion at a stated date in the future. They usually trade at a substantial discount from their face (par) value. Zero-coupon securities are subject to greater market value fluctuations in response to changing interest rates than debt obligations of comparable maturities that make distributions of interest in cash. Securities Lending ------------------ All Accounts may lend their portfolio securities. None of the Accounts will lend its portfolio securities if as a result the aggregate of such loans made by the Account would exceed the limits established by the 1940 Act. Portfolio securities may be lent to unaffiliated broker-dealers and other unaffiliated qualified financial institutions provided that such loans are callable at any time on not more than five business days' notice and that cash or other liquid assets equal to at least 100% of the market value of the securities loaned, determined daily, is deposited by the borrower with the Account and is maintained each business day. While such securities are on loan, the borrower pays the Account any income accruing thereon. The Account may invest any cash collateral, thereby earning additional income, and may receive an agreed-upon fee from the borrower. Borrowed securities must be returned when the loan terminates. Any gain or loss in the market value of the borrowed securities that occurs during the term of the loan belongs to the Account and its shareholders. An Account pays reasonable administrative, custodial and other fees in connection with such loans and may pay a negotiated portion of the interest earned on the cash or government securities pledged as collateral to the borrower or placing broker. An Account does not normally retain voting rights attendant to securities it has lent, but it may call a loan of securities in anticipation of an important vote. When-Issued, Delayed Delivery and Forward Commitment Transactions ----------------------------------------------------------------- Each of the Accounts may purchase or sell securities on a when-issued, delayed delivery, or forward commitment basis. When such purchases are outstanding, the Account will segregate until the settlement date assets determined to be liquid by the Sub-Advisor in accordance with procedures established by the Board of Directors, in an amount sufficient to meet the purchase price. Typically, no income accrues on securities an Account has committed to purchase prior to the time delivery of the securities is made, although an Account may earn income on securities it has segregated. When purchasing a security on a when-issued, delayed delivery, or forward commitment basis, the Account assumes the rights and risks of ownership of the security, including the risk of price and yield fluctuations, and takes such fluctuations into account when determining its net asset value. Because the Account is not required to pay for the security until the delivery date, these risks are in addition to the risks associated with the Account's other investments. If the Account remains substantially fully invested at a time when when-issued, delayed delivery, or forward commitment purchases are outstanding, the purchases may result in a form of leverage. When the Account has sold a security on a when-issued, delayed delivery, or forward commitment basis, the Account does not participate in future gains or losses with respect to the security. If the other party to a transaction fails to deliver or pay for the securities, the Account could miss a favorable price or yield opportunity or could suffer a loss. An Account may dispose of or renegotiate a transaction after it is entered into, and may sell when-issued, delayed delivery or forward commitment securities before they are delivered, which may result in a capital gain or loss. There is no percentage limitation on the extent to which the Accounts may purchase or sell securities on a when-issued, delayed delivery, or forward commitment basis. Money Market Instruments/Temporary Defensive Position ----------------------------------------------------- The Money Market Account invests all of its available assets in money market instruments maturing in 397 days or less. In addition, all of the Accounts may make money market investments (cash equivalents), without limit, pending other investment or settlement, for liquidity or in adverse market conditions. Following are descriptions of the types of money market instruments that the Accounts may purchase: . U.S. Government Securities - Securities issued or guaranteed by the U.S. government, including treasury bills, notes and bonds. . U.S. Government Agency Securities - Obligations issued or guaranteed by agencies or instrumentalities of the U.S. government. . U.S. agency obligations include, but are not limited to, the Bank for Cooperatives, Federal Home Loan Banks and Federal Intermediate Credit Banks. . U.S. instrumentality obligations include, but are not limited to, the Export-Import Bank, Federal Home Loan Mortgage Corporation and Federal National Mortgage Association. Some obligations issued or guaranteed by U.S. government agencies and instrumentalities are supported by the full faith and credit of the U.S. Treasury. Others, such as those issued by the Federal National Mortgage Association, are supported by discretionary authority of the U.S. government to purchase certain obligations of the agency or instrumentality. Still others, such as those issued by the Student Loan Marketing Association, are supported only by the credit of the agency or instrumentality. . Bank Obligations - Certificates of deposit, time deposits and bankers' acceptances of U.S. commercial banks having total assets of at least one billion dollars and overseas branches of U.S. commercial banks and foreign banks, which in the opinion of the Sub-Advisor, are of comparable quality. However, each such bank with its branches has total assets of at least five billion dollars, and certificates, including time deposits of domestic savings and loan associations having at least one billion dollars in assets that are insured by the Federal Savings and Loan Insurance Corporation. The Account may acquire obligations of U.S. banks that are not members of the Federal Reserve System or of the Federal Deposit Insurance Corporation. Obligations of foreign banks and obligations of overseas branches of U.S. banks are subject to somewhat different regulations and risks than those of U.S. domestic banks. For example, an issuing bank may be able to maintain that the liability for an investment is solely that of the overseas branch which could expose an Account to a greater risk of loss. In addition, obligations of foreign banks or of overseas branches of U.S. banks may be affected by governmental action in the country of domicile of the branch or parent bank. Examples of adverse foreign governmental actions include the imposition of currency controls, the imposition of withholding taxes on interest income payable on such obligations, interest limitations, seizure or nationalization of assets, or the declaration of a moratorium. Deposits in foreign banks or foreign branches of U.S. banks are not covered by the Federal Deposit Insurance Corporation. An Account only buys short-term instruments where the risks of adverse governmental action are believed by the Sub-Advisor to be minimal. An Account considers these factors, along with other appropriate factors, in making an investment decision to acquire such obligations. It only acquires those which, in the opinion of management, are of an investment quality comparable to other debt securities bought by the Account. An Account may invest in certificates of deposit of selected banks having less than one billion dollars of assets providing the certificates do not exceed the level of insurance (currently $100,000) provided by the applicable government agency. A certificate of deposit is issued against funds deposited in a bank or savings and loan association for a definite period of time, at a specified rate of return. Normally they are negotiable. However, an Account occasionally may invest in certificates of deposit which are not negotiable. Such certificates may provide for interest penalties in the event of withdrawal prior to their maturity. A bankers' acceptance is a short-term credit instrument issued by corporations to finance the import, export, transfer or storage of goods. They are termed "accepted" when a bank guarantees their payment at maturity and reflect the obligation of both the bank and drawer to pay the face amount of the instrument at maturity. . Commercial Paper - Short-term promissory notes issued by U.S. or foreign corporations. . Short-term Corporate Debt - Corporate notes, bonds and debentures that at the time of purchase have 397 days or less remaining to maturity. . Repurchase Agreements - Instruments under which securities are purchased from a bank or securities dealer with an agreement by the seller to repurchase the securities at the same price plus interest at a specified rate. . Taxable Municipal Obligations - Short-term obligations issued or guaranteed by state and municipal issuers which generate taxable income. The ratings of nationally recognized statistical rating organization (NRSRO), such as Moody's Investor Services, Inc. ("Moody's") and Standard & Poor's ("S&P"), which are described in Appendix A, represent their opinions as to the quality of the money market instruments which they undertake to rate. It should be emphasized, however, that ratings are general and are not absolute standards of quality. These ratings, including ratings of NRSROs other than Moody's and S&P, are the initial criteria for selection of portfolio investments, but the Sub-Advisor further evaluates these securities. Other Investment Companies ------------------------------ Each Account reserves the right to invest up to 10% of its total assets in the securities of all investment companies, but may not acquire more than 3% of the voting securities of, nor invest more than 5% of its total assets in securities of, any other investment company. Securities of other investment companies, including shares of closed-end investment companies, unit investment trusts, various exchange-traded funds ("ETFs") and other open-end investment companies, represent interests in professionally managed portfolios that may invest in any type of instrument. Certain types of investment companies, such as closed-end investment companies, issue a fixed number of shares that trade on a stock exchange or over-the-counter at a premium or a discount to their net asset value. Others are continuously offered at net asset value, but may also be traded in the secondary market. ETFs are often structured to perform in a similar fashion to a broad-based securities index. Investing in ETFs involves substantially the same risks as investing directly in the underlying instruments. In addition, ETFs involve the risk that they will not perform in exactly the same fashion, or in response to the same factors, as the index or underlying instruments. As a shareholder in an investment company, a Account would bear its ratable share of that entity's expenses, including its advisory and administrative fees. The Fund would also continue to pay its own advisory fees and other expenses. Consequently, the Account and its shareholders, in effect, will be absorbing two levels of fees with respect to investments in other investment companies. INDUSTRY CONCENTRATIONS Each of the Accounts, except the Real Estate Securities Account, may not concentrate (invest more than 25% of its assets) its investments in any particular industry. The Real Estate Securities Account may hold more than 25% of its assets in securities of companies in the real estate industry. The LargeCap Stock Index Account may concentrate its investments in a particular industry only to the extent that the S&P 500 Index is concentrated. For purposes of applying the LargeCap Growth Equity Account and SmallCap Growth Account (portion sub-advised by Emerald) industry concentration restrictions, the Accounts use the industry groups used in the Data Monitor Portfolio Monitoring System of William O'Neill & Co., Incorporated. The portion of the SmallCap Growth Account sub-advised by UBS uses the S&P Global Industry Classification Standards (GICS) sector and industry classifications. The LargeCap Growth Account uses Bloomberg L.P. industry classifications. The Equity Value Account uses the industry groups of Morgan Stanley Capital International - Global Industry Classification Standard. The other Accounts use industry classifications based on the "Directory of Companies Filing Annual Reports with the Securities and Exchange Commission ("SEC")." The Accounts interpret their policy with respect to concentration in a particular industry to apply to direct investments in the securities of issuers in a particular industry. For purposes of this restriction, mortgage-backed securities that are issued or guaranteed by the U.S. Government, its agencies or instrumentalities are not subject to the Accounts' industry concentration restrictions, by virtue of the exclusion from that test available to all U.S. Government securities. In the case of privately issued mortgage-related securities, or any asset-backed securities, the Accounts take the position that such securities do not represent interests in any particular "industry" or group of industries. PORTFOLIO TURNOVER Portfolio turnover is a measure of how frequently a portfolio's securities are bought and sold. The portfolio turnover rate is generally calculated as the dollar value of the lesser of a portfolio's purchases or sales of shares of securities during a given year, divided by the monthly average value of the portfolio securities during that year (excluding securities whose maturity or expiration at the time of acquisition were less than one year). For example, a portfolio reporting a 100% portfolio turnover rate would have purchased and sold securities worth as much as the monthly average value of its portfolio securities during the year. It is not possible to predict future turnover rates with accuracy. Many variable factors are outside the control of a portfolio manager. The investment outlook for the securities in which a portfolio may invest may change as a result of unexpected developments in securities markets, economic or monetary policies, or political relationships. High market volatility may result in a portfolio manager using a more active trading strategy than might otherwise be employed. Each portfolio manager considers the economic effects of portfolio turnover but generally does not treat the portfolio turnover rate as a limiting factor in making investment decisions. Sale of shares by investors may require the liquidation of portfolio securities to meet cash flow needs. In addition, changes in a particular portfolio's holdings may be made whenever the portfolio manager considers that a security is no longer appropriate for the portfolio or that another security represents a relatively greater opportunity. Such changes may be made without regard to the length of time that a security has been held. Higher portfolio turnover rates generally increase transaction costs that are expenses of the portfolio. Active trading may generate short-term gains (losses) for taxable shareholders. The following Accounts had significant variation in portfolio turnover rates over the two most recently completed fiscal years: . Equity Growth (2005 - 51.6%; 2004 - 147.7%): The Account's sub-advisor was changed effective August 24, 2004. Bringing the portfolio in line with the strategy of the new portfolio manager resulted in the variation noted. . Government & High Quality Bond (2005 - 262.1%; 2004 - 67.2%): The portfolio managers increased the allocation to certain fixed-income sectors, such as commercial mortgage-backed securities and asset-backed securities, for diversification purposes. The allocation to Treasury and mortgage-backed securities decreased throughout the year to enhance the portfolio's diversification. In addition, the portfolio managers purchased short duration securities, that in turn require more reinvestment as they mature, and utilized mortgage-backed forward purchases (referred to as dollar rolls), which require monthly reinvestment. . Real Estate Securities (2005 - 23.6%; 2004 - 58.8%): The Account experienced lower turnover as market conditions warranted less need for portfolio repositioning. The management approach remains consistent and thus turnover levels may increase as conditions change going forward. MANAGEMENT BOARD OF DIRECTORS Under Maryland law, the Board of Directors of the Fund is responsible for overseeing the management of the Fund's business and affairs. The Board meets several times during the year to fulfill this responsibility Other than serving as Directors, most of the Board members have no affiliation with the Fund or its service providers. Each Director serves until a successor is duly qualified and elected. MANAGEMENT INFORMATION The name, tenure in office, address and date of birth of the officers and Board members are shown below. Each person also has the same position (including committee memberships, if any) with the Principal Investors Fund, Inc. which is also sponsored by Principal Life. Unless an address is shown, the mailing address for the Directors and Officers is the Principal Financial Group, Des Moines, Iowa 50392. The following directors are considered not to be "interested persons" as defined -------------------------------------------------------------------------------- in the 1940 Act. --------------------
NUMBER OF PORTFOLIOS IN FUND OTHER COMPLEX DIRECTORSHIPS NAME, ADDRESS AND OVERSEEN HELD YEAR OF BIRTH POSITION(S) HELD WITH LENGTH OF PRINCIPAL OCCUPATION(S) BY BY ----------------- FUND TIME SERVED DURING PAST 5 YEARS DIRECTOR DIRECTOR --------------------- ----------- ----------------------- ---------- ------------- Elizabeth Ballantine Director Since 2004 Principal, EBA Associates since 1998 86 The McClatchy 1113 Basil Road Member Audit and (consulting and investments) Company McLean, Virginia Nominating Committee 1948 Richard W. Gilbert Director Since 1997 President, Gilbert Communications, 86 5040 Arbor Lane, #302 Member Audit and Inc. since 1993. (management and Calamos Asset Northfield, Illinois Nominating Committee advisory services) Management, Inc. 1940 Mark A. Grimmett Director Since 2004 Executive Vice President and CFO, 86 6310 Deerfield Avenue Member Audit and Merle Norman Cosmetics, Inc., since None San Gabriel, Nominating Committee 2000. Prior thereto, Vice President California and CFO. (manufactorer and 1960 distributor of skin care products) Fritz S. Hirsch Director Since 2005 President and CEO, Sassy, Inc. 86 Suite 203 Member Audit and (manufacturer of infant and juvenile 2101 Waukegan Road Nominating Committee products) None Bannockburn, Illinois 60015 1951 William C. Kimball Director Since 1999 Former Chairman and CEO, Medicap 86 3094 104th Member Audit and Pharmacies, Inc. (chain of retail Casey's General Urbandale, Iowa Nominating Committee pharmacies) Stores, Inc. 1947 Barbara A. Lukavsky Director Since 1997 President and CEO, Barbican 86 100 Market, #314 Member Audit and Enterprises, Inc. since 1997. None Des Moines IA Nominating Committee (holding company for franchises in 1940 Member Executive the cosmetics industry) Committee
The following directors are considered to be Interested Directors because they ------------------------------------------------------------------------------ are affiliated person of Principal Management Corporation (the "Manager") or ---------------------------------------------------------------------------- Princor Financial Services Corporation ("Princor") the principal underwriter for -------------------------------------------------------------------------------- the Fund. ---------
NUMBER OF PORTFOLIOS IN FUND OTHER COMPLEX DIRECTORSHIPS NAME, ADDRESS AND OVERSEEN HELD YEAR OF BIRTH POSITION(S) HELD WITH LENGTH OF PRINCIPAL OCCUPATION(S) BY BY ----------------- FUND TIME SERVED DURING PAST 5 YEARS DIRECTOR DIRECTOR --------------------- ----------- ----------------------- ---------- ------------- John E. Aschenbrenner Director Since 1998 Director, Principal Management 86 None 711 High Street Corporation and Princor Financial Des Moines, Iowa 50392 Services Corporation ("Princor") since 1949 1998. President, Insurance and Financial Services since 2003. Executive Vice President, Principal Life Insurance Company 2000-2003; Prior thereto, Senior Vice President, 1996-2000. Ralph C. Eucher Director Since 1999 Director and President, the Manager since 86 None 711 High Street President and CEO 1999. Director, Princor since 1999. Des Moines, Iowa 50392 Member Executive President, Princor 1999-2005. Senior Vice 1952 Committee President, Principal Life, since 2002. Prior thereto, Vice President. Larry D. Zimpleman Director Since 2001 Chairman and Director, Princor and 86 None 711 High Street Chairman of the Board Principal Management Corporation since Des Moines, Iowa 50392 Member Executive 2001. President, Retirement and Investor 1951 Committee Services since 2003. Executive Vice President, Principal Life 2001-2003. Senior Vice President,1999-2001. Prior thereto, Vice President,1998-1999.
The Executive Committee is selected by the Board. It may exercise all the powers of the Board, with certain exceptions, when the Board is not in session. The Committee must report its actions to the Board. During the year ended December 31, 2005, the committee met once. Officers of the Fund -------------------- The following table presents certain information regarding the officers of the Fund, including their principal occupations which, unless specific dates are shown, are of more than five years duration. Officers serve at the pleasure of the Board of Directors.
NAME, ADDRESS AND POSITION(S) HELD WITH PRINCIPAL OCCUPATION(S) YEAR OF BIRTH FUND DURING PAST 5 YEARS ----------------- --------------------- ----------------------- Craig L. Bassett Treasurer (since 1997) Vice President and Treasurer, 711 High Street Principal Life Des Moines, Iowa 50392 1952 Michael J. Beer Executive Vice Executive Vice President and 711 High Street President Chief Operating Officer, the Des Moines, Iowa 50392 Principal Accounting Manager; President, Princor, 1961 Officer since 2005 (since 1997) Randy L. Bergstrom Assistant Tax Counsel Counsel, Principal Life 711 High Street (since 2005) Des Moines, Iowa 50392 1955 David J. Brown Chief Compliance Vice President, Product & 711 High Street Officer Distribution Compliance, Des Moines, Iowa 50392 (since 2004) Principal Life; Senior Vice 1960 President, the Manager since 2004; Second Vice President, Princor, since 2003, and prior thereto, Vice President, the Manager and Princor Jill R. Brown Vice President Second Vice President, 711 High Street Chief Financial Officer Principal Financial Group and Des Moines, Iowa 50392 (since 2003) Senior Vice President, the 1967 Manager and Princor, since 2006, Chief Financial Officer, Princor since 2003, Vice President, Princor 2003-2006. Prior thereto, Assistant Financial Controller, Principal Life Ernest H. Gillum Vice President Vice President and Chief 711 High Street Assistant Secretary Compliance Officer, the Des Moines, Iowa 50392 (since 1997) Manager, since 2004, and 1955 prior thereto, Vice President, Compliance and Product Development, the Manager Jane E. Karli Assistant Treasurer Assistant Treasurer, 711 High Street (since 1997) Principal Life Des Moines, Iowa 50392 1957 Patrick A. Kirchner Assistant Counsel Counsel, Principal Life 711 High Street (since 2002) Des Moines, Iowa 50392 1960 Carolyn F. Kolks Assistant Tax Counsel Counsel, Principal Life, 711 High Street (since 2005) since 2003 and prior thereto, Des Moines, Iowa 50392 Attorney 1962 Thomas J. Loftus Assistant Counsel Counsel, Principal Life, 711 High Street (since 2002) since 2002, and prior Des Moines, Iowa 50392 thereto, Counsel, Merrill 1953 Lynch Insurance Group David W. Miles Senior Vice President Vice President, Principal 711 High Street and Financial Group, since 2006, Des Moines, Iowa 50392 Secretary Senior Vice President - 1957 (since 2005) Product Development, Princor and the Manager, since 2005, Second Vice President, Principal Financial Group, Inc., 2005-2006. Prior thereto, Executive Vice President, Amcore Financial, Inc. (banking) Sarah J. Pitts Assistant Counsel Counsel, Principal Life 711 High Street (since 2000) Des Moines, Iowa 50392 1945 Layne A. Rasmussen Vice President and Vice President and Controller 711 High Street Controller - Mutual Funds, the Manager Des Moines, Iowa 50392 (since 1997) 1958 Michael D. Roughton Counsel (since 1997) Vice President and Senior 711 High Street Securities Counsel, Principal Des Moines, Iowa 50392 Financial Group, Inc.; Senior 1951 Vice President and Counsel, the Manager and Princor; and Counsel, Principal Global James F. Sager Assistant Secretary Vice President, the Manager 711 High Street (since 2005) and Princor Des Moines, Iowa 50392 1950
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES BOARD COMMITTEES . The Fund's board has an Audit and Nominating Committee. Its members are identified above. All are Independent Directors. During the last fiscal year, the Committee met four times. The audit committee functions of the Committee include: (1) appointing, compensating, and conducting oversight of the work of the independent auditors; (2) reviewing the scope and approach of the proposed audit plan and the audit procedures to be performed; (3) ensuring the objectivity of the internal auditors and the independence of the independent auditors; and (4) establishing and maintaining procedures for the handling of complaints received regarding accounting, internal controls, and auditing. In addition, the Committee meets with the independent and internal auditors to discuss the results of the audits and reports to the full Board of the Fund. The committee also receives reports about accounting and financial matters affecting the Fund. The nominating committee functions of the Committee include selecting and nominating all candidates who are not "interested persons" of the Fund (as defined in the 1940 Act) for election to the Board. Generally, the Committee requests director nominee suggestions from the Committee members and management. In addition, the Committee will consider director candidates recommended by shareholders of the Fund. Recommendations should be submitted in writing to Principal Variable Contracts Fund at 680 8th Street, Des Moines, Iowa 50392-2080. the Committee has not established any specific minimum qualifications for nominees. When evaluating a person as a potential nominee to serve as an independent director, the Committee will generally consider, among other factors: age; education; relevant business experience; geographical factors; whether the person is "independent" and otherwise qualified under applicable laws and regulations to serve as a director; and whether person is willing to serve, and willing and able to commit the time necessary for attendance at meetings and the performance of the duties of an independent director. The Committee also meets personally with the nominees and conducts a reference check. The final decisions is based on a combination of factors, including the strengths and the experience an individual may bring to the Board. The Board does not use regularly the services of any professional search firms to identify or evaluate or assist in identifying or evaluating potential candidates or nominees. The following tables set forth the aggregate dollar range of the equity securities of the mutual funds within the Fund Complex which were beneficially owned by the Directors as of December 31, 2005. The Fund Complex currently includes the Fund and the separate series of Principal Investors Fund, Inc. For the purpose of these tables, beneficial ownership means a direct or indirect pecuniary interest. Only the Directors who are "interested persons" are eligible to participate in an employee benefit program which invests in the Principal Investors Fund, Inc. Directors who beneficially owned shares of the series of Principal Variable Contracts Fund, Inc. did so through variable life insurance and variable annuity contracts issued by Principal Life. Please note that exact dollar amounts of securities held are not listed. Rather, ownership is listed based on the following dollar ranges:Independent Directors (not considered to be "Interested Persons")
A $0 B $1 up to and including $10,000 C $10,001 up to and including $50,000 D $50,001 up to and including $100,000 E $100,001 or more PRINCIPAL INVESTORS FUND BALLANTINE GILBERT GRIMMETT HIRSCH KIMBALL LUKAVSKY ------------------------ ---------- ------- -------- ------ ------- -------- Bond & Mortgage Securities A D C A A E Disciplined LargeCap Blend A B A A A A Diversified International C C A A A E Equity Income A C A A E A Government & High Quality Bond A B A A A A Inflation Protection A A C A A A International Emerging Markets C A A A A A LargeCap Growth A D A A A A LargeCap Value A C A A A A MidCap Blend A D C A A A Money Market A B C A A C Partners LargeCap Blend I A B C A A A Partners LargeCap Value C A A A A A Preferred Securities A A A A D A Principal LifeTime 2050 A A A B A A Real Estate Securities C A A A D A Short-Term Bond A A A A E E Tax-Exempt Bond A A C A A A TOTAL FUND COMPLEX D E D B E E
Directors considered to be "Interested Persons"
A $0 B $1 up to and including $10,000 C $10,001 up to and including $50,000 D $50,001 up to and including $100,000 E $100,001 or more JOHN E. RALPH C. LARRY D. PRINCIPAL INVESTORS FUND ASCHENBRENNER EUCHER ZIMPLEMAN ------------------------ ------------- ------ --------- Bond & Mortgage Securities B A A Disciplined LargeCap Blend B A A Diversified International D C A Equity Income C C A Government & High Quality Bond A C A LargeCap Growth C D A LargeCap S&P 500 Index A E A LargeCap Value C A A MidCap Blend C E A Money Market B E A Partners LargeCap Blend A D A Partners LargeCap Blend I C C A Partners LargeCap Growth I C C A Partners LargeCap Growth II A C A Partners LargeCap Value A D A Partners MidCap Growth B A A Real Estate Securities C A A Short-Term Bond C A A Tax-Exempt Bond A D A PRINCIPAL INVESTORS FUND (THROUGH PARTICIPATION IN AN EMPLOYEE BENEFIT PLAN) Bond & Mortgage Securities A C A Diversified International E A A Government & High Quality Bond A C A International Emerging Markets D A A LargeCap Growth D A A LargeCap S&P 500 Index E D A LargeCap Value A D A MidCap Blend D C A Partners LargeCap Blend I C A A Partners LargeCap Growth I C A A Partners LargeCap Value E A A Partners MidCap Growth D A A Principal LifeTime 2020 A A E Principal LifeTime Strategic Income C A A Real Estate Securities D A A SmallCap S&P 600 Index E A A TOTAL FUND COMPLEX E E E
COMPENSATION . The Fund does not pay any remuneration to its Directors who are employed by the Manager or its affiliates or to its officers who are furnished to the Fund by the Manager and its affiliates pursuant to the Management Agreement. Each Director who is not an "interested person" received compensation for service as a member of the Boards of all investment companies sponsored by Principal Life based on a schedule that takes into account an annual retainer amount and the number of meetings attended. These fees and expenses are divided among the funds and portfolios based on their relative net assets. The following table provides information regarding the compensation received by the Independent Directors from the Fund and the from the Fund Complex during the fiscal year ended December 31, 2005. On that date, there were 2 funds (with a total of 86 portfolios in the Fund Complex). The Fund does not provide retirement benefits to any of the Directors.
DIRECTOR THE FUND FUND COMPLEX -------- -------- ------------ Elizabeth Ballantine $17,981.51 $81,500.00 Frizt Hirsch* $10,453.59 $29,000.00 Richard W. Gilbert $17,801.40 $81,000.00 Mark A. Grimmett $17,981.54 $84,500.00 William C. Kimball $17,981.56 $81,500.00 Barbara A. Lukavsky $17,981.58 $81,500.00 * Mr. Hirsch did not become a Director until September 2005.
INVESTMENT ADVISORY AND OTHER SERVICES INVESTMENT ADVISORS The Manager of the Fund is Principal Management Corporation, a wholly-owned subsidiary of Princor Financial Services Corporation ("Princor") which is a wholly-owned subsidiary of Principal Financial Services, Inc. The Manager is an affiliate of Principal Life. The address of both Princor and the Manager is the Principal Financial Group, Des Moines, Iowa 50392-2080. The Manager was organized on January 10, 1969, and since that time has managed various mutual funds sponsored by Principal Life. The Manager has executed agreements with various Sub-Advisors. Under those Sub-Advisory agreements, the Sub-Advisor agrees to assume the obligations of the Manager to provide investment advisory services for a specific Account. For these services, each Sub-Advisor is paid a fee by the Manager. Accounts: LargeCap Value Sub-Advisor: AllianceBernstein L.P. ("AllianceBernstein") managed $579 billion in assets as of December 31, 2005. AllianceBernstein is located at 1345 Avenue of the Americas, New York, NY 10105. Accounts: Equity Value Sub-Advisor: American Century Investment Management, Inc. ("American Century") was founded in 1958. Its office is located in the American Century Tower at 4500 Main Street, Kansas City, MO 64111. As of December 31, 2005, American Century managed $100.9 billion in assets. Accounts: Growth Sub-Advisor: Columbus Circle Investors ("CCI") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. CCI was founded in 1975. Its address is Metro Center, One Station Place, Stamford, CT 06902. As of December 31, 2005, CCI had approximately $5.9 billion in assets under management. Accounts: SmallCap Growth Sub-Advisor: Emerald Advisers, Inc. ("Emerald") is a wholly-owned subsidiary of Emerald Asset Management. Emerald provides professional investment advisory services to institutional investors, high net worth individuals and the general public. As of December 31, 2005, Emerald managed approximately $2.36 billion in assets. Emerald's offices are located at 1703 Oregon Pike Road, Suite 101, Lancaster, Pennsylvania 17601. Accounts: LargeCap Growth Equity Sub-Advisor: Grantham, Mayo, Van Otterloo & Co. LLC ("GMO") is a privately held global investment management firm servicing clients in the corporate, public, endowment and foundation marketplace located at 40 Rowes Wharf, Boston, MA 02110. As of December 31, 2005, GMO managed $111 billion in client assets. Accounts: SmallCap Value Sub-Advisor: J.P. Morgan Investment Management Inc. ("Morgan"), 522 Fifth Avenue, New York, NY 10036 is an indirect wholly-owned subsidiary of JPMorgan Chase & Co. ("JPMorgan"), a bank holding company. Morgan offers a wide range of services to governmental, institutional, corporate and individual customers and acts as investment advisor to individual and institutional clients. As of December 31, 2005, Morgan had total combined assets under management of approximately $847 billion. Accounts: MidCap Growth and SmallCap Value Sub-Advisor: Mellon Equity Associates, LLP ("Mellon Equity"), 500 Grant Street, Suite 4200, Pittsburgh, PA 15258. Mellon Equity is a wholly owned subsidiary of Mellon Financial Corporation ("Mellon"). Mellon has approximately $4.7 trillion in assets under management, administration or custody, including $781 billion under management. As of December 31, 2005, Mellon Equity managed approximately $21.3 billion in assets. Accounts: Asset Allocation Sub-Advisor: Morgan Stanley Investment Management Inc. ("MSIM Inc."), doing business in certain instances (including its role as sub-advisor to the Asset Allocation Account) under the name "Van Kampen," is a registered investment adviser, located at 1221 Avenue of the Americas, New York, New York, 10020, and is a direct subsidiary of Morgan Stanley. As of December 31, 2005, Van Kampen, together with its affiliated asset management companies, had approximately $434.0 billion in asset under management. Accounts: MidCap Value Sub-Advisor: Neuberger Berman Management, Inc. ("Neuberger Berman") is an affiliate of Neuberger Berman, LLC. Neuberger Berman, LLC is located at 605 Third Avenue, 2nd Floor, New York, NY 10158-0180. Together with Neuberger Berman, the firms manage more than $105.9 billion in total assets (as of December 31, 2005) and continue an asset management history that began in 1939. Neuberger Berman Management, Inc. is an indirect, wholly owned subsidiary of Lehman Brothers Holdings, Inc. Lehman Brothers is located at 745 Seventh Avenue, New York, NY 10019. Accounts: Balanced, Capital Value, Diversified International, Government & High Quality Bond, Equity Income, International Emerging Markets, International SmallCap, LargeCap Stock Index, MidCap, Principal LifeTime 2010, Principal LifeTime 2020, Principal LifeTime 2030, Principal LifeTime 2040, Principal LifeTime 2050, Principal LifeTime Strategic Income, Short-Term Bond and SmallCap. Sub-Advisor: Principal Global Investors, LLC ("Principal") is an indirectly wholly-owned subsidiary of Principal Life Insurance Company and an affiliate of the Manager. Principal manages equity, fixed-income and real estate investments primarily for institutional investors, including Principal Life. As of December 31, 2005, Principal, together with its affiliated asset management companies, had approximately $159 billion in asset under management. Principal Global Investor's headquarters address is 801 Grand Avenue, Des Moines, Iowa 50392 and has other primary asset management offices in New York, London, Sydney and Singapore. Accounts: Real Estate Securities Sub-Advisor: Principal Real Estate Investors, LLC ("Principal - REI"), an indirect wholly-owned subsidiary of Principal Life and an affiliate of the Manager, was founded in 2000. It manages investments for institutional investors, including Principal Life. As of December 31, 2005, Principal - REI, together with its affiliated asset management companies, had approximately $32.0 billion in asset under management. Principal - REI's address is 801 Grand Avenue, Des Moines, Iowa 50392. Accounts: Equity Growth and LargeCap Blend Sub-Advisor: T. Rowe Price Associates, Inc. ("T. Rowe Price"), a wholly-owned subsidiary of T. Rowe Price Group, Inc., a financial services holding company, has over 68 years of investment management experience. Together with its affiliates, T. Rowe Price had approximately $269.5 billion in assets under management as of December 31, 2005. T. Rowe Price is located at 100 East Pratt Street, Baltimore, MD 21202. Accounts: SmallCap Growth Sub-Advisor: UBS Global Asset Management (Americas) Inc., a Delaware corporation located at One North Wacker, Chicago, IL 60606 ("UBS Global AM"), is a registered investment advisor. UBS Global AM, a subsidiary of UBS AG, is a member of the UBS Global Asset Management business group (the "Group") of UBS AG. As of December 31, 2005, UBS Global AM managed approximately $66.12 billion in assets and the Group managed approximately $581.49 billion in assets. THE SUB-SUB-ADVISORS Principal, has entered into a sub-sub-advisory agreement with Post Advisory Group, LLC ("Post") for the Bond Account, with Spectrum Asset Management, Inc. ("Spectrum") for the Bond and Equity Income Accounts and Principal -REI for the Equity Income Account. Under the agreements, the sub-sub-advisors agree to manage the day-to-day investment of the Funds' assets allocated to it consistent with the Funds' investment objectives, policies and restrictions and will be responsible for, among other things, placing all orders for the purchase and sale of portfolio securities, subject to supervision and monitoring by Principal and oversight by the Board. Each firm, at its own expense, will provide all investment, management and administrative personnel, facilities and equipment necessary for the investment advisory services which it conducts for the Accounts. Under the agreements, Principal pays each sub-sub-advisor a fee which is accrued daily and paid monthly (calculated as percentage of the average daily net assets managed by each respective firm). Entering into these agreements does not change the management fee that the Account pays the Manager under its Management Agreement or the sub-advisory fee that the Manager pays Principal under its sub-advisory agreement. Principal, and not the Account, will bear the expenses of the services that each of the sub-sub-advisors provides to the Account under the agreements. See the discussion regarding Principal - REI provided in connection with the Real Estate Securities Account for a description of the firm. Sub-Advisor: Post Advisory Group, LLC ("Post") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. Post was founded in April 1992. Its address is 11755 Wilshire Boulevard, Los Angeles, CA 90025. As of December 31, 2005, Post had approximately $8.1 billion in asset under management. Sub-Advisor: Spectrum Asset Management, Inc. ("Spectrum") is an affiliate of Principal Global Investors LLC and a member of the Principal Financial Group. Spectrum was founded in 1987. Its address is 4 High Ridge Park, Stamford, CT 06905. As of December 31, 2005, Spectrum, together with its affiliated asset management companies, had approximately $13.2 billion in asset under management. Each of the persons affiliated with the Fund who is also an affiliated person of the Manager or Principal is named below, together with the capacities in which such person is affiliated:
NAME OFFICE HELD WITH THE FUND OFFICE HELD WITH THE MANAGER/PRINCIPAL ---- ------------------------- -------------------------------------- John E. Aschenbrenner Director Director (Manager) Craig L. Bassett Treasurer Treasurer (Manager) Michael J. Beer Executive Vice President and Principal Executive Vice President and Chief Operating Officer Accounting Officer (Manager) David J. Brown Chief Compliance Officer Senior Vice President (Manager) Jill R. Brown Vice President and Chief Financial Officer Senior Vice President and Chief Financial Officer (Manager) Ralph C. Eucher Director, President and CEO Director and President (Manager) Ernest H. Gillum Vice President and Assistant Secretary Vice President and Chief Compliance Officer (Manager) David W. Miles Senior Vice President and Secretary Senior Vice President (Manager) Layne A. Rasmussen Vice President and Controller Vice President and Controller (Manager) Michael D. Roughton Counsel Counsel (Manager; Principal) James F. Sager Assistant Secretary Vice President (Manager) Larry D. Zimpleman Director and Chairman of the Board Director and Chairman of the Board (Manager)
CODES OF ETHICS The Fund, the Manager, each of the Sub-Advisors and Princor (as principal underwriter of the Fund) have adopted Codes of Ethics ("Codes") under Rule 17j-1 of the 1940 Act. The Manager has also adopted such a Code under Rule 204A-1 of the Investment Advisers Act of 1940. These Codes are designed to prevent persons with access to information regarding the portfolio trading activity of an Account from using that information for their personal benefit. In certain circumstances, personal securities trading is permitted in accordance with procedures established by the Codes. The Boards of Directors of the Manager, the Fund, Princor and each of the Sub-Advisors periodically review their respective Codes. The Codes are on file with, and available from, the SEC. A copy will also be provided upon request, which may be made by contacting the Fund. PROXY VOTING POLICIES The Board of Directors has delegated responsibility for decisions regarding proxy voting for securities held by each Account to that Account's Sub-Advisors. The Sub-Advisors will vote such proxies in accordance with its proxy policies and procedures, which have been reviewed by the Board of Directors, and which are found in Appendix B. Any material changes to the proxy policies and procedures will be submitted to the Board of Directors for approval. COST OF MANAGER'S SERVICES For providing the investment advisory services, and specified other services, the Manager, under the terms of the Management Agreement for the Fund, is entitled to receive a fee computed and accrued daily and payable monthly, at the following annual rates:
NET ASSET VALUE OF ACCOUNT ------------------------------------------------------------------- FIRST NEXT NEXT NEXT ACCOUNT $250 MILLION $250 MILLION $250 MILLION $250 MILLION THEREAFTER ------- ------------- ------------ ------------ ------------ ---------- Capital Value and Growth 0.60% 0.55% 0.50% 0.45% 0.40% LargeCap Blend and LargeCap Value 0.75 0.70 0.65 0.60 0.55 Diversified International and Equity Value 0.85 0.80 0.75 0.70 0.65 International Emerging Markets 1.25 1.20 1.15 1.10 1.05 MidCap Value 1.05 1.00 0.95 0.90 0.85
OVERALL FEE ---- LargeCap Growth Equity 1.00% LargeCap Stock Index 0.35 Principal LifeTime 2010 0.12 Principal LifeTime 2020 0.12 Principal LifeTime 2030 0.12 Principal LifeTime 2040 0.12 Principal LifeTime 2050 0.12 Principal LifeTime Strategic Income 0.12
FIRST NEXT NEXT NEXT $100 MILLION $100 MILLION $100 MILLION $100 MILLION THEREAFTER ------------- ------------ ------------ ------------ ---------- Asset Allocation and Equity Growth 0.80% 0.75% 0.70% 0.65% 0.60% Balanced and Equity Income 0.60 0.55 0.50 0.45 0.40 International SmallCap 1.20 1.15 1.10 1.05 1.00 SmallCap Growth 1.00 0.95 0.90 0.85 0.80 MidCap 0.65 0.60 0.55 0.50 0.45 MidCap Growth and Real Estate Securities 0.90 0.85 0.80 0.75 0.70 SmallCap 0.85 0.80 0.75 0.70 0.65 SmallCap Value 1.10 1.05 1.00 0.95 0.90 All Other 0.50 0.45 0.40 0.35 0.30
There is no assurance that the net assets of any Account will reach sufficient amounts to be able to take advantage of the rate decreases. The net assets of each Account and the rate of the fee for each Account for investment management services as provided in the Management Agreement were as follows:
NET ASSETS AS OF MANAGEMENT FEE ACCOUNT DECEMBER 31, 2005 FOR PERIODS ENDED DECEMBER 31, 2005 ------- ----------------- ----------------------------------- Asset Allocation $100,637,258 0.80% Balanced 116,927,248 0.59 Bond 338,043,816 0.45 Capital Value 258,490,061 0.60 Diversified International 293,647,093 0.85 Equity Growth 274,191,746 0.76 Equity Income 91,488,956 0.60 Equity Value 3,721,557 0.85 Government & High Quality Bond 316,047,443 0.44 Growth 124,254,046 0.60 International Emerging Markets 71,638,896 1.25 International SmallCap 143,454,186 1.19 LargeCap Blend 135,072,477 0.75 LargeCap Growth Equity 36,911,889 1.00 LargeCap Stock Index 179,143,046 0.35 LargeCap Value 122,220,922 0.75 MidCap 420,811,644 0.57 MidCap Growth 68,470,760 0.90 MidCap Value 112,436,561 1.05 Money Market 150,653,430 0.49 Principal LifeTime 2010 12,929,978 0.12 Principal LifeTime 2020 26,753,137 0.12 Principal LifeTime 2030 3,917,775 0.12 Principal LifeTime 2040 1,893,385 0.12 Principal LifeTime 2050 1,160,328 0.12 Principal LifeTime Strategic Income 5,463,480 0.12 Real Estate Securities 178,922,205 0.88 Short-Term Bond 83,822,116 0.50 SmallCap 94,475,932 0.85 SmallCap Growth 66,655,747 1.00 SmallCap Value 132,035,121 1.09
Except for certain Fund expenses set out below, the Manager is responsible for expenses, administrative duties and services including the following: expenses incurred in connection with the registration of the Fund and Fund shares with the SEC; office space, facilities and costs of keeping the books of the Fund; compensation of all personnel who are officers and any directors who are also affiliated with the Manager; fees for auditors and legal counsel; preparing and printing Fund prospectuses; administration of shareholder accounts, including issuance, maintenance of open account system, dividend disbursement, reports to shareholders and redemptions. However, some of all of these expenses may be assumed by Principal Life and some or all of the administrative duties and services may be delegated by the Manager to Principal Life or affiliate thereof. Each Account pays for certain corporate expenses incurred in its operation. Among such expenses, the Account pays brokerage commissions on portfolio transactions, transfer taxes and other charges and fees attributable to investment transactions, any other local, state or federal taxes, fees and expenses of all directors of the Fund who are not persons affiliated with the Manager, interest, fees for Custodian of the Account, and the cost of meetings of shareholders. Sub-Advisory Agreement ---------------------- For providing the investment advisory services, and specified other services, the Sub-Advisor, under the terms of the Sub-Advisory Agreement for the Account, is entitled to receive a fee computed and accrued daily and payable monthly, at the following annual rates:
NET ASSET VALUE OF ACCOUNT ----------------------------------------------- FIRST NEXT NEXT OVER ACCOUNT $40 MILLION $160 MILLION $100 MILLION $300 MILLION ------- ------------ ------------ ------------ ------------ Asset Allocation 0.45% 0.30% 0.25% 0.20%
The Sub-Advisory Fee on all Equity Growth Account assets through the period ending July 31, 2005 is 0.35%. Thereafter: NET ASSET VALUE OF ACCOUNT -------------------------------------------------------------------------- FIRST NEXT ACCOUNT $250 MILLION $250 MILLION ------- ------------- ------------ Equity Growth 0.40% 0.375% The above fee schedule will be in place subsequent to the period ending July 31, 2006. Prior to July 31, 2006, a transitional fee of 0.350% will be applied to all assets of the Account. In calculating the fee, assets of the Accounts and any mutual fund sponsored by Principal Life to which T. Rowe Price, as Sub-Advisor, provides investment advisory services and which have the same investment mandate as the Accounts will be combined (together "aggregated assets"). The fee charged for the assets in the Accounts are determined by calculating a fee on the value of the aggregated assets using the above fee schedules. The Sub-Advisory Fee on all Equity Growth Account assets through the period ending July 31, 2005 is 0.35%. Thereafter: OVER ACCOUNT $500 MILLION ------- ------------ Equity Growth 0.35% The above fee schedule will be in place subsequent to the period ending July 31, 2006. Prior to July 31, 2006, a transitional fee of 0.350% will be applied to all assets of the Account. In calculating the fee, assets of the Accounts and any mutual fund sponsored by Principal Life to which T. Rowe Price, as Sub-Advisor, provides investment advisory services and which have the same investment mandate as the Accounts will be combined (together "aggregated assets"). The fee charged for the assets in the Accounts are determined by calculating a fee on the value of the aggregated assets using the above fee schedules.
NET ASSET VALUE OF ACCOUNT ------------------------------------------------------- FIRST NEXT NEXT OVER ACCOUNT $200 MILLION $300 MILLION $250 MILLION $750 MILLION ------- ------------- ------------ ------------ ------------ Equity Value 0.40% 0.35% 0.30% 0.28%
NET ASSET VALUE OF ACCOUNT FIRST NEXT NEXT NEXT NEXT NEXT OVER ACCOUNT $50 MILLION $50 MILLION $100 MILLION $200 MILLION $350 MILLION $750 MILLION $1.5 BILLION ------- ------------ ----------- ------------ ------------ ------------ ------------ ------------ Growth 0.27% 0.25% 0.22% 0.18% 0.13% 0.09% 0.06%
NET ASSET VALUE OF ACCOUNT ----------------------------------------------------------------------------- FIRST NEXT NEXT NEXT OVER ACCOUNT $50 MILLION $200 MILLION $350 MILLION $400 MILLION $1 BILLION ------- ------------ ------------ ------------ ------------ ---------- 0.275 % on LargeCap Blend 0.40% 0.35% 0.30% 0.275% all assets
NET ASSET VALUE OF ACCOUNT ---------------------------------------------------------- FIRST NEXT NEXT OVER ACCOUNT $250 MILLION $250 MILLION $500 MILLION $1 BILLION ------- ------------- ------------ ------------ ---------- LargeCap Growth Equity 0.41% 0.33% 0.25% 0.20 % on all assets
NET ASSET VALUE OF ACCOUNT ------------------------------------------------------------------------------------------- FIRST NEXT NEXT NEXT NEXT NEXT NEXT ACCOUNT $10 MILLION $15 MILLION $25 MILLION $50 MILLION $50 MILLION $50 MILLION $200 MILLION ------- ------------ ----------- ----------- ----------- ----------- ----------- ------------ LargeCap Value 0.60% 0.50% 0.40% 0.30% 0.25% 0.225% 0.20%
NET ASSET VALUE OF ACCOUNT --------------------------- FIRST OVER ACCOUNT $50 MILLION $50 MILLION ------- ------------ ----------- MidCap Growth 0.40% 0.35%
NET ASSET VALUE OF ACCOUNT ------------------------------------------------------------------- FIRST NEXT NEXT NEXT ACCOUNT $100 MILLION $150 MILLION $250 MILLION $250 MILLION THEREAFTER ------- ------------- ------------ ------------ ------------ ---------- MidCap Value 0.50% 0.475% 0.45% 0.425% 0.40%
NET ASSET VALUE OF ACCOUNT ------------------------------------------ FIRST NEXT OVER ACCOUNT $50 MILLION $250 MILLION $300 MILLION ------- ------------ ------------ ------------ SmallCap Growth - UBS 0.60% 0.55% 0.45%
NET ASSET VALUE OF ACCOUNT ----------------------------------------------------- FIRST NEXT NEXT OVER ACCOUNT $10 MILLION $40 MILLION $150 MILLION $200 MILLION ------- ------------ ----------- ------------ ------------ SmallCap Growth - Emerald 0.75% 0.60% 0.50% 0.45%
NET ASSET VALUE OF ACCOUNT ------------------------------------------ FIRST NEXT OVER ACCOUNT $100 MILLION $200 MILLION $300 MILLION ------- ------------- ------------ ------------ SmallCap Value - Mellon Equity/Morgan 0.50% 0.45% 0.35%
ACCOUNTS FOR WHICH PRINCIPAL SERVES AS SUB-ADVISOR . Principal is Sub-Advisor for each Account identified below. The Manager pays Principal a fee, computed and paid monthly, at an annual rate as shown below. To calculate the fee for an Account in Table A, assets of the Account, along with the assets of all other Accounts in Table A, are combined with any: . Principal Life non-registered separate account sub-advised by Principal with assets invested primarily in fixed-income securities (except money market separate accounts); . Principal Life sponsored mutual fund sub-advised by Principal with assets invested primarily in fixed-income securities (except money market mutual funds); and . assets of the Principal Balanced Fund, Inc. The calculation does not include any portion of such mutual funds and/or separate accounts for which advisory services are provided, directly or indirectly, by employees of Post Advisory Group, LLC ("Post"). To calculate the fee for an Account in Table B, the assets of the Account are combined with assets sub-advised by Principal with the same investment mandate (e.g. midcap value) in . (a) Principal Life non-registered separate account sub-advised by Principal and . (b) Principal Life sponsored mutual fund sub-advised by Principal. For any Account for which investment advisory services are provided, directly or indirectly, by employees of Post, the Manager pays a fee equal to an annual rate of 0.30% for the portion of the net assets for which Post provides investment advisory services.
TABLE A NET ASSET VALUE OF ACCOUNT ------------------------------------------------ FIRST NEXT NEXT OVER ACCOUNT $5 BILLION $1 BILLION $4 BILLION $10 BILLION ------- ----------- ---------- ---------- ----------- Balanced, Government & High Quality Bond and Short-Term Bond 0.115% 0.100% 0.095% 0.090%
TABLE B NET ASSET VALUE OF ACCOUNT ----------------------------------------------------------------------------------------------- FIRST NEXT NEXT NEXT NEXT NEXT OVER ACCOUNT $50 MILLION $50 MILLION $100 MILLION $200 MILLION $350 MILLION $750 MILLION $1.5 BILLION ------- ------------ ----------- ------------ ------------ ------------ ------------ ------------ Capital Value and Equity Income 0.27% 0.25% 0.22% 0.18% 0.13% 0.09% 0.06% Diversified International 0.35 0.28 0.20 0.16 0.12 0.10 0.08
TABLE B NET ASSET VALUE OF ACCOUNT ----------------------------------------------------------------------------------------------- FIRST NEXT NEXT NEXT NEXT NEXT OVER ACCOUNT $25 MILLION $75 MILLION $100 MILLION $300 MILLION $500 MILLION $500 MILLION $1.5 BILLION ------- ------------ ----------- ------------ ------------ ------------ ------------ ------------ MidCap 0.40% 0.32% 0.27% 0.23% 0.18% 0.13% 0.08% SmallCap 0.48 0.36 0.27 0.25 0.22 0.18 0.12
TABLE C SUB-ADVISOR PERCENTAGE ACCOUNT FEE ------- ----------- International Emerging Markets 0.5000% International SmallCap 0.5000 LargeCap Stock Index 0.0150 Principal LifeTime 2010 0.0425 Principal LifeTime 2020 0.0425 Principal LifeTime 2030 0.0425 Principal LifeTime 2040 0.0425 Principal LifeTime 2050 0.0425 Principal LifeTime Strategic Income 0.0425
Fees paid for investment management services during the periods indicated were as follows:
MANAGEMENT FEES FOR PERIODS ENDED DECEMBER 31, ACCOUNT 2005 2004 2003 ------- ---- ---- ---- Asset Allocation $ 794,369 $ 794,336 $ 684,764 Balanced 711,012 737,265 670,500 Bond 1,370,420 1,239,048 1,164,438 Capital Value 1,547,178 1,506,086 1,307,704 Diversified International 2,099,980 1,594,080 1,113,831 Equity Growth 2,016,294 2,028,524 1,798,319 Equity Income 371,535 214,226 159,295 Equity Value 23,031* 6,032* - Government & High Quality Bond 1,435,824 1,512,695 1,633,416 Growth 760,105 812,984 773,354 International Emerging Markets 698,756 399,404 185,777* International SmallCap 1,392,029 949,855 566,727 LargeCap Blend 813,224 531,456 225,306 LargeCap Growth Equity 325,795 275,666 77,701 LargeCap Stock Index 577,607 479,784 306,803 LargeCap Value 735,546 465,940 196,493 MidCap 2,291,867 2,075,365 1,654,689 MidCap Growth 555,783 495,611 275,040 MidCap Value 977,864 643,832 369,527 Money Market 687,456 698,379 858,412 Principal LifeTime 2010 5,196* 4* - Principal LifeTime 2020 10,624* 5* - Principal LifeTime 2030 1,519* 22* - Principal LifeTime 2040 893* 32* - Principal LifeTime 2050 389* 31* - Principal LifeTime Strategic Income 2,641* 4* - Real Estate Securities 1,389,887 972,586 588,499 Short-Term Bond 337,343 200,782 38,467 SmallCap 754,056 605,273 347,933 SmallCap Growth 626,217 572,912 414,201 SmallCap Value 1,274,392 998,160 637,097 *before reimbursement from Manager
Fees paid for Sub-Advisory services during the periods indicated were as follows:
SUB-ADVISOR FEES FOR PERIODS ENDED DECEMBER 31, ACCOUNT 2005 2004 2003 ------- ---- ---- ---- Asset Allocation $357,978 $358,964 $316,910 Balanced 126,028 127,684 102,307 Bond 217,117* - - Capital Value 358,111 328,396 215,037 Diversified International 247,925 200,560 140,055 Equity Growth 899,715 826,575 749,065 Equity Income 106,498 71,338 18,310 Equity Value 10,838 2,849 - Government & High Quality Bond 340,937 363,825 377,766 Growth 170,822 166,883 89,509 International Emerging Markets 269,798 154,000 69,527 International SmallCap 565,335 386,951 225,589 LargeCap Blend 321,517 243,712 108,749 LargeCap Growth Equity 124,438 111,181 34,989 LargeCap Stock Index 24,167 20,151 12,633 LargeCap Value 208,538 199,688 136,201 MidCap 573,398 496,500 267,108 MidCap Growth 221,801 209,408 122,357 MidCap Value 430,137 299,828 176,123 Money Market 69,458* - - Principal LifeTime 2010 1,570 0 - Principal LifeTime 2020 3,179 0 - Principal LifeTime 2030 456 4 - Principal LifeTime 2040 274 7 - Principal LifeTime 2050 116 9 - Principal LifeTime Strategic Income 1,570 0 - Real Estate Securities 594,787* - - Short-Term Bond 69,334 40,291 0 SmallCap 169,636 142,249 98,871 SmallCap Growth 339,255 315,599 234,954 SmallCap Value 577,223 525,787 342,873 *Period from May 26, 2005, date the Account began utilizing a Sub-Advisor, through December 31, 2005
For the periods ended December 31, the Manager waived a portion of its fee from the following:
ACCOUNT 2005 2004 2003 ------- ---- ---- ---- Equity Value $ 955 $1,456 International Emerging Markets N/A N/A $12,743 Principal LifeTime 2010 1,572 349 Principal LifeTime 2020 2,576 350 Principal LifeTime 2030 2,697 343 Principal LifeTime 2040 3,068 345 Principal LifeTime 2050 3,122 348 Principal LifeTime Strategic Income 2,733 349
The Manager has contractually agreed to limit the expenses paid by the following Accounts and, if necessary, pay expenses normally payable by each such Account through the period ending April 30, 2007. The expense limit will maintain a total level of operating expenses (expressed as a percentage of average net assets attributable to each Account on an annualized basis) not to exceed the following percentages:
ACCOUNT ------- Equity Value 1.05% Principal LifeTime 2010 0.16 Principal LifeTime 2020 0.13 Principal LifeTime 2030 0.16 Principal LifeTime 2040 0.13 Principal LifeTime 2050 0.12 Principal LifeTime Strategic Income 0.14
The expense limits in place through the period ended April 30, 2006 maintained operating expenses (expressed as a percentage of average net assets attributable to an Account on an annualized basis) which did not exceed the following percentages:
ACCOUNT ------- Equity Value 1.10% Principal LifeTime 2010 0.16 Principal LifeTime 2020 0.13 Principal LifeTime 2030 0.16 Principal LifeTime 2040 0.13 Principal LifeTime 2050 0.12 Principal LifeTime Strategic Income 0.14
Custodian --------- The custodian for the portfolio securities and cash assets of the Accounts is Bank of New York, 100 Church Street, 10th Floor, Brooklyn, NY 10286. The custodian performs no managerial or policymaking functions for the Fund or the Accounts. BROKERAGE ALLOCATION AND OTHER PRACTICES BROKERAGE ON PURCHASES AND SALES OF SECURITIES All orders for the purchase or sale of portfolio securities are placed on behalf of a Account by the Account's Sub-Advisor pursuant to the terms of the applicable sub-advisory agreement. In distributing brokerage business arising out of the placement of orders for the purchase and sale of securities for any Account, the objective of each Account's Sub-Advisor is to obtain the best overall terms. In pursuing this objective, a Sub-Advisor considers all matters it deems relevant, including the breadth of the market in the security, the price of the security, the financial condition and executing capability of the broker or dealer, confidentiality, including trade anonymity, and the reasonableness of the commission, if any (for the specific transaction and on a continuing basis). This may mean in some instances that a Sub-Advisor will pay a broker commissions that are in excess of the amount of commissions another broker might have charged for executing the same transaction when the Sub-Advisor believes that such commissions are reasonable in light of a) the size and difficulty of the transaction b) the quality of the execution provided and c) the level of commissions paid relative to commissions paid by other institutional investors. (Such factors are viewed both in terms of that particular transaction and in terms of all transactions that broker executes for accounts over which the Sub-Advisor exercises investment discretion. A Sub-Advisor may purchase securities in the over-the-counter market, utilizing the services of principal market makers unless better terms can be obtained by purchases through brokers or dealers, and may purchase securities listed on the NYSE from non-Exchange members in transactions off the Exchange.) A Sub-Advisor may give consideration in the allocation of business to services performed by a broker (e.g., the furnishing of statistical data and research generally consisting of, but not limited to, information of the following types: analyses and reports concerning issuers, industries, economic factors and trends, portfolio strategy and performance of client accounts). If any such allocation is made, the primary criteria used will be to obtain the best overall terms for such transactions. A Sub-Advisor may also pay additional commission amounts for research services. Such statistical data and research information received from brokers or dealers as described above may be useful in varying degrees and a Sub-Advisor may use it in servicing some or all of the accounts it manages. Sub-Advisors allocated portfolio transactions for the Accounts indicated in the following table to certain brokers during the most recent fiscal year due to research services provided by such brokers. The table also indicates the commissions paid to such brokers as a result of these portfolio transactions.
ACCOUNT AMOUNT OF TRANSACTIONS COMMISSIONS PAID ------- ---------------------- ---------------- Balanced $ 43,482,430 $ 26,084 Capital Value 356,595,829 280,437 Diversified International 134,156,954 112,452 Equity Income 38,985,639 18,026 Growth 31,443,769 36,592 International Emerging Markets 68,460,466 81,710 International SmallCap 122,896,994 59,852 LargeCap Stock Index 4,515,650 779 LargeCap Value 33,866 59 MidCap 130,357,978 107,804 MidCap Growth 16,812,806 22,752 MidCap Value 16,807,829 22,155 Real Estate Securities 35,483,571 25,806 SmallCap 92,723,076 60,919 SmallCap Growth 7,703,177 14,040
Subject to the rules promulgated by the SEC, as well as other regulatory requirements, the Board has approved procedures whereby an Account may purchase securities that are offered in underwritings in which an affiliate of a Sub-Advisor, or the Manager, participates. These procedures prohibit an Account from directly or indirectly benefiting a Sub-Advisor affiliate or a Manager affiliate in connection with such underwritings. In addition, for underwritings where a Sub-Advisor affiliate or a Manager participates as a principal underwriter, certain restrictions may apply that could, among other things, limit the amount of securities that the Account could purchase in the underwritings. The Sub-Advisor shall determine the amounts and proportions of orders allocated to the Sub-Advisor or affiliate. The Directors of the Fund will receive quarterly reports on these transactions. The Board has approved procedures that permit a Fund to effect a purchase or sale transaction between the Account and any other affiliated mutual fund or between the Account and affiliated persons of the Account under limited circumstances prescribed by SEC rules. Any such transaction must be effected without any payment other than a cash payment for the securities, for which a market quotation is readily available, at the current market price; no brokerage commission or, fee (except for customary transfer fees), or other remuneration may be paid in connection with the transaction. The Board receives quarterly reports of all such transactions. The Board has also approved procedures that permit a Account's sub-advisor to place portfolio trades with an affiliated broker under circumstances prescribed by SEC Rules 17e-1 and 17a-10. The procedures require that total commissions, fees or other remuneration received or to be received by an affiliated broker must be reasonable and fair compared to the commissions, fees or other remuneration received by other brokers in connection with comparable transactions involving similar securities being purchased or sold on a securities exchange during a comparable time period. The Board receives quarterly reports of all transactions completed pursuant to the Account's procedures. Purchases and sales of debt securities and money market instruments usually are principal transactions; portfolio securities are normally purchased directly from the issuer or from an underwriter or marketmakers for the securities. Such transactions are usually conducted on a net basis with the Account paying no brokerage commissions. Purchases from underwriters include a commission or concession paid by the issuer to the underwriter, and the purchases from dealers serving as marketmakers include the spread between the bid and asked prices. The Board has approved procedures whereby an Account may participate in a commission recapture program. Commission recapture is a form of institutional discount brokerage that returns commission dollars directly to an Account. It provides a way to gain control over the commission expenses incurred by an Account's Manager and/or Sub-Advisor, which can be significant over time and thereby reduces expenses, improves cash flow and conserves assets. An Account can derive commission recapture dollars from both equity trading commissions and fixed-income (commission equivalent) spreads. The Accountsmay participate in a program through a relationship with Frank Russell Securities, Inc. From time to time, the Board reviews whether participation in the recapture program is in the best interest of the Accounts. The following table shows the brokerage commissions paid during the periods indicated.
TOTAL BROKERAGE COMMISSIONS PAID FOR PERIODS ENDED DECEMBER 31 ACCOUNT 2005 2004 2003 ------- ---- ---- ---- Asset Allocation $ 35,452 $ 32,842 $ 137,183 Balanced 126,012 203,332 303,483 Capital Value 797,323 1,392,434 1,004,105 Diversified International 1,220,449 1,348,767 702,806 Equity Growth 328,962 857,167 901,138 Equity Income 158,195 157,343 16,250 Equity Value 822 595/(1)/ Growth 238,697 295,144 148,663 International Emerging Markets 567,487 379,974 139,853 International SmallCap 621,674 507,642 311,164 LargeCap Blend 114,933 138,909 61,404 LargeCap Growth Equity 25,869 58,177 25,798 LargeCap Stock Index 11,824 22,811 17,972 LargeCap Value 56,822 89,929 62,968 MidCap 566,537 436,158 405,297 MidCap Growth 133,296 67,970 69,231 MidCap Value 139,692 115,251 87,313 Real Estate Securities 93,466 193,422 141,989 SmallCap 371,599 521,340 331,111 SmallCap Growth 134,978 78,134 68,630 SmallCap Value 151,715 109,148 131,174
/(1) /Period from August 30, 2004 (date operations commenced) through December 31, 2004. Certain broker-dealers are considered to be affiliates of the Fund. . Archipelago Securities, LLC, Goldman Sachs Execution & Clearing L.P. (fka Spear, Leeds & Kellogg Specialist LLC) and Goldman Sachs JBWere, Inc. are affiliates of Goldman Sachs & Co. Goldman Sachs Asset Management is a sub-advisor for two portfolios of the Principal Investors Fund, Inc. . BNY Broker, Inc. and Pershing, LLC are affiliates of BNY Investments which serves as a sub-advisor for two portfolios of the Principal Investors Fund, Inc. . Cazenove, Inc. is an affiliate of American Century which serves as sub-advisor to the Equity Value Account of Principal Variable Contracts Fund, Inc. and two portfolios in the Principal Investors Fund, Inc. . J.P. Morgan Securities, Inc. is an affiliate of J.P.Morgan Investment Management Inc. which a sub-advisor for the SmallCap Value Account of Principal Variable Contracts Fund, Inc. and a portfolio of Principal Investors Fund, Inc. . Fidelity Brokerage Services, LLC and National Financial Services LLC are affiliates of Fidelity Management & Research Company which serves as a sub-advisor for two portfolios of the Principal Investors Fund, Inc. . Lehman Brothers Inc. and Neuberger Berman Management Inc. are affiliates of Neuberger Berman LLC. Neuberger Berman Management Inc. is a sub-advisor for the MidCap Value Account of Principal Variable Contracts Fund, Inc. and a portfolio of the Principal Investors Fund, Inc. . Morgan Stanley DW, Inc. and Dean Witter Reynolds, Inc. are affiliates with Morgan Stanley Investment Management, which acts as sub-advisor to the Asset Allocation Account of Principal Variable Contracts Fund, Inc. . Sanford C. Bernstein & Co., LLC are affiliates of AllianceBernstein L.P. sub-advises the LargeCap Value Account of Principal Variable Contracts Fund, Inc. and two portfolios in the Principal Investors Fund, Inc. . Spectrum Asset Management, Inc. is an affiliate of the Principal Global Investors which serves as sub-advisor for several portfolios of the Principal Investors Fund, Inc. and several accounts of the Principal Variable Contracts Fund, Inc. . UBS Financial Services Inc. and UBS Securities LLC are affiliates of UBS Global AM which serves as sub-advisor to the SmallCap Growth Account of Principal Variable Contracts Fund, Inc. and two portfolios in the Principal Investors Fund, Inc. Brokerage commissions paid to affiliates during the periods ending December 31 were as follows:
COMMISSIONS PAID TO ARCHIPELAGO SECURITIES LLC ---------------------------------------------- TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF ACCOUNT AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTIONS ------- ------ ----------------- --------------------------- Equity Growth 2005 16 0.00 0.04 2004 127 0.01 0.12 Equity Value 2005 4 0.52 3.83 2004 2 0.36 2.07 LargeCap Blend 2005 62 0.05 0.09 2004 69 0.05 0.18 MidCap Growth 2005 965 0.72 1.45 SmallCap Value 2005 314 0.21 0.42 2004 327 0.30 0.43 2003 124 0.09 0.17
COMMISSIONS PAID TO BNY BROKER, INC. ------------------------------------ TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF ACCOUNT AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTIONS ------- ------ ----------------- --------------------------- Balanced 2005 885 0.70 0.38 Capital Value 2005 4,747 0.60 0.61 Diversified International 2005 10 0.00 0.00 Equity Growth 2005 792 0.24 0.19 Equity Income 2005 845 0.53 0.28 Growth 2005 1,160 0.49 0.67 International Emerging Markets 2005 50 0.01 0.03 LargeCap Blend 2005 258 0.22 0.34 LargeCap Stock Index 2005 40 0.33 0.29 MidCap 2005 3,613 0.64 0.64 MidCap Growth 2005 513 0.38 0.51 SmallCap 2005 892 0.24 0.14 SmallCap Value 2005 45 0.03 0.01
COMMISSIONS PAID TO CAZENOVE, INC. ---------------------------------- TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF ACCOUNT AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTIONS ------- ------ ----------------- --------------------------- Diversified International 2005 8,653 0.71 0.79 International Emerging Markets 2005 280 0.05 0.08 International SmallCap 2005 4,648 0.75 0.87
COMMISSIONS PAID TO DEAN WITTER REYNOLDS, INC. ---------------------------------------------- TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF ACCOUNT AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTIONS ------- ------ ----------------- --------------------------- SmallCap Growth 2005 75 0.06 0.04 2004 69 0.09 0.04
COMMISSIONS PAID TO FIDELITY BROKERAGE SERVICES, LLC ---------------------------------------------------- TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF ACCOUNT AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTIONS ------- ------ ----------------- --------------------------- Equity Income 2005 188 0.12 0.08 SmallCap 2005 474 0.13 0.08
COMMISSIONS PAID TO GOLDMAN SACHS EXECUTION & CLEARING L.P. (FKA SPEER, LEEDS & KELLOGG SPECIALIST LLC) --------------- TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF ACCOUNT AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTIONS ------- ------ ----------------- --------------------------- Equity Growth 2005 1,554 0.47 1.37 2004 40 0.00 0.04 Equity Value 2005 18 2.22 2.93 2004 2 0.29 0.27 LargeCap Blend 2005 618 0.54 1.06 2004 245 0.18 0.34 MidCap Value 2005 50 0.04 0.04 2004 270 0.23 0.17 SmallCap Growth 2005 438 0.32 0.73 2004 380 0.49 0.24
COMMISSIONS PAID TO GOLDMAN SACHS & CO. --------------------------------------- TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF ACCOUNT AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTIONS ------- ------ ----------------- --------------------------- Asset Allocation 2005 5,570 15.71 20.40 2004 9,998 30.44 33.81 2003 5,626 4.10 4.98 Balanced 2005 7,575 6.01 2.68 2004 6,639 3.26 1.94 2003 11,377 3.75 2.73 Capital Value 2005 85,642 10.74 6.57 2004 69,769 5.01 4.35 2003 42,501 4.23 2.68 Diversified International 2005 57,309 4.70 4.67 2004 39,744 2.95 2.64 2003 37,111 5.28 4.89 Equity Growth 2005 5,646 1.72 1.77 2004 27,748 3.24 2.63 2003 41,345 4.59 4.23 Equity Income 2005 3,616 2.29 1.62 2004 4,083 2.60 2.25 Equity Value 2005 33 4.06 1.38 2004 3 0.56 0.15 Growth 2005 7,236 3.03 4.17 2004 19,289 6.54 3.67 2003 7,310 4.92 4.77 International Emerging Markets 2005 12,844 2.26 2.24 2004 350 0.09 0.12 2003 364 0.26 0.27 International SmallCap 2005 15,582 2.51 2.44 2004 11,436 2.25 2.25 2003 12,270 3.94 3.69 LargeCap Blend 2005 3,988 3.47 3.78 2004 2,231 1.61 1.28 2003 1,889 3.08 1.61 LargeCap Growth Equity 2005 2,740 10.59 9.17 2004 3,226 5.54 4.48 2003 532 2.06 1.42 LargeCap Stock Index 2005 161 1.36 0.58 2004 27 0.12 0.13 LargeCap Value 2005 11,907 20.95 15.17 2004 15,821 17.59 18.17 2003 1,789 2.84 3.08 MidCap 2005 9,838 1.74 1.73 2004 14,147 3.24 3.27 2003 13,810 3.41 3.42 MidCap Growth 2005 11,784 8.84 7.49 2004 13,974 20.56 18.59 2003 4,884 7.05 12.47 MidCap Value 2005 2,497 1.79 1.64 2004 1,920 1.67 1.79 2003 227 0.25 0.32 Real Estate Securities 2005 7,876 8.43 7.00 2004 8,511 4.40 2.14 2003 2,904 2.04 1.61 SmallCap 2005 5,209 1.40 1.11 2004 13,564 2.60 2.48 2003 19,199 5.80 5.51 SmallCap Growth 2005 780 0.58 1.55 2004 1,405 1.80 1.74 2003 250 0.36 0.31 SmallCap Value 2005 7,252 4.78 6.02 2004 4,044 3.70 3.30 2003 6,607 5.04 5.71
COMMISSIONS PAID TO GOLDMAN SACHS JBWERE, INC. ---------------------------------------------- TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF ACCOUNT AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTIONS ------- ------ ----------------- --------------------------- International SmallCap 2004 507 0.10 0.07
COMMISSIONS PAID TO J. P. MORGAN SECURITIES, INC. --------------- TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF ACCOUNT AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTIONS ------- ------ ----------------- --------------------------- Asset Allocation 2003 2,405 1.75 1.26 Balanced 2005 1,486 1.18 0.62 2004 2,023 1.00 0.69 2003 3,971 1.31 0.85 Capital Value 2005 13,040 1.64 1.69 2004 24,970 1.79 2.09 2003 6,904 0.69 0.70 Diversified International 2005 33,218 2.72 2.38 2004 85,389 6.33 5.72 2003 28,759 4.09 3.53 Equity Growth 2005 10,478 3.19 3.78 2004 19,204 2.24 2.27 2003 28,396 3.15 3.40 Equity Income 2005 1,852 1.17 0.85 2004 4,142 2.63 1.60 Equity Value 2005 3 0.36 0.12 Growth 2005 240 0.10 0.10 2004 1,764 0.60 0.49 2003 2,240 1.51 0.71 International Emerging Markets 2005 25,847 4.55 4.29 2004 18,546 4.88 4.60 2003 19,086 13.65 9.40 International SmallCap 2005 14,974 2.41 2.58 2004 22,955 4.52 4.95 2003 3,107 1.00 0.96 LargeCap Blend 2005 4,180 3.64 2.85 2004 867 0.62 0.46 2003 1,190 1.94 0.91 LargeCap Growth Equity 2005 900 3.48 2.70 2004 58 0.10 0.05 2003 256 0.99 0.68 LargeCap Value 2004 120 0.13 0.03 2003 132 0.21 0.03 MidCap 2005 17,398 3.07 3.55 2004 11,723 2.69 2.79 2003 8,446 2.08 1.58 MidCap Growth 2005 6,685 5.02 4.60 2004 2,982 4.39 2.43 MidCap Value 2005 2,626 1.88 1.50 2004 2,180 1.89 1.86 2003 1,341 1.54 1.43 Real Estate Securities 2005 142 0.15 0.21 2004 1,520 0.79 0.62 2003 5,210 3.67 3.05 SmallCap 2005 5,189 1.40 1.02 2004 2,998 0.58 0.38 2003 2,695 0.81 1.00 SmallCap Growth 2005 5,291 3.92 2.04 2004 255 0.33 0.30 2003 635 0.93 0.69 SmallCap Value 2005 1,432 0.94 0.55
COMMISSIONS PAID TO LEHMAN BROTHERS INC. ---------------------------------------- TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF ACCOUNT AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTIONS ------- ------ ----------------- --------------------------- Asset Allocation 2004 1,486 4.52 5.60 2003 15,593 11.37 10.85 Balanced 2005 8,144 6.46 5.50 2004 11,247 5.53 5.02 2003 15,580 5.13 4.85 Capital Value 2005 58,269 7.31 6.59 2004 109,944 7.90 8.05 2003 70,924 7.06 8.09 Diversified International 2005 38,343 3.14 3.26 2004 96,626 7.16 6.51 2003 31,035 4.42 4.56 Equity Growth 2005 9,581 2.91 3.26 2004 51,660 6.03 5.73 2003 45,924 5.10 5.00 Equity Income 2005 8,916 5.64 12.92 2004 13,509 8.59 7.32 Equity Value 2005 14 1.73 0.59 2004 1 0.13 0.03 Growth 2005 42,047 17.62 14.78 2004 13,099 4.44 3.57 2003 21,698 14.60 13.90 International Emerging Markets 2005 16,067 2.83 2.68 2004 17,167 4.52 4.49 2003 406 0.29 0.38 International SmallCap 2005 13,898 2.24 2.36 2004 13,101 2.58 2.61 2003 7,078 2.27 2.52 LargeCap Blend 2005 4,671 4.06 4.52 2004 6,487 4.67 5.44 2003 12,113 19.73 40.33 LargeCap Growth Equity 2005 2,861 11.06 9.30 2004 808 1.39 1.43 2003 334 1.29 1.10 LargeCap Stock Index 2005 3,074 26.00 27.47 2004 14,546 63.76 50.15 2003 12,646 70.37 62.21 LargeCap Value 2004 63 0.07 0.09 2003 785 1.25 0.98 MidCap 2005 50,872 8.98 8.89 2004 46,442 10.65 10.75 2003 31,625 7.80 5.94 MidCap Growth 2005 9,107 6.83 6.51 2004 1,098 1.62 1.18 2003 420 0.61 0.23 MidCap Value 2005 24,894 17.82 15.69 2004 22,663 19.66 19.04 2003 1,741 1.99 2.65 Real Estate Securities 2005 15,314 16.38 21.17 2004 21,221 10.97 16.86 2003 19,839 13.97 10.73 SmallCap 2005 16,812 4.52 5.33 2004 16,550 3.17 3.09 2003 18,379 5.55 3.72 SmallCap Growth 2005 1,510 1.12 0.92 2004 2,968 3.80 2.53 2003 1,345 1.96 1.57 SmallCap Value 2005 3,403 2.24 2.17 2004 2,576 2.36 2.84 2003 2,586 1.97 1.79
COMMISSIONS PAID TO MORGAN STANLEY DW INC. ------------------------------------------ TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF ACCOUNT AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTIONS ------- ------ ----------------- --------------------------- Asset Allocation 2003 63 0.05 0.04 Balanced 2005 6,968 5.53 7.84 2004 10,429 5.13 5.33 2003 21,239 7.00 6.51 Capital Value 2005 33,184 4.16 6.25 2004 52,943 3.80 3.72 2003 73,609 7.33 6.64 Diversified International 2005 78,904 6.47 6.28 2004 115,073 8.53 7.62 2003 69,681 9.91 10.38 Equity Growth 2005 13,884 4.22 4.45 2004 15,984 1.86 1.29 2003 3,749 0.42 0.58 Equity Income 2005 3,193 2.02 2.17 2004 2,879 1.83 2.75 Equity Value 2005 5 0.66 0.39 2004 380 63.81 80.89 Growth 2005 6,473 2.71 2.88 2004 5,448 1.85 1.62 2003 7,332 4.93 6.20 International Emerging Markets 2005 49,626 8.74 10.66 2004 42,993 11.31 11.29 2003 17,407 12.45 16.69 International SmallCap 2005 44,995 7.24 6.90 2004 29,272 5.77 5.27 2003 17,176 5.52 4.94 LargeCap Blend 2005 4,408 3.84 4.28 2004 5,416 3.90 3.89 2003 4,492 7.32 3.64 LargeCap Growth Equity 2005 675 2.61 2.67 2004 2,424 4.17 3.52 2003 1,284 4.98 4.60 LargeCap Stock Index 2005 2,888 24.42 25.30 2004 1,805 7.91 9.75 2003 19 0.11 0.14 LargeCap Value 2005 517 0.91 2.94 2003 513 0.81 0.24 MidCap 2005 24,275 4.28 2.62 2004 13,964 3.20 3.16 2003 8,025 1.98 4.27 MidCap Growth 2005 7,585 5.69 5.02 2004 2,374 3.49 3.79 2003 9,287 13.41 16.57 MidCap Value 2005 2,547 1.82 2.79 2004 1,909 1.66 1.63 2003 729 0.83 0.71 Real Estate Securities 2005 1,732 1.85 0.55 2004 4,414 2.28 3.38 2003 4,463 3.14 5.30 SmallCap 2005 8,836 2.38 5.73 2004 18,858 3.62 5.72 2003 17,231 5.20 4.42 SmallCap Growth 2005 1,283 0.95 1.95 2004 1,170 1.50 1.06 2003 2,555 3.72 2.24 SmallCap Value 2005 11,214 7.39 10.25 2004 8,864 8.12 8.14 2003 10,275 7.83 8.07
COMMISSIONS PAID TO NATIONAL FINANCIAL SERVICES LLC --------------------------------------------------- TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF ACCOUNT AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTIONS ------- ------ ----------------- --------------------------- LargeCap Blend 2005 132 0.11 0.04 2004 205 0.15 0.06 MidCap Value 2005 255 0.18 0.13 SmallCap Value 2005 295 0.19 0.25 2004 3,180 2.91 2.21
COMMISSIONS PAID TO NEUBERGER BERMAN ------------------------------------ TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF ACCOUNT AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTIONS ------- ------ ----------------- --------------------------- Asset Allocation 2003 515 0.38 0.29 Equity Growth 2003 1,440 0.16 0.17 MidCap Value 2005 510 0.37 0.09 2004 152 0.13 0.15 2003 43,708 50.06 47.69
COMMISSIONS PAID TO PERSHING, LLC --------------------------------- TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF ACCOUNT AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTIONS ------- ------ ----------------- --------------------------- Equity Growth 2005 148 0.04 0.04 LargeCap Value 2005 366 0.64 0.52 MidCap Value 2005 2,326 1.67 0.64 SmallCap Growth 2005 810 0.60 0.26
COMMISSIONS PAID TO SANFORD C. BERNSTEIN ---------------------------------------- TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF ACCOUNT AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTIONS ------- ------ ----------------- --------------------------- Asset Allocation 2003 3,646 2.66 1.93 Balanced 2005 4,586 3.64 2.93 2004 4,410 2.17 2.15 2003 8,693 2.86 3.32 Capital Value 2005 8,537 1.07 1.08 2004 8,175 0.59 0.60 2003 20,011 1.99 2.59 Diversified International 2004 2,568 0.19 0.20 Equity Growth 2005 9,696 2.95 1.93 2004 14,693 1.71 1.29 2003 15,950 1.77 1.80 Equity Income 2005 1,025 0.65 0.48 2004 152 0.10 0.29 2003 935 0.66 0.56 Equity Value 2005 173 21.06 26.85 Growth 2005 1,819 0.76 0.76 2004 6,033 2.04 1.85 2003 5,288 3.56 2.48 LargeCap Blend 2005 4,302 3.74 2.99 2004 2,015 1.45 1.03 LargeCap Growth Equity 2003 123 0.48 0.42 LargeCap Stock Index 2003 35 0.20 0.26 LargeCap Value 2005 35,845 63.08 59.69 2004 56,234 62.53 63.25 2003 38,590 61.28 67.61 MidCap 2005 10,570 1.87 1.63 2004 3,531 0.81 1.24 2003 11,216 2.77 3.55 MidCap Growth 2005 448 0.34 0.48 MidCap Value 2005 5,155 3.69 3.17 2004 4,285 3.72 3.78 2003 1,805 2.07 1.73 SmallCap 2005 1,289 0.35 0.49 2004 11,082 2.13 2.50 2003 19,669 5.94 9.69 SmallCap Growth 2005 300 0.22 0.40 2004 255 0.33 0.77 2003 785 1.14 0.82 SmallCap Value 2005 6,032 3.98 5.67 2004 897 0.82 0.81 2003 4,666 3.56 3.36
COMMISSIONS PAID TO SPECTRUM ASSET MANAGEMENT --------------------------------------------- TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF ACCOUNT AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTIONS ------- ------ ----------------- --------------------------- Equity Income 2005 24,297 15.36 11.76 2004 4,145 2.63 4.62 2003 16,250 100.00 100.00
COMMISSIONS PAID TO UBS FINANCIAL SERVICES INC. ----------------------------------------------- TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF ACCOUNT AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTIONS ------- ------ ----------------- --------------------------- LargeCap Growth Equity 2003 125 0.48 0.26 SmallCap Growth 2005 595 0.44 0.20 2004 226 0.29 0.30 2003 936 1.36 1.33 SmallCap Value 2003 297 0.23 0.19
COMMISSIONS PAID TO UBS SECURITIES LLC -------------------------------------- TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF ACCOUNT AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTIONS ------- ------ ----------------- --------------------------- Asset Allocation 2005 4,353 12.28 18.06 2004 5,801 17.66 17.13 2003 46,382 33.81 39.17 Balanced 2005 7,064 5.61 5.55 2004 12,868 6.33 8.96 2003 33,899 11.17 15.37 Capital Value 2005 60,571 7.60 8.34 2004 104,579 7.51 8.87 2003 87,090 8.67 10.86 Diversified International 2005 160,448 13.15 15.16 2004 194,788 14.44 18.26 2003 86,477 12.30 13.09 Equity Growth 2005 26,355 8.01 6.40 2004 47,642 5.56 5.76 2003 57,221 6.35 6.01 Equity Income 2005 19,629 12.41 13.70 2004 19,369 12.31 9.05 Equity Value 2005 18 2.19 0.66 2004 2 0.34 0.10 Growth 2005 13,560 5.68 3.71 2004 9,409 3.19 3.00 2003 5,564 3.74 3.50 International Emerging Markets 2005 76,236 13.43 14.10 2004 43,829 11.53 13.81 2003 14,588 10.43 12.65 International SmallCap 2005 71,751 11.54 12.82 2004 55,236 10.88 11.31 2003 38,541 12.39 12.46 LargeCap Blend 2005 6,302 5.48 6.26 2004 14,853 10.69 8.02 2003 805 1.31 1.08 LargeCap Growth Equity 2005 1,349 5.21 4.07 2004 1,765 3.03 2.25 2003 258 1.00 1.43 LargeCap Stock Index 2005 47 0.40 0.41 2004 891 3.90 4.86 2003 101 0.56 0.73 LargeCap Value 2005 691 1.22 5.79 2004 4,717 5.24 3.96 MidCap 2005 17,814 3.14 3.12 2004 25,361 5.81 6.08 2003 30,964 7.64 9.11 MidCap Growth 2005 1,596 1.20 1.08 MidCap Value 2005 1,614 1.16 1.08 2004 2,055 1.78 1.64 2003 1,782 2.04 2.38 Real Estate Securities 2005 2,100 2.25 1.71 2004 13,426 6.94 5.39 2003 5,801 4.09 3.36 SmallCap 2005 20,872 5.62 5.47 2004 23,783 4.56 7.20 SmallCap Growth 2005 1,939 1.44 2.38 SmallCap Value 2005 5,015 3.31 2.52 2004 11,317 10.37 10.20
ALLOCATION OF TRADES BY THE SUB-ADVISORS Each Sub-Advisor manages a number of accounts other than the Account's portfolios. Each Sub-Advisor has adopted and implemented policies and procedures that it believes address the potential conflicts associated with managing accounts for multiple clients and ensures that all clients are treated fairly and equitably. Investments the Sub-Advisor deems appropriate for the Account's portfolio may also be deemed appropriate by it for other accounts. Therefore, the same security may be purchased or sold at or about the same time for both the Account's portfolio and other accounts. In such circumstances, the Sub-Advisor may determine that orders for the purchase or sale of the same security for the Account's portfolio and one or more other accounts should be combined. In this event the transactions will be priced and allocated in a manner deemed by the Sub-Advisor to be equitable and in the best interests of the Account portfolio and such other accounts. While in some instances combined orders could adversely affect the price or volume of a security, the Account believes that its participation in such transactions on balance will produce better overall results for the Account PRICING OF FUND SHARES The Fund's shares are bought and sold at the current share price. The share price of each class of the Fund is calculated each day the New York Stock Exchange ("NYSE") is open, at the close of business of the Exchange (normally 3:00 p.m. Central time). The NAV of Account shares is not determined on days the NYSE is closed (generally, New Year's Day, Martin Luther King Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving and Christmas). When an order to buy or sell shares is received, the share price used to fill the order is the next price calculated after the order is received. The share price is calculated by: . taking the current market value of the total assets of the Fund . subtracting liabilities of the Fund . dividing the remainder proportionately into the classes of the Fund . subtracting the liability of each class . dividing the remainder by the total number of shares owned in that class. For all Accounts except the Money Market Account -------------------- In determining NAV, securities listed on an Exchange, the NASDAQ National Market and foreign markets are valued at the closing prices on such markets, or if such price is lacking for the trading period immediately preceding the time of determination, such securities are valued at their current bid price. Municipal securities held by the Accounts are traded primarily in the over-the-counter market. Valuations of such securities are furnished by one or more pricing services employed by the Accounts and are based upon appraisals obtained by a pricing service, in reliance upon information concerning market transactions and quotations from recognized municipal securities dealers. Other securities that are traded on the over-the-counter market are valued at their closing bid prices. Each Account will determine the market value of individual securities held by it, by using prices provided by one or more professional pricing services which may provide market prices to other funds, or, as needed, by obtaining market quotations from independent broker-dealers. Short-term securities maturing within 60 days are valued on an amortized cost basis. Securities for which quotations are not readily available, and other assets, are valued at fair value determined in good faith under procedures established by and under the supervision of the Board of Directors. A Fund's securities may be traded on foreign securities markets that close each day prior to the time the New York Stock Exchange closes. In addition, foreign securities trading generally or in a particular country or countries may not take place on all business days in New York. The Fund has adopted policies and procedures to "fair value" some or all securities held by a Fund if significant events occur after the close of the market on which the foreign securities are traded but before the Fund's NAV is calculated. Significant events can be specific to a single security or can include events that impact a particular foreign market or markets. A significant event can also include a general market movement in the U.S. securities markets. These fair valuation procedures are intended to discourage shareholders from investing in the Fund for the purpose of engaging in market timing or arbitrage transactions. The values of foreign securities used in computing share price are determined at the time the foreign market closes. Foreign securities and currencies are converted to U.S. dollars using the exchange rate in effect at the close of the London Exchange (generally 11 a.m. Eastern Time). Occasionally, events affecting the value of foreign securities occur when the foreign market is closed and the NYSE is open. The NAV of a Fund investing in foreign securities may change on days when shareholders are unable to purchase or redeem shares. If the Sub-Advisor believes that the market value is materially affected, the share price will be calculated using the policy adopted by the Fund. Certain securities issued by companies in emerging market countries may have more than one quoted valuation at any point in time, sometimes referred to as a "local" price and a "premium" price. The premium price is often a negotiated price which may not consistently represent a price at which a specific transaction can be effected. It is the policy of the Accounts to value such securities at prices at which it is expected those shares may be sold, and the Manager or any Sub-Advisor is authorized to make such determinations subject to the oversight of the Board of Directors as may from time to time be necessary. Money Market Account -------------------- The share priceof shares of the Money Market Account is determined at the same time and on the same days as the Accounts described above. All securities held by the Money Market Account are valued on an amortized cost basis. Under this method of valuation, a security is initially valued at cost; thereafter, the Account assumes a constant proportionate amortization in value until maturity of any discount or premium, regardless of the impact of fluctuating interest rates on the market value of the security. While this method provides certainty in valuation, it may result in periods during which value, as determined by amortized cost, is higher or lower than the price that would be received upon sale of the security. Use of the amortized cost valuation method by the Money Market Account requires the Account to maintain a dollar weighted average maturity of 90 days or less and to purchase only obligations that have remaining maturities of 397 days or less or have a variable or floating rate of interest. In addition, the Account invests only in obligations determined by the Directors to be of high quality with minimal credit risks. The Board of Directors have established procedures for the Money Market Account designed to stabilize, to the extent reasonably possible, the Account's price per share as computed for the purpose of sales and redemptions at $1.00. Such procedures include a directive to the Manager to test price the portfolio or specific securities on a weekly basis using a mark-to-market method of valuation to determine possible deviations in the net asset value from $1.00 per share. If such deviation exceeds 1/2 of 1%, the Board of Directors promptly consider what action, if any, will be initiated. In the event the Board of Directors determine that a deviation exists which may result in material dilution or other unfair results to shareholders, they take such corrective action as they regard as appropriate, including: sale of portfolio instruments prior to maturity; the withholding of dividends; redemptions of shares in kind; the establishment of a net asset value per share based upon available market quotations; or splitting, combining or otherwise recapitalizing outstanding shares. The Account may also reduce the number of shares outstanding by redeeming proportionately from shareholders, without the payment of any monetary compensation, such number of full and fractional shares as is necessary to maintain the net asset value at $1.00 per share. CALCULATION OF PERFORMANCE DATA FOR ALL ACCOUNTS EXCEPT THE MONEY MARKET ACCOUNT An Account's performance will vary from time to time depending upon market conditions, the composition of its portfolio, and its operating expenses. Consequently, any given performance quotation should not be considered representative of an Account's performance for any specified period in the future. In addition, because performance will fluctuate, it may not provide a basis for comparing an investment in an Account with certain bank deposits or other investments that pay a fixed yield or return for a stated period of time. In addition, the calculations of total return and yield for the Accounts do not include any separate account expenses or contract level expenses. Comparative performance information may be used from time to time in advertising the Accounts, including appropriate market indices including the benchmarks shown in the prospectus for the Account or data from Lipper, Inc., Ibbotson Associates, Morningstar Inc., the Dow Jones Industrial Average and other industry publications. From time to time, the Account may, in addition to any other permissible information, include the following types of information in advertisements, supplemental sales literature and reports to shareholders: 1) discussions of general economic or financial principles (such as the effects of compounding and the benefits of dollar-cost averaging); 2) discussions of general economic trends; 3) presentations of statistical data to supplement such discussions; 4) descriptions of past or anticipated portfolio holdings for one or more of the Accounts; 5) descriptions of investment strategies for one or more of the Accounts; 6) descriptions or comparisons of various savings and investment products (including, but not limited to, qualified retirement plans and individual stocks and bonds), which may or may not include the Accounts; 7) comparisons of investment products (including the Accounts) with relevant markets or industry indices or other appropriate benchmarks; 8) discussions of fund rankings or ratings by recognized rating organizations; and 9) discussions of various statistical methods quantifying the Account's volatility relative to its benchmark or to past performance, including risk adjusted measures. The Account may also include calculations, such as hypothetical compounding examples, which describe hypothetical investment results in such communications. Such performance examples will be based on an express set of assumptions and are not indicative of the performance of any of the Accounts. Money Market Account Yield -------------------------- The Money Market Account may advertise its yield and its effective yield. Yield is computed by determining the net change, exclusive of capital changes, in the value of a hypothetical pre-existing account having a balance of one share at the beginning of the period, subtracting a hypothetical charge reflecting deductions from shareholder accounts, and dividing the difference by the value of the account at the beginning of the base period to obtain the base period return, and then multiplying the base period return by (365/7) with the resulting yield figure carried to at least the nearest hundredth of one percent. As of December 31, 2005, the Money Market Account's yield was 3.42%. Because realized capital gains or losses in an Account's portfolio are not included in the calculation, the Account's net investment income per share for yield purposes may be different from the net investment income per share for dividend purposes, that includes net short-term realized gains or losses on the Account's portfolio. Effective yield is computed by determining the net change, exclusive of capital changes, in the value of a hypothetical pre-existing account having a balance of one share at the beginning of the period, subtracting a hypothetical charge reflecting deductions from shareholder accounts, and dividing the difference by the value of the account at the beginning of the base period to obtain the base period return, and then compounding the base period return by adding 1, raising the sum to a power equal to 365 divided by 7, and subtracting 1 from the result. The resulting effective yield figure is carried to at least the nearest hundredth of one percent. As of December 31, 2005, the Money Market Account's effective yield was 3.47%. The yield quoted at any time for the Money Market Account represents the amount that was earned during a specific, recent seven-day period and is a function of the quality, types and length of maturity of instruments in the Account's portfolio and the Account's operating expenses. The length of maturity for the portfolio is the average dollar weighted maturity of the portfolio. This means that the portfolio has an average maturity of a stated number of days for its issues. The calculation is weighted by the relative value of each investment. The yield for the Money Market Account fluctuates daily as the income earned on the investments of the Account fluctuates. Accordingly, there is no assurance that the yield quoted on any given occasion will remain in effect for any period of time. There is no guarantee that the net asset value or any stated rate of return will remain constant. A shareholder's investment in the Account is not insured. Investors comparing results of the Money Market Account with investment results and yields from other sources such as banks or savings and loan associations should understand these distinctions. Historical and comparative yield information may, from time to time, be presented by the Account. Total Return for all other Accounts ----------------------------------- When advertising total return figures, each of the other Accounts will include its average annual total return for each of the one, five and ten year periods that end on the last day of the most recent calendar quarter. Average annual total return is computed by calculating the average annual compounded rate of return over the stated period that would equate an initial $1,000 investment to the ending redeemable value assuming the reinvestment of all dividends and capital gains distributions at net asset value. In its advertising, an Account may also include average annual total return for some other period or cumulative total return for a specified period. Cumulative total return is computed by dividing the ending redeemable value (assuming the reinvestment of all dividends and capital gains distributions at net asset value) by the initial investment. Principal Underwriter --------------------- Princor Financial Services Corporation ("Princor") is the principal underwriter of the Fund and offers shares of each Account on a continuous basis. As principal underwriter, Princor is paid for the distribution of the Fund. For the last three fiscal years, Princor has received and returned the following commissions:
2005 2004 2003 ---- ---- ---- $42,488,646 $38,938,760 $30,520,667
Princor may, from time to time, at its expense or as an expense for which it may be compensated under a distribution plan, if applicable, pay a bonus or other consideration or incentive to dealers who sell a minimum dollar amount of the shares of the Fund during a specific period of time. In some instances, these incentives may be offered only to certain dealers who have sold or may sell significant amounts of shares. The total amount of such additional bonus payments or other consideration shall not exceed 0.25% of the public offering price of the shares sold. Any such bonus or incentive program will not change the price paid by investors for the purchase of the Fund's shares or the amount that any particular Account receives as the proceeds from such sales. Dealers may not use sales of the Fund's shares to qualify for any incentives to the extent that such incentives may be prohibited by the laws of any state. TAX STATUS It is the policy of each Account to distribute substantially all net investment income and net realized gains. Through such distributions, and by satisfying certain other requirements, the Fund intends to qualify for the tax treatment accorded to regulated investment companies under the applicable provisions of the Internal Revenue Code. This means that in each year in which the Fund so qualifies, it is exempt from federal income tax upon the amount so distributed to investors. If an Account fails to qualify as a regulated investment company, it will be liable for taxes, significantly reducing its distributions to shareholders and eliminating shareholders' ability to treat distributions of the Account in the manner they were received by the Account. For federal income tax purposes, capital gains and losses on futures contracts or options thereon, index options or options traded on qualified exchanges are generally treated at 60% long-term and 40% short-term. In addition, an Account must recognize any unrealized gains and losses on such positions held at the end of the fiscal year. An Account may elect out of such tax treatment, however, for a futures or options position that is part of an "identified mixed straddle" such as a put option purchased by the Account with respect to a portfolio security. Gains and losses on figures and options included in an identified mixed straddle will be considered 100% short-term and unrealized gain or loss on such positions will not be realized at year end. The straddle provisions of the Code may require the deferral of realized losses to the extent that the Account has unrealized gains in certain offsetting positions at the end of the fiscal year, and may also require recharacterization of all or a part of losses on certain offsetting positions from short-term to long-term, as well as adjustment of the holding periods of straddle positions. The 1986 Tax Reform Act imposes an excise tax on mutual funds that fail to distribute net investment income and capital gains by the end of the calendar year in accordance with the provisions of the Act. The Fund intends to comply with the Act's requirements and to avoid this excise tax. GENERAL INFORMATION LargeCap Stock Index Account only --------------------------------- The Account is not sponsored, endorsed, sold or promoted by Standard & Poor's, a division of The McGraw-Hill Companies, Inc. ("S&P"). S&P makes no representation or warranty, express or implied, to Account shareholders or any member of the public regarding the advisability of investing in securities generally or in the Account particularly or the ability of the S&P 500 Index to track general stock market performance. S&P's only relationship to Principal Life Insurance Company and the Manager is the licensing of certain trademarks and trade names of S&P and the S&P 500 Index which is determined, composed and calculated by S&P without regard to Principal Life Insurance Company, the Manager or the Account. S&P has no obligation to take the needs of Principal Life Insurance Company, the Manager or Account shareholders into consideration in determining, composing or calculating the S&P 500 Index. S&P is not responsible for and has not participated in the determination of the prices of the Account or the timing of the issuance or sale of the Account or in the determination or calculation of the equation by which the Account is to be converted into cash. S&P has no obligation or liability in connection with the administration, marketing or trading of the Account. S&P DOES NOT GUARANTEE THE ACCURACY AND/OR THE COMPLETENESS OF THE S&P 500 INDEX OR ANY DATA CONTAINED THEREIN AND S&P SHALL HAVE NO LIABILITY FOR ANY ERRORS, OMISSIONS OR INTERRUPTIONS THEREIN. S&P MAKES NO WARRANTY, EXPRESS OR IMPLIED, AS TO RESULTS TO BE OBTAINED BY PRINCIPAL LIFE INSURANCE COMPANY, THE MANAGER, ACCOUNT SHAREHOLDERS OR ANY OTHER PERSON OR ENTITY FROM THE USE OF THE S&P 500 INDEX OR ANY DATA INCLUDED THEREIN. S&P MAKES NO EXPRESS OR IMPLIES WARRANTIES, AND EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE WITH RESPECT TO THE S&P 500 INDEX OR ANY DATA INCLUDED THEREIN. WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT SHALL S&P HAVE ANY LIABILITY FOR ANY SPECIAL, PUNITIVE, INDIRECT OR CONSEQUENTIAL DAMAGES (INCLUDING LOST PROFITS), EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES. PORTFOLIO HOLDINGS DISCLOSURE A mutual fund and its investment adviser may disclose information regarding the Account's portfolio securities only in a manner consistent with the antifraud provisions of the federal securities laws and applicable fiduciary duties. Divulging non-public portfolio holdings to selected third parties is permissible only when the Fund has a legitimate business purpose for doing so and the recipients are subject to a duty of confidentiality, including a duty to not trade on the non-public information. The Fund files a schedule of portfolio investments with the SEC on Form N-Q within 60 days after the end of the Fund's first and third fiscal quarters, and in connection with the N-CSR filing after the close of its second and fourth fiscal quarters. The portfolio information included in these filings is as of the last calendar day of the respective fiscal quarter. The information is public information upon filing with the SEC. The Fund also publishes portfolio holdings information as of the end of the most recent calendar quarter for each of the Fund's portfolios on the principal.com website. The information will be published on the first business day of the second month following the end of the calendar quarter (e.g. June 30 portfolio holdings information would be published on the website on the first business day of August). The Accounts may also occasionally publish information on the website relating to specific events, such as the impact of a natural disaster, corporate debt default; or similar events on portfolio holdings. It is the Fund's policy to disclose only public information regarding portfolio holdings (i.e. information published on the website or filed with the SEC), except as described below. POLICY. The Fund and the Manager have adopted a policy of disclosing non-public portfolio holdings information to third parties only to the extent required by federal law, and to the following third parties, so long as such third party has agreed, or is legally obligated, to maintain the confidentiality of the information and to refrain from using such information to engage in securities transactions: 1) Daily to the Fund's portfolio pricing services to obtain prices for portfolio securities; 2) Upon proper request to government regulatory agencies or to self regulatory organizations; 3) As needed to Ernst & Young LLP, the independent registered public accounting firm, in connection with the performance of the services provided by Ernst & Young LLP to the Fund; 4) To the Account adviser's or sub-adviser's proxy service provider to facilitate voting of proxies; 5) To the Account's custodians in connection with the services provided by the custodian to the Account; and 6) To such other third parties in connection with the performance of a legitimate business purpose if such third party agrees in writing to maintain the confidentiality of the information prior to the information being disclosed. Any such written agreement must be approved by an officer of the Fund, the Manager or the Account's sub-advisor. Approval must be based on a reasonable belief that disclosure to such other third party is in the best interests of the Account's shareholders. If a conflict of interest is identified in connection with disclosure to any such third party, the Fund's CCO must approve such disclosure, in writing before it occurs. Any agreement by which any Account or any party acting on behalf of the Fund agrees to provide Account portfolio information to a third party, other than a third party identified in the policy described above, must be approved prior to information being provided to the third party, unless the third party is a regulator or has a duty to maintain the confidentiality of such information and to refrain from using such information to engage in securities transactions. A written record of approval will be made by the person granting approval. The Fund's non-public portfolio holdings information policy applies without variation to individual investors, institutional investors, intermediaries that distribute the Fund's shares, third party service providers, rating and ranking organizations, and affiliated persons of the Fund. Neither the Fund nor the Manager nor any other party receive compensation in connection with the disclosure of Fund portfolio information. The Fund's CCO will periodically, but no less frequently than annually, review the Fund's portfolio holdings disclosure policy and recommend changes the CCO believes are appropriate, if any, to the Fund's Board of Directors. In addition, the Fund's Board of Directors must approve any change in the Fund's portfolio holdings disclosure policy that would expand the distribution of such information. FINANCIAL STATEMENTS The financial statements for the Fund appear in the Annual Report to Shareholders and are legally a part of this Statement of Additional Information. Reports on those statements from the Fund's independent registered public accounting firm, Ernst & Young LLP, are included in the Annual Report. The Annual Reports are furnished, without charge, to investors who request copies. APPENDIX A Description of Bond Ratings: Moody's Investors Service, Inc. Rating Definitions: Long-Term Obligation Ratings Moody's long-term obligation ratings are opinions of the relative credit risk of fixed-income obligations with an original maturity of one year or more. they address the possibility that a financial obligation will not be honored as promised. Such ratings reflect both the likelihood of default and any financial loss suffered in the event of default. Aaa: Obligations rated Aaa are judged to be of the highest quality, with minimal credit risk. Aa: Obligations rated Aa are judged to be of high quality and are subject to very low credit risk. A: Obligations rated A are considered upper-medium grade and are subject to low credit risk. Baa: Obligations rated Baa are subject to moderate credit risk. They are considered medium-grade and as such may possess certain speculative characteristics. Ba: Obligations rated Ba are judged to have speculative elements and are subject to substantial credit risk. B: Obligations rated B are considered speculative and are subject to high credit risk. Caa: Obligations rated Caa are judged to be of poor standing and are subject to very high credit risk. Ca: Obligations rated Ca are highly speculative and are likely in, or very near, default, with some prospect of recovery of principal and interest. C: Obligations rated C are the lowest rated class of bonds and are typically in default, with little prospect for recovery of principal or interest. NOTE: Moody's appends numerical modifiers, 1, 2 and 3 to each generic rating classification from Aa through Caa. The modifier 1 indicates that the obligation ranks in the higher end of its generic rating category; the modifier 2 indicate a mid-range ranking; and the modifier 3 indicates a ranking in the lower end of that generate rating category. SHORT-TERM NOTES: The four ratings of Moody's for short-term notes are MIG 1, MIG 2, MIG 3 and MIG 4; MIG 1 denotes "best quality, enjoying strong protection from established cash flows"; MIG 2 denotes "high quality" with "ample margins of protection"; MIG 3 notes are of "favorable quality...but lacking the undeniable strength of the preceding grades"; MIG 4 notes are of "adequate quality, carrying specific risk for having protection...and not distinctly or predominantly speculative." Description of Moody's Commercial Paper Ratings: Moody's Commercial Paper ratings are opinions of the ability to repay punctually promissory obligations not having an original maturity in excess of nine months. Moody's employs the following three designations, all judged to be investment grade, to indicate the relative repayment capacity of rated issuers: Issuers rated Prime-1 (or related supporting institutions) have a superior capacity for repayment of short-term promissory obligations. Issuers rated Prime-2 (or related supporting institutions) have a strong capacity for repayment of short-term promissory obligations. Issuers rated Prime-3 (or related supporting institutions) have an acceptable capacity for repayment of short-term promissory obligations. Issuers rated Not Prime do not fall within any of the Prime rating categories. Description of Standard & Poor's Corporation's Debt Ratings: A Standard & Poor's debt rating is a current assessment of the creditworthiness of an obligor with respect to a specific obligation. This assessment may take into consideration obligors such as guarantors, insurers, or lessees. The debt rating is not a recommendation to purchase, sell or hold a security, inasmuch as it does not comment as to market price or suitability for a particular investor. The ratings are based on current information furnished by the issuer or obtained by Standard & Poor's from other sources Standard & Poor's considers reliable. Standard & Poor's does not perform an audit in connection with any rating and may, on occasion, rely on unaudited financial information. The ratings may be changed, suspended or withdrawn as a result of changes in, or unavailability of, such information, or for other circumstances. The ratings are based, in varying degrees, on the following considerations: I. Likelihood of default -- capacity and willingness of the obligor as to the timely payment of interest and repayment of principal in accordance with the terms of the obligation; II. Nature of and provisions of the obligation; III. Protection afforded by, and relative position of, the obligation in the event of bankruptcy, reorganization or other arrangement under the laws of bankruptcy and other laws affecting creditor's rights. AAA: Debt rated "AAA" has the highest rating assigned by Standard & Poor's. Capacity to pay interest and repay principal is extremely strong. AA: Debt rated "AA" has a very strong capacity to pay interest and repay principal and differs from the highest-rated issues only in small degree. A: Debt rated "A" has a strong capacity to pay interest and repay principal although they are somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than debt in higher-rated categories. BBB: Debt rated "BBB" is regarded as having an adequate capacity to pay interest and repay principal. Whereas it normally exhibits adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for debt in this category than for debt in higher-rated categories. BB, B, CCC, CC: Debt rated "BB", "B", "CCC" and "CC" is regarded, on balance, as predominantly speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the obligation. "BB" indicates the lowest degree of speculation and "CC" the highest degree of speculation. While such debt will likely have some quality and protective characteristics, these are outweighed by large uncertainties or major risk exposures to adverse conditions. C: The rating "C" is reserved for income bonds on which no interest is being paid. D: Debt rated "D" is in default, and payment of interest and/or repayment of principal is in arrears. Plus (+) or Minus (-): The ratings from "AA" to "B" may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories. Provisional Ratings: The letter "p" indicates that the rating is provisional. A provisional rating assumes the successful completion of the project being financed by the bonds being rated and indicates that payment of debt service requirements is largely or entirely dependent upon the successful and timely completion of the project. This rating, however, while addressing credit quality subsequent to completion of the project, makes no comment on the likelihood of, or the risk of default upon failure of, such completion. The investor should exercise his own judgment with respect to such likelihood and risk. NR: Indicates that no rating has been requested, that there is insufficient information on which to base a rating or that Standard & Poor's does not rate a particular type of obligation as a matter of policy. Standard & Poor's, Commercial Paper Ratings A Standard & Poor's Commercial Paper Rating is a current assessment of the likelihood of timely payment of debt having an original maturity of no more than 365 days. Ratings are graded into four categories, ranging from "A" for the highest quality obligations to "D" for the lowest. Ratings are applicable to both taxable and tax-exempt commercial paper. The four categories are as follows: A: Issues assigned the highest rating are regarded as having the greatest capacity for timely payment. Issues in this category are delineated with the numbers 1, 2 and 3 to indicate the relative degree of safety. A-1: This designation indicates that the degree of safety regarding timely payment is either overwhelming or very strong. Issues that possess overwhelming safety characteristics will be given a "+" designation. A-2: Capacity for timely payment on issues with this designation is strong. However, the relative degree of safety is not as high as for issues designated "A-1". A-3: Issues carrying this designation have a satisfactory capacity for timely payment. They are, however, somewhat more vulnerable to the adverse effects of changes in circumstances than obligations carrying the highest designations. B: Issues rated "B" are regarded as having only an adequate capacity for timely payment. However, such capacity may be damaged by changing conditions or short-term adversities. C: This rating is assigned to short-term debt obligations with a doubtful capacity for payment. D: This rating indicates that the issue is either in default or is expected to be in default upon maturity. The Commercial Paper Rating is not a recommendation to purchase or sell a security. The ratings are based on current information furnished to Standard & Poor's by the issuer and obtained by Standard & Poor's from other sources it considers reliable. The ratings may be changed, suspended, or withdrawn as a result of changes in or unavailability of, such information. Standard & Poor's rates notes with a maturity of less than three years as follows: SP-1: A very strong, or strong, capacity to pay principal and interest. Issues that possess overwhelming safety characteristics will be given a "+" designation. SP-2: A satisfactory capacity to pay principal and interest. SP-3: A speculative capacity to pay principal and interest. APPENDIX B PROXY VOTING POLICIES The Proxy voting policies applicable to each Account follow. OCTOBER 2005 ALLIANCE CAPITAL MANAGEMENT L.P. STATEMENT OF POLICIES AND PROCEDURES FOR PROXY VOTING INTRODUCTION As a registered investment adviser, Alliance Capital Management L.P. ("Alliance Capital", "we" or "us") has a fiduciary duty to act solely in the best interests of our clients. We recognize that this duty requires us to vote client securities in a timely manner and make voting decisions that are in the best interests of our clients. Consistent with these obligations, we will disclose our clients' voting records only to them and as required by mutual fund vote disclosure regulations. In addition, the proxy committees may, after careful consideration, choose to respond to surveys regarding past votes. This statement is intended to comply with Rule 206(4)-6 of the Investment Advisers Act of 1940. It sets forth our policies and procedures for voting proxies for our discretionary investment advisory clients, including investment companies registered under the Investment Company Act of 1940. This statement applies to Alliance Capital's growth and value investment groups investing on behalf of clients in both US and non-US securities. PROXY POLICIES This statement is designed to be responsive to the wide range of proxy voting subjects that can have a significant effect on the investment value of the securities held in our clients' accounts. These policies are not exhaustive due to the variety of proxy voting issues that we may be required to consider. Alliance Capital reserves the right to depart from these guidelines in order to avoid voting decisions that we believe may be contrary to our clients' best interests. In reviewing proxy issues, we will apply the following general policies: CORPORATE GOVERNANCE: Alliance Capital's proxy voting policies recognize the importance of good corporate governance in ensuring that management and the board of directors fulfill their obligations to the shareholders. We favor proposals promoting transparency and accountability within a company. We will vote for proposals providing for equal access to the proxy materials so that shareholders can express their views on various proxy issues. We also support the appointment of a majority of independent directors on key committees and separating the positions of chairman and chief executive officer. Finally, because we believe that good corporate governance requires shareholders to have a meaningful voice in the affairs of the company, we will support non-binding shareholder proposals that request that companies amend their by-laws to provide that director nominees be elected by an affirmative vote of a majority of the votes cast. ELECTIONS OF DIRECTORS: Unless there is a proxy fight for seats on the Board or we determine that there are other compelling reasons for withholding votes for directors, we will vote in favor of the management proposed slate of directors. That said, we believe that directors have a duty to respond to shareholder actions that have received significant shareholder support. We may withhold votes for directors that fail to act on key issues such as failure to implement proposals to declassify boards, failure to implement a majority vote requirement, failure to submit a rights plan to a shareholder vote or failure to act on tender offers where a majority of shareholders have tendered their shares. In addition, we will withhold votes for directors who fail to attend at least seventy-five percent of board meetings within a given year without a reasonable excuse. Finally, we may withhold votes for directors of non-U.S. issuers where there is insufficient information about the nominees disclosed in the proxy statement. APPOINTMENT OF AUDITORS: Alliance Capital believes that the company remains in the best position to choose the auditors and will generally support management's recommendation. However, we recognize that there may be inherent conflicts when a company's independent auditor performs substantial non-audit related services for the company. Although we recognize that there may be special circumstances that could lead to high levels of non-audit fees in some years, we would normally consider non-audit fees in excess of 70% of total fees paid to the auditing firm to be disproportionate. Therefore, absent unique circumstances, we may vote against the appointment of auditors if the fees for non-audit related services exceed 70% of the total fees paid by the company to the auditing firm or there are other reasons to question the independence of the company's auditors. CHANGES IN LEGAL AND CAPITAL STRUCTURE: Changes in a company's charter, articles of incorporation or by-laws are often technical and administrative in nature. Absent a compelling reason to the contrary, Alliance Capital will cast its votes in accordance with the company's management on such proposals. However, we will review and analyze on a case-by-case basis any non-routine proposals that are likely to affect the structure and operation of the company or have a material economic effect on the company. For example, we will generally support proposals to increase authorized common stock when it is necessary to implement a stock split, aid in a restructuring or acquisition or provide a sufficient number of shares for an employee savings plan, stock option or executive compensation plan. However, a satisfactory explanation of a company's intentions must be disclosed in the proxy statement for proposals requesting an increase of greater than one hundred percent of the shares outstanding. We will oppose increases in authorized common stock where there is evidence that the shares will be used to implement a poison pill or another form of anti-takeover device. CORPORATE RESTRUCTURINGS, MERGERS AND ACQUISITIONS: Alliance Capital believes proxy votes dealing with corporate reorganizations are an extension of the investment decision. Accordingly, we will analyze such proposals on a case-by-case basis, weighing heavily the views of our research analysts that cover the company and our investment professionals managing the portfolios in which the stock is held. PROPOSALS AFFECTING SHAREHOLDER RIGHTS: Alliance Capital believes that certain fundamental rights of shareholders must be protected. We will generally vote in favor of proposals that give shareholders a greater voice in the affairs of the company and oppose any measure that seeks to limit those rights. However, when analyzing such proposals we will weigh the financial impact of the proposal against the impairment of shareholder rights. ANTI-TAKEOVER MEASURES: Alliance Capital believes that measures that impede corporate transactions such as takeovers or entrench management not only infringe on the rights of shareholders but may also have a detrimental effect on the value of the company. We will generally oppose proposals, regardless of whether they are advanced by management or shareholders, the purpose or effect of which is to entrench management or excessively or inappropriately dilute shareholder ownership. Conversely, we support proposals that would restrict or otherwise eliminate anti-takeover or anti-shareholder measures that have already been adopted by corporate issuers. For example, we will support shareholder proposals that seek to require the company to submit a shareholder rights plan to a shareholder vote. We will evaluate, on a case-by-case basis, proposals to completely redeem or eliminate such plans. Furthermore, we will generally oppose proposals put forward by management (including the authorization of blank check preferred stock, classified boards and supermajority vote requirements) that appear to be anti-shareholder or intended as management entrenchment mechanisms. EXECUTIVE COMPENSATION: Alliance Capital believes that company management and the compensation committee of the board of directors should, within reason, be given latitude to determine the types and mix of compensation and benefit awards offered to company employees. Whether proposed by a shareholder or management, we will review proposals relating to executive compensation plans on a case-by-case basis to ensure that the long-term interests of management and shareholders are properly aligned. In general, we will analyze the proposed plans to ensure that shareholder equity will not be excessively diluted. With regard to stock award or option plans, we consider whether the option exercise prices are below the market price on the date of grant and whether an acceptable number of employees are eligible to participate in such programs. We will generally oppose plans that have below market value exercise prices on the date of issuance or permit repricing of underwater stock options without shareholder approval. Other factors such as the company's performance and industry practice will generally be factored into our analysis. We will support proposals requiring managements to submit severance packages that exceed 2.99 times the sum of an executive officer's base salary plus bonus that are triggered by a change in control to a shareholder vote. Finally, we will support shareholder proposals requiring companies to expense stock options because we view them as a large corporate expense that should be appropriately accounted for. Social and Corporate Responsibility: Alliance Capital will review and analyze on a case-by-case basis proposals relating to social, political and environmental issues to determine whether they will have a financial impact on shareholder value. We will vote against proposals that are unduly burdensome or result in unnecessary and excessive costs to the company. We may abstain from voting on social proposals that do not have a readily determinable financial impact on shareholder value. PROXY VOTING PROCEDURES ----------------------- PROXY VOTING COMMITTEES ----------------------- Our growth and value investment groups have formed separate proxy voting committees to establish general proxy policies for Alliance Capital and consider specific proxy voting matters as necessary. These committees periodically review these policies and new types of corporate governance issues, and decide how we should vote on proposals not covered by these policies. When a proxy vote cannot be clearly decided by an application of our stated policy, the proxy committee will evaluate the proposal. In addition, the committees, in conjunction with the analyst that covers the company, may contact corporate management and interested shareholder groups and others as necessary to discuss proxy issues. Members of the committee include senior investment personnel and representatives of the Legal and Compliance Department. The committees may also evaluate proxies where we face a potential conflict of interest (as discussed below). Finally, the committees monitor adherence to these policies. CONFLICTS OF INTEREST ---------------------- Alliance Capital recognizes that there may be a potential conflict of interest when we vote a proxy solicited by an issuer whose retirement plan we manage, or we administer, who distributes Alliance Capital sponsored mutual funds, or with whom we or an employee has another business or personal relationship that may affect how we vote on the issuer's proxy. Similarly, Alliance may have a potential material conflict of interest when deciding how to vote on a proposal sponsored or supported by a shareholder group that is a client. We believe that centralized management of proxy voting, oversight by the proxy voting committees and adherence to these policies ensures that proxies are voted with only our clients' best interests in mind. Additionally, we have implemented procedures to ensure that our votes are not the product of a material conflict of interests, including: (i) on an annual basis, the proxy committees will take reasonable steps to evaluate the nature of Alliance Capital's and our employees' material business and personal relationships (and those of our affiliates) with any company whose equity securities are held in client accounts and any client that has sponsored or has material interest in a proposal upon which we will be eligible to vote; (ii) requiring anyone involved in the decision making process to disclose to the chairman of the appropriate proxy committee any potential conflict that they are aware of (including personal relationships) and any contact that they have had with any interested party regarding a proxy vote; (iii) prohibiting employees involved in the decision making process or vote administration from revealing how we intend to vote on a proposal in order to reduce any attempted influence from interested parties; and (iv) where a material conflict of interests exists, reviewing our proposed vote by applying a series of objective tests and, where necessary, considering the views of third party research services to ensure that our voting decision is consistent with our clients' best interests. Because under certain circumstances Alliance Capital considers the recommendation of third party research services, the proxy committees will take reasonable steps to verify that any third party research service is in fact independent based on all of the relevant facts and circumstances. This includes reviewing the third party research service's conflict management procedures and ascertaining, among other things, whether the third party research service (i) has the capacity and competency to adequately analyze proxy issues; and (ii) can make such recommendations in an impartial manner and in the best interests of our clients. PROXIES OF CERTAIN NON-US ISSUERS --------------------------------- Proxy voting in certain countries requires "share blocking." Shareholders wishing to vote their proxies must deposit their shares shortly before the date of the meeting (usually one-week) with a designated depositary. During this blocking period, shares that will be voted at the meeting cannot be sold until the meeting has taken place and the shares are returned to the clients' custodian banks. Absent compelling reasons to the contrary, Alliance Capital believes that the benefit to the client of exercising the vote does not outweigh the cost of voting (i.e. not being able to sell the shares during this period). Accordingly, if share blocking is required we generally abstain from voting those shares. In addition, voting proxies of issuers in non-US markets may give rise to a number of administrative issues that may prevent Alliance Capital from voting such proxies. For example, Alliance Capital may receive meeting notices without enough time to fully consider the proxy or after the cut-off date for voting. Other markets require Alliance Capital to provide local agents with power of attorney prior to implementing Alliance Capital's voting instructions. Although it is Alliance Capital's policy to seek to vote all proxies for securities held in client accounts for which we have proxy voting authority, in the case of non-US issuers, we vote proxies on a best efforts basis. LOANED SECURITIES ----------------- Many clients of Alliance Capital have entered into securities lending arrangements with agent lenders to generate additional revenue. Alliance Capital will not be able to vote securities that are on loan under these types of arrangements. However, under rare circumstances, for voting issues that may have a significant impact on the investment, we may request that clients recall securities that are on loan if we determine that the benefit of voting outweighs the costs and lost revenue to the client or fund and the administrative burden of retrieving the securities. PROXY VOTING RECORDS -------------------- Clients may obtain information about how we voted proxies on their behalf by contacting their Alliance Capital administrative representative. Alternatively, clients may make a written request for proxy voting information to: Mark R. Manley, Senior Vice President & Chief Compliance Officer, Alliance Capital Management L.P., 1345 Avenue of the Americas, New York, NY 10105. AMERICAN CENTURY INVESTMENTS PROXY VOTING POLICIES American Century Investment Management, Inc. and American Century Global Investment Management, Inc. (collectively, the "Adviser") are the investment managers for a variety of clients, including the American Century family of mutual funds. As such, the Adviser has been delegated the authority to vote proxies with respect to investments held in the accounts it manages. The following is a statement of the proxy voting policies that have been adopted by the Adviser. GENERAL PRINCIPLES In voting proxies, the Adviser is guided by general fiduciary principles. It must act prudently, solely in the interest of our clients, and for the exclusive purpose of providing benefits to them. The Adviser will attempt to consider all factors of its vote that could affect the value of the investment. We will not subordinate the interests of clients in the value of their investments to unrelated objectives. In short, the Adviser will vote proxies in the manner that we believe will do the most to maximize shareholder value. SPECIFIC PROXY MATTERS A.ROUTINE MATTERS 1) ELECTION OF DIRECTORS a) GENERALLY. THE ADVISER will generally support the election of directors that result in a board made up of a majority of independent directors. In general, the Adviser will vote in favor of management's director nominees if they are running unopposed. The Adviser believes that management is in the best possible position to evaluate the qualifications of directors and the needs and dynamics of a particular board. The Adviser of course maintains the ability to vote against any candidate whom it feels is not qualified. For example, we will generally vote for management's director nominees unless there are specific concerns about the individual, such as criminal wrongdoing or breach of fiduciary responsibilities. Conversely, we will vote against individual directors if they do not provide an adequate explanation for repeated absences at board meetings. When management's nominees are opposed in a proxy contest, the Adviser will evaluate which nominees' publicly-announced management policies and goals are most likely to maximize shareholder value, as well as the past performance of the incumbents. In cases where the Adviser's clients are significant holders of a company's voting securities, management's recommendations will be reviewed with the client or an appropriate fiduciary responsible for the client (e.g., a committee of the independent directors of a fund, the trustee of a retirement plan). b) COMMITTEE SERVICE. The Adviser will withhold votes for non-independent directors who serve on the audit, compensation and/or nominating committees of the board. C) CLASSIFICATION OF BOARDS. The Adviser will support proposals that seek to declassify boards. Conversely, the Adviser will oppose efforts to adopt classified board structures. D) MAJORITY INDEPENDENT BOARD. The Adviser will support proposals calling for a majority of independent directors on a board. We believe that a majority of independent directors can helps to facilitate objective decision making and enhances accountability to shareholders. E)WITHHOLDING CAMPAIGNS. The Adviser will support proposals calling for shareholders to withhold votes for directors where such actions will advance the principles set forth in paragraphs (a) through (d) above. 2) RATIFICATION OF SELECTION OF AUDITORS The Adviser will generally rely on the judgment of the issuer's audit committee in selecting the independent auditors who will provide the best service to the company. The Adviser believes that independence of the auditors is paramount and will vote against auditors whose independence appears to be impaired. We will vote against proposed auditors in those circumstances where (1) an auditor has a financial interest in or association with the company, and is therefore not independent; (2) non-audit fees comprise more than 50% of the total fees paid by the company to the audit firm; or (3) there is reason to believe that the independent auditor has previously rendered an opinion to the issuer that is either inaccurate or not indicative of the company's financial position. B. EQUITY-BASED COMPENSATION PLANS The Adviser believes that equity-based incentive plans are economically significant issues upon which shareholders are entitled to vote. The Adviser recognizes that equity-based compensation plans can be useful in attracting and maintaining desirable employees. The cost associated with such plans must be measured if plans are to be used appropriately to maximize shareholder value. The Adviser will conduct a case-by-case analysis of each stock option, stock bonus or similar plan or amendment, and generally approve management's recommendations with respect to adoption of or amendments to a company's equity-based compensation plans, provided that the total number of shares reserved under all of a company's plans is reasonable and not excessively dilutive. The Adviser will review equity-based compensation plans or amendments thereto on a case-by-case basis. Factors that will be considered in the determination include the company's overall capitalization, the performance of the company relative to its peers, and the maturity of the company and its industry; for example, technology companies often use options broadly throughout its employee base which may justify somewhat greater dilution. Amendments which are proposed in order to bring a company's plan within applicable legal requirements will be reviewed by the Adviser's legal counsel; amendments to executive bonus plans to comply with IRS Section 162(m) disclosure requirements, for example, are generally approved. The Adviser will generally vote against the adoption of plans or plan amendments that: . provide for immediate vesting of all stock options in the event of a change of control of the company (see "Anti-Takeover Proposals" below);. reset outstanding stock options at a lower strike price unless accompanied by a corresponding and proportionate reduction in the number of shares designated. The Adviser will generally oppose adoption of stock option plans that explicitly or historically permit repricing of stock options, regardless of the number of shares reserved for issuance, since their effect is impossible to evaluate; . establish restriction periods shorter than three years for restricted stock grants; . do not reasonably associate awards to performance of the company; and . are excessively dilutive to the company. C.ANTI-TAKEOVER PROPOSALS In general, the Adviser will vote against any proposal, whether made by management or shareholders, which the Adviser believes would materially discourage a potential acquisition or takeover. In most cases an acquisition or takeover of a particular company will increase share value. The adoption of anti-takeover measures may prevent or frustrate a bid from being made, may prevent consummation of the acquisition, and may have a negative effect on share price when no acquisition proposal is pending. The items below discuss specific anti-takeover proposals. 1) CUMULATIVE VOTING The Adviser will vote in favor of any proposal to adopt cumulative voting and will vote against any proposal to eliminate cumulative voting that is already in place, except in cases where a company has a staggered board. Cumulative voting gives minority shareholders a stronger voice in the company and a greater chance for representation on the board. The Adviser believes that the elimination of cumulative voting constitutes an anti-takeover measure. 2) STAGGERED BOARD If a company has a "staggered board," its directors are elected for terms of more than one year and only a segment of the board stands for election in any year. Therefore, a potential acquiror cannot replace the entire board in one year even if it controls a majority of the votes. Although staggered boards may provide some degree of continuity and stability of leadership and direction to the board of directors, the Adviser believes that staggered boards are primarily an anti-takeover device and will vote against them. However, the Adviser does not necessarily vote against the re-election of staggered boards. 3) BLANK CHECK" PREFERRED STOCK Blank check preferred stock gives the board of directors the ability to issue preferred stock, without further shareholder approval, with such rights, preferences, privileges and restrictions as may be set by the board. In response to a hostile take-over attempt, the board could issue such stock to a friendly party or "white knight" or could establish conversion or other rights in the preferred stock which would dilute the common stock and make an acquisition impossible or less attractive. The argument in favor of blank check preferred stock is that it gives the board flexibility in pursuing financing, acquisitions or other proper corporate purposes without incurring the time or expense of a shareholder vote. Generally, the Adviser will vote against blank check preferred stock. However, the Adviser may vote in favor of blank check preferred if the proxy statement discloses that such stock is limited to use for a specific, proper corporate objective as a financing instrument. 4) ELIMINATION OF PREEMPTIVE RIGHTS When a company grants preemptive rights, existing shareholders are given an opportunity to maintain their proportional ownership when new shares are issued. A proposal to eliminate preemptive rights is a request from management to revoke that right. While preemptive rights will protect the shareholder from having its equity diluted, it may also decrease a company's ability to raise capital through stock offerings or use stock for acquisitions or other proper corporate purposes. Preemptive rights may therefore result in a lower market value for the company's stock. In the long term, shareholders could be adversely affected by preemptive rights. The Adviser generally votes against proposals to grant preemptive rights, and for proposals to eliminate preemptive rights. 5) NON-TARGETED SHARE REPURCHASE A non-targeted share repurchase is generally used by company management to prevent the value of stock held by existing shareholders from deteriorating. A non-targeted share repurchase may reflect management's belief in the favorable business prospects of the company. The Adviser finds no disadvantageous effects of a non-targeted share repurchase and will generally vote for the approval of a non-targeted share repurchase subject to analysis of the company's financial condition. 6) INCREASE IN AUTHORIZED COMMON STOCK The issuance of new common stock can also be viewed as an anti-takeover measure, although its effect on shareholder value would appear to be less significant than the adoption of blank check preferred. The Adviser will evaluate the amount of the proposed increase and the purpose or purposes for which the increase is sought. If the increase is not excessive and is sought for proper corporate purposes, the increase will be approved. Proper corporate purposes might include, for example, the creation of additional stock to accommodate a stock split or stock dividend, additional stock required for a proposed acquisition, or additional stock required to be reserved upon exercise of employee stock option plans or employee stock purchase plans. Generally, the Adviser will vote in favor of an increase in authorized common stock of up to 100%; increases in excess of 100% are evaluated on a case-by-case basis, and will be voted affirmatively if management has provided sound justification for the increase. 7) "SUPERMAJORITY" VOTING PROVISIONS OR SUPER VOTING SHARE CLASSES A "supermajority" voting provision is a provision placed in a company's charter documents which would require a "supermajority" (ranging from 66 to 90%) of shareholders and shareholder votes to approve any type of acquisition of the company. A super voting share class grants one class of shareholders a greater per-share vote than those of shareholders of other voting classes. The Adviser believes that these are standard anti-takeover measures and will vote against them. The supermajority provision makes an acquisition more time-consuming and expensive for the acquiror. A super voting share class favors one group of shareholders disproportionately to economic interest. Both are often proposed in conjunction with other anti-takeover measures. 8) "FAIR PRICE" AMENDMENTS This is another type of charter amendment that would require an offeror to pay a "fair" and uniform price to all shareholders in an acquisition. In general, fair price amendments are designed to protect shareholders from coercive, two-tier tender offers in which some shareholders may be merged out on disadvantageous terms. Fair price amendments also have an anti-takeover impact, although their adoption is generally believed to have less of a negative effect on stock price than other anti-takeover measures. The Adviser will carefully examine all fair price proposals. In general, the Adviser will vote against fair price proposals unless it can be determined from the proposed operation of the fair price proposal that it is likely that share price will not be negatively affected and the proposal will not have the effect of discouraging acquisition proposals. 9) LIMITING THE RIGHT TO CALL SPECIAL SHAREHOLDER MEETINGS. The incorporation statutes of many states allow minority shareholders at a certain threshold level of ownership (frequently 10%) to call a special meeting of shareholders. This right can be eliminated (or the threshold increased) by amendment to the company's charter documents. The Adviser believes that the right to call a special shareholder meeting is significant for minority shareholders; the elimination of such right will be viewed as an anti-takeover measure and we will vote against proposals attempting to eliminate this right and for proposals attempting to restore it. 10) POISON PILLS OR SHAREHOLDER RIGHTS PLANS Many companies have now adopted some version of a poison pill plan (also known as a shareholder rights plan). Poison pill plans generally provide for the issuance of additional equity securities or rights to purchase equity securities upon the occurrence of certain hostile events, such as the acquisition of a large block of stock. The basic argument against poison pills is that they depress share value, discourage offers for the company and serve to "entrench" management. The basic argument in favor of poison pills is that they give management more time and leverage to deal with a takeover bid and, as a result, shareholders may receive a better price. The Adviser believes that the potential benefits of a poison pill plan are outweighed by the potential detriments. The Adviser will generally vote against all forms of poison pills. We will, however, consider on a case-by-case basis poison pills that are very limited in time and preclusive effect. We will generally vote in favor of such a poison pill if it is linked to a business strategy that will - in our view - likely result in greater value for shareholders, if the term is less than three years, and if shareholder approval is required to reinstate the expired plan or adopt a new plan at the end of this term. 11) GOLDEN PARACHUTES Golden parachute arrangements provide substantial compensation to executives who are terminated as a result of a takeover or change in control of their company. The existence of such plans in reasonable amounts probably has only a slight anti-takeover effect. In voting, the Adviser will evaluate the specifics of the plan presented. 12) REINCORPORATION Reincorporation in a new state is often proposed as one part of a package of anti-takeover measures. Several states (such as Pennsylvania, Ohio and Indiana) now provide some type of legislation that greatly discourages takeovers. Management believes that Delaware in particular is beneficial as a corporate domicile because of the well-developed body of statutes and case law dealing with corporate acquisitions. We will examine reincorporation proposals on a case-by-case basis. If the Adviser believes that the reincorporation will result in greater protection from takeovers, the reincorporation proposal will be opposed. We will also oppose reincorporation proposals involving jurisdictions that specify that directors can recognize non-shareholder interests over those of shareholders. When reincorporation is proposed for a legitimate business purpose and without the negative effects identified above, the Adviser will vote affirmatively. 13) CONFIDENTIAL VOTING Companies that have not previously adopted a "confidential voting" policy allow management to view the results of shareholder votes. This gives management the opportunity to contact those shareholders voting against management in an effort to change their votes. Proponents of secret ballots argue that confidential voting enables shareholders to vote on all issues on the basis of merit without pressure from management to influence their decision. Opponents argue that confidential voting is more expensive and unnecessary; also, holding shares in a nominee name maintains shareholders' confidentiality. The Adviser believes that the only way to insure anonymity of votes is through confidential voting, and that the benefits of confidential voting outweigh the incremental additional cost of administering a confidential voting system. Therefore, we will vote in favor of any proposal to adopt confidential voting. 14) OPTING IN OR OUT OF STATE TAKEOVER LAWS State takeover laws typically are designed to make it more difficult to acquire a corporation organized in that state. The Adviser believes that the decision of whether or not to accept or reject offers of merger or acquisition should be made by the shareholders, without unreasonably restrictive state laws that may impose ownership thresholds or waiting periods on potential acquirors. Therefore, the Adviser will vote in favor of opting out of restrictive state takeover laws. C. OTHER MATTERS 1) SHAREHOLDER PROPOSALS INVOLVING SOCIAL, MORAL OR ETHICAL MATTERS The Adviser will generally vote management's recommendation on issues that primarily involve social, moral or ethical matters, such as the MacBride Principles pertaining to operations in Northern Ireland. While the resolution of such issues may have an effect on shareholder value, the precise economic effect of such proposals, and individual shareholder's preferences regarding such issues is often unclear. Where this is the case, the Adviser believes it is generally impossible to know how to vote in a manner that would accurately reflect the views of the Adviser's clients, and therefore will review management's assessment of the economic effect of such proposals and rely upon it if we believe its assessment is not unreasonable. Shareholders may also introduce social, moral or ethical proposals which are the subject of existing law or regulation. Examples of such proposals would include a proposal to require disclosure of a company's contributions to political action committees or a proposal to require a company to adopt a non-smoking workplace policy. The Adviser believes that such proposals are better addressed outside the corporate arena, and will vote with management's recommendation; in addition, the Adviser will generally vote against any proposal which would require a company to adopt practices or procedures which go beyond the requirements of existing, directly applicable law. 2) ANTI-GREENMAIL PROPOSALS "Anti-greenmail" proposals generally limit the right of a corporation, without a shareholder vote, to pay a premium or buy out a 5% or greater shareholder. Management often argues that they should not be restricted from negotiating a deal to buy out a significant shareholder at a premium if they believe it is in the best interest of the company. Institutional shareholders generally believe that all shareholders should be able to vote on such a significant use of corporate assets. The Adviser believes that any repurchase by the company at a premium price of a large block of stock should be subject to a shareholder vote. Accordingly, it will vote in favor of anti-greenmail proposals. 3) INDEMNIFICATION The Adviser will generally vote in favor of a corporation's proposal to indemnify its officers and directors in accordance with applicable state law. Indemnification arrangements are often necessary in order to attract and retain qualified directors. The adoption of such proposals appears to have little effect on share value. 4) NON-STOCK INCENTIVE PLANS Management may propose a variety of cash-based incentive or bonus plans to stimulate employee performance. In general, the cash or other corporate assets required for most incentive plans is not material, and the Adviser will vote in favor of such proposals, particularly when the proposal is recommended in order to comply with IRC Section 162(m) regarding salary disclosure requirements. Case-by-case determinations will be made of the appropriateness of the amount of shareholder value transferred by proposed plans. 5) DIRECTOR TENURE These proposals ask that age and term restrictions be placed on the board of directors. The Adviser believes that these types of blanket restrictions are not necessarily in the best interests of shareholders and therefore will vote against such proposals, unless they have been recommended by management. 6) DIRECTORS' STOCK OPTIONS PLANS The Adviser believes that stock options are an appropriate form of compensation for directors, and the Adviser will vote for director stock option plans which are reasonable and do not result in excessive shareholder dilution. Analysis of such proposals will be made on a case-by-case basis, and will take into account total board compensation and the company's total exposure to stock option plan dilution. 7) DIRECTOR SHARE OWNERSHIP The Adviser will vote against shareholder proposals which would require directors to hold a minimum number of the company's shares to serve on the Board of Directors, in the belief that such ownership should be at the discretion of Board members. MONITORING POTENTIAL CONFLICTS OF INTEREST Corporate management has a strong interest in the outcome of proposals submitted to shareholders. As a consequence, management often seeks to influence large shareholders to vote with their recommendations on particularly controversial matters. In the vast majority of cases, these communications with large shareholders amount to little more than advocacy for management's positions and give the Adviser's staff the opportunity to ask additional questions about the matter being presented. Companies with which the Adviser has direct business relationships could theoretically use these relationships to attempt to unduly influence the manner in which the Adviser votes on matters for its clients. To ensure that such a conflict of interest does not affect proxy votes cast for the Adviser's clients, our proxy voting personnel regularly catalog companies with whom the Adviser has significant business relationships; all discretionary (including case-by-case) voting for these companies will be voted by the client or an appropriate fiduciary responsible for the client (e.g., a committee of the independent directors of a fund or the trustee of a retirement plan). ************************************************************ The voting policies expressed above are of course subject to modification in certain circumstances and will be reexamined from time to time. With respect to matters that do not fit in the categories stated above, the Adviser will exercise its best judgment as a fiduciary to vote in the manner which will most enhance shareholder value. Case-by-case determinations will be made by the Adviser's staff, which is overseen by the General Counsel of the Adviser, in consultation with equity managers. Electronic records will be kept of all votes made. Original 6/1/1989 Revised 12/05/1991 Revised 2/15/1997 Revised 8/1/1999 Revised 7/1/2003 Revised 12/13/2005 COLUMBUS CIRCLE INVESTORS PROXY VOTING POLICY 2006 I. PROCEDURES ---------- Columbus Circle Investors (Columbus Circle) is generally authorized by its clients, as a term of its Investment Advisory Agreement, the authority to vote and give proxies for the securities held in clients' investment accounts. At their election, however, clients may retain this authority, in which case Columbus Circle will consult with clients regarding proxy voting decisions as requested. For those clients for whom Columbus Circle Investors (Columbus Circle) has undertaken to vote proxies, Columbus Circle retains the final authority and responsibility for such voting subject to any specific restrictions or voting instructions by clients. In addition to voting proxies for clients, Columbus Circle: 1) provides clients with a concise summary of its proxy voting policy, which includes information describing how clients may obtain a copy of this complete policy and information regarding how specific proxies related to each respective investment account are voted. Columbus Circle provides this summary to all new clients as part of its Form ADV, Part II disclosure brochure, which is available to any clients upon request; 2) applies its proxy voting policy according to the following voting policies and keeps records of votes for each client through Institutional Shareholder Services; 3) keeps records of proxy voting available for inspection by each client or governmental agencies - to both determine whether the votes were consistent with policy and to determine all proxies were voted; 4) monitors such voting for any potential conflicts of interest and maintains systems to deal with these issues appropriately; and 5) maintains this written proxy voting policy, which may be updated and supplemented from time to time; Frank Cuttita, Columbus Circle's Chief Administrative Officer and Chief Compliance Officer, will maintain Columbus Circle's proxy voting process. Clients with questions regarding proxy voting decisions in their accounts should contact Mr. Cuttita. II. VOTING GUIDELINES ----------------- Keeping in mind the concept that no issue is considered "routine," outlined below are general voting parameters on various types of issues when there are no extenuating circumstances, i.e., company specific reason for voting differently. The Operating Committee of Columbus Circle has adopted the following voting parameters. To assist in its voting process, Columbus Circle has engaged Institutional Shareholder Services (ISS), an independent investment advisor that specializes in providing a variety of fiduciary level proxy related services to institutional investment managers, plan sponsors, custodians, consultants, and other institutional investors. ISS also provides Columbus Circle with reports that reflect proxy voting activities for Columbus Circle's client portfolios which provide information for appropriate monitoring of such delegated responsibilities. Columbus Circle has delegated to ISS the authority to vote Columbus Circle's clients' proxies consistent with the following parameters. ISS further has the authority to determine whether any extenuating specific company circumstances exist that would mandate a special consideration of the application of these voting parameters. If ISS makes such a determination, the matter will be forwarded to Mr. Frank Cuttita for review. Likewise, ISS will present to Columbus Circle any specific matters not addressed within the following parameters for consideration. A. MANAGEMENT PROPOSALS: 1.When voting on ballot items that are fairly common management sponsored initiatives certain items are generally, although not always, voted affirmatively. . "Normal" elections of directors . Approval of auditors/CPA . Directors' liability and indemnification . General updating/corrective amendments to charter . Elimination of cumulative voting . Elimination of preemptive rights 2.When voting items that have a potential substantive financial or best interest impact, certain items are generally, although not always, voted affirmatively: . Capitalization changes that eliminate other classes of stock and voting rights . Changes in capitalization authorization for stock splits, stock dividends, and other specified needs. . Stock purchase plans with an exercise price of not less than 85% FMV . Stock option plans that are incentive based and not excessive . Reductions in supermajority vote requirements . Adoption of antigreenmail provisions 3.When voting items which have a potential substantive financial or best interest impact, certain items are generally not voted in support of the proposed management sponsored initiative: . Capitalization changes that add classes of stock that are blank check in nature or that dilute the voting interest of existing shareholders . Changes in capitalization authorization where management does not offer an appropriate rationale or that are contrary to the best interest of existing shareholders . Anti-takeover and related provisions which serve to prevent the majority of shareholders from exercising their rights or effectively deter appropriate tender offers and other offers . Amendments to bylaws that would require super-majority shareholder votes to pass or repeal certain provisions . Classified or single-slate boards of directors . Reincorporation into a state that has more stringent anti-takeover and related provisions . Shareholder rights plans that allow appropriate offers to shareholders to be blocked by the board or trigger provisions which prevent legitimate offers from proceeding. . Excessive compensation or non-salary compensation related proposals, always company specific and considered case-by-case . Change-in-control provisions in non-salary compensation plans, employment contracts, and severance agreements that benefit management and would be costly to shareholders if triggered . Amending articles to relax quorum requirements for special resolutions . ^ Re-election of director(s) directly responsible for a company's fraudulent or criminal act . ^ Re-election of director(s) who holds offices of chairman and CEO . Re-election of director(s) who serve on audit, compensation and nominating committees . ^ Election of directors with service contracts of three years, which exceed best practice and any change in control provisions . ^ Adoption of option plans/grants to directors or employees of related companies . ^ Lengthening internal auditors' term in office to four years B. SHAREHOLDER PROPOSALS: Traditionally shareholder proposals have been used mainly for putting social initiatives and issues in front of management and other shareholders. Under ERISA, it is inappropriate to use (vote) plan assets to carry out such social agendas or purposes. Thus, shareholder proposals are examined closely for their relationship to the best interest of shareholders, i.e., beneficiaries, and economic impact. 1.When voting shareholder proposals, in general, initiatives related to the following items are supported: . Auditors should attend the annual meeting of shareholders . ^Election of the board on an annual basis . Equal access to proxy process . ^Submit shareholder rights plan poison pill to vote or redeem . ^Undo various anti-takeover related provisions . ^Reduction or elimination of super-majority vote requirements . Anti-greenmail provisions . ^ Submit audit firm ratification to shareholder votes . Audit firm rotations every five or more years . Requirement to expense stock options . ^ Establishment of holding periods limiting executive stock sales . ^ Report on executive retirement benefit plans . ^ Require two-thirds of board to be independent . ^ Separation of chairman and chief executive posts 2.When voting shareholder proposals, in general, initiatives related to the following items are not supported: . Requiring directors to own large amounts of stock before being eligible to be elected . Restoring cumulative voting in the election of directors . Reports which are costly to provide or which would require duplicative efforts or expenditures which are of a non-business nature or would provide no pertinent information from the perspective of ERISA shareholders . Restrictions related to social, political or special interest issues which impact the ability of the company to do business or be competitive and which have a significant financial or best interest impact, such as specific boycotts or restrictions based on political, special interest or international trade considerations; restrictions on political contributions; and the Valdez principles. . Restrictions banning future stock option grants to executives except in extreme cases 3.Additional shareholder proposals require case-by-case analysis . Prohibition or restriction of auditors from engaging in non-audit services (auditors will be voted against if non-audit fees are greater than audit and audit-related fees, and permitted tax fees combined) . Requirements that stock options be performance-based . Submission of extraordinary pension benefits for senior executives under a company's SERP for shareholder approval . Shareholder access to nominate board members^ . Requiring offshore companies to reincorporate into the United States Another expression of active involvement is the voting of shareholder proposals. Columbus Circle evaluates and supports those shareholder proposals on issues that appropriately forward issues of concern to the attention of corporate management. Historically, many shareholder proposals received very little support, often not even enough to meet SEC refiling requirements in the following year although the SEC is considering relaxing the standards for the placement of shareholder initiatives on ballots. Support of appropriate shareholder proposals is becoming a more widespread and acknowledged practice and is viewed by many as a direct expression of concern on an issue to corporate management. It is noted, however, that the source (and motivation of the shareholder proposal proponent) can affect outcome on a shareholder proposal vote. Columbus Circle has not, to date, actively considered filing shareholder proposals, writing letters to companies on a regular basis, or engaging numerous companies in a dialogue. These activities and others that could be considered expressions of activism are not under consideration at this time. Should a particular equity company's policy become of concern, the evaluation and voting process will continue to be the first level of monitoring and communication. Columbus Circle's staff participates in national forums and maintains contacts with corporate representatives. III. CONFLICTS OF INTEREST Columbus Circle will monitor its proxy voting process for material conflicts of interest. By maintaining the above-described proxy voting process, most votes are made based on overall voting parameters rather than their application to any particular company thereby eliminating the effect of any potential conflict of interest. Columbus Circle has reviewed its business, financial and personal relationships to determine whether any conflicts of interest exist, and will at least annually assess the impact of any conflicts of interest. As of the date of this policy, Columbus Circle may have a conflict of interest related to voting certain securities of publicly held companies to which the firm provides investment advisory services. In the event of a vote involving a conflict of interest that does not meet the specific outlined parameters above or and requires additional company-specific decision-making, Columbus Circle will vote according to the voting recommendation of ISS. In the rare occurrence that ISS does not provide a recommendation, CCI may request client consent on the issue. Eff. 01/20/2006 EMERALD ADVISERS, INC. PROXY VOTING POLICY The voting policies set forth below apply to all proxies which Emerald Advisers, Inc. is entitled to vote. It is EAI's policy to vote all such proxies. Corporate governance through the proxy process is solely concerned with the accountability and responsibility for the assets entrusted to corporations. The role of institutional investors in the governance process is the same as the responsibility due all other aspects of the fund's management. First and foremost, the investor is a fiduciary and secondly, an owner. Fiduciaries and owners are responsible for their investments. These responsibilities include: 1) Selecting proper directors 2) Insuring that these directors have properly supervised management 3) Resolve issues of natural conflict between shareholders and managers a) Compensation b) Corporate Expansion c) Dividend Policy d) Free Cash Flow e) Various Restrictive Corporate Governance Issues, Control Issues, etc. f) Preserving Integrity In voting proxies, EAI will consider those factors which would affect the value of the investment and vote in the manner, which in its view, will best serve the economic interest of its clients. Consistent with this objective, EAI will exercise its vote in an activist pro-shareholder manner in accordance with the following policies. I. BOARD OF DIRECTORS In theory, the Board represents shareholders, in practice, all too often Board members are selected by management. Their allegiance is therefore owed to management in order to maintain their very favorable retainers and prestigious position. In some cases, corporations never had a nominating process, let alone criteria for the selection of Board members. Shareholders have begun to focus on the importance of the independence of the Board of Directors and the nominating process for electing these Board members. Independence is an important criterium to adequately protect shareholders' ongoing financial interest and to properly conduct a board member's oversight process. Independence though, is only the first criteria for a Board. Boards need to be responsible fiduciaries in their oversight and decision-making on behalf of the owners of the corporations. Too many companies are really ownerless. Boards who have failed to perform their duties, or do not act in the best interests of the shareholders should be voted out. A clear message is sent when a no confidence vote is given to a set of directors or to a full Board. A. ELECTION OF DIRECTORS, a Board of Directors, or any number of Directors. In order to assure Boards are acting solely for the shareholders they represent, the following resolutions will provide a clear message to underperforming companies and Boards who have failed to fulfill duties assigned to them. . Votes should be cast in favor of shareholder proposals asking that boards be comprised of a majority of outside directors. . Votes should be case in favor of shareholder proposals asking that board audit, compensation and nominating committees be comprised exclusively of outside directors. . Votes should be cast against management proposals to re-elect the board if the board has a majority of inside directors. . Votes should be withheld for directors who nay have an inherent conflict of interest by virtue of receiving consulting fees from a corporation (affiliated outsiders). . Votes should be withheld, on a case by case basis, for those directors of the compensation committees responsible for particularly egregious compensation plans. . Votes should be withheld for directors who have failed to attend 75% of board or committee meetings in cases where management does not provide adequate explanation for absences. . Votes should be withheld for incumbent directors of poor performing companies; defining poor performing companies as those companies who have below average stock performance (vs. peer group/Wilshire 5000) and below average return on assets and operating margins. . Votes should be cast in favor of proposals to create shareholder advisory committees. These committees will represent shareholders' views, review management, and provide oversight of the board and their directors. B. SELECTION OF ACCOUNTANTS: EAI will generally support a rotation of accountants to provide a truly independent audit. This rotation should generally occur every 4-5 years. C. INCENTIVE STOCK PLANS. EAI will generally vote against all excessive compensation and incentive stock plans which are not performance related. D. CORPORATE RESTRUCTURING PLANS or company name changes, will generally be evaluated on a case by case basis. E. ANNUAL MEETING LOCATION. This topic normally is brought forward by minority shareholders, requesting management to hold the annual meeting somewhere other than where management desires. RESOLUTION: EAI normally votes with management, except in those cases where management seeks a location to avoid their shareholders. F. PREEMPTIVE RIGHTS. This is usually a shareholder request enabling shareholders to participate first in any new offering of company common stock. RESOLUTION: We do not feel that preemptive rights would add value to shareholders, we would vote against such shareholder proposals. G. MERGERS AND/OR ACQUISITIONS. Each Merger and/or acquisition has numerous ramifications for long term shareholder value. RESOLUTION: After in-depth valuation EAI will vote its shares on a case by case basis. II. CORPORATE GOVERNANCE ISSUES These issues include those areas where voting with management may not be in the best interest of the institutional investor. All proposals should be examined on a case by case basis. A. PROVISIONS RESTRICTING SHAREHOLDER RIGHTS. These provisions would hamper shareholders' ability to vote on certain corporate actions, such as changes in the bylaws, greenmail, poison pills, recapitalization plans, golden parachutes, and on any item that would limit shareholders' rights to nominate, elect, or remove directors. These items can change the course of the corporation overnight and shareholders should have the right to vote on these critical issues. RESOLUTION: Vote AGAINST ------------------------ management proposals to implement such restrictions and vote For shareholder ---------------------------------------------------------------------------- proposals to eliminate them. ---------------------------- B. ANTI-SHAREHOLDER MEASURES These are measures designed to entrench management so as to make it more difficult to effect a change in control of the corporation. They are normally not in the best interest of shareholders since they do not allow for the most productive use of corporate assets. 1. CLASSIFICATION OF THE BOARD OF DIRECTORS: A classified Board is one in which directors are not elected in the same year rather their terms of office are staggered. This eliminates the possibility of removing entrenched management at any one annual election of directors. RESOLUTION: Vote AGAINST proposals to classify the Board and ------------------------------------------------------------ support proposals (usually shareholder initiated) to implement annual --------------------------------------------------------------------- election of the Board. ---------------------- 2. SHAREHOLDER RIGHTS PLANS (POISON PILLS): Anti-acquisition proposals of this sort come in a variety of forms. In general, issuers confer contingent benefits of some kind on their common stockholders. The most frequently used benefit is the right to buy shares at discount prices in the event of defined changes in corporate control. RESOLUTION: Vote Against proposals to adopt Shareholder Rights Plans, and ------------------------------------------------------------------------- vote For Shareholder proposals eliminating such plans. ------------------------------------------------------ 3. UNEQUAL VOTING RIGHTS: A takeover defense, also known as superstock, which give holders disproportionate voting rights. EAI adheres to the One Share, One Vote philosophy, as all holders of common equity must be treated fairly and equally. RESOLUTION: Vote AGAINST proposals creating different classes of ---------------------------------------------------------------- stock with unequal voting privileges. ------------------------------------- 4. SUPERMAJORITY CLAUSES: These are implemented by management requiring that an overly large amount of shareholders (66-95% of shareholders rather than a simple majority) approve business combinations or mergers, or other measures affecting control. This is another way for management to make changes in control of the company more difficult. RESOLUTION: Vote AGAINST management proposals --------------------------------------------- to implement supermajority clauses and support shareholder proposals to ----------------------------------------------------------------------- eliminate them. --------------- 5. FAIR PRICE PROVISIONS: These provisions allow management to set price requirements that a potential bidder would need to satisfy in order to consummate a merger. The pricing formulas normally used are so high that the provision makes any tender offer prohibitively expensive. Therefore, their existence can foreclose the possibility of tender offers and hence, the opportunity to secure premium prices for holdings. RESOLUTION: Vote AGAINST management ----------------------------------- proposals to implement fair price provisions and vote FOR shareholder --------------------------------------------------------------------- proposals to eliminate them. CAVEAT: Certain fair price provisions are --------------------------- legally complex and require careful analysis and advice before concluding whether or not their adoption would serve stockholders' interest. 6. INCREASES IN AUTHORIZED SHARES AND/OR CREATION OF NEW CLASSES OF COMMON AND PREFERRED STOCK: a. INCREASING AUTHORIZED SHARES. EAI will support management if they have a stated purpose for increasing the authorized number of common and preferred stock. Under normal circumstances, this would indicate stock splits, stock dividends, stock option plans, and for additional financing needs. However, in certain circumstances, it is apparent that management is proposing these increases as an anti-takeover measure. When used in this manner, share increases could inhibit or discourage stock acquisitions by a potential buyer, thereby negatively affecting a fair price valuation for the company. Resolution: On a case by case basis, vote AGAINST management if they attempt to increase the amount of shares that they are authorized to issue if their intention is to use the excess shares to discourage a beneficial business combination. One way to determine if management intends to abuse its rights to issue shares is if the amount of authorized shares requested is double the present amount of authorized shares. b. CREATION OF NEW CLASSES OF STOCK. Managements have proposed authorizing shares of new classes of stock, usually preferreds, which the Board would be able to issue at their discretion. The Board would also be granted the discretion to determine the dividend rate, voting privileges, redemption provisions, conversion rights, etc. without approval of the shareholders. These "blank check" issues are designed specifically to inhibit a takeover, merger, or accountability to its shareholders. Resolution: EAI would vote AGAINST ---------------------------------- management in allowing the Board the discretion to issue any type of -------------------------------------------------------------------- "blank check" stock without shareholder approval. ------------------------------------------------- C. DIRECTORS AND MANAGEMENT LIABILITY AND INDEMNIFICATION These proposals are a result of the increasing cost of insuring directors and top management against lawsuits. Generally, managements propose that the liability of directors and management be either eliminated or limited. Shareholders must have some recourse for losses that are caused by negligence on the part of directors and management. Therefore directors and management should be responsible for their fiduciary duty of care towards the company. The Duty of Care is defined as the obligation of directors and management to be diligent in considering a transaction or in taking or refusing to take a corporate action. Resolution: On a case by case basis, ------------------------------------ EAI votes AGAINST attempts by management to eliminate director's and -------------------------------------------------------------------- management liability for their duty of care. -------------------------------------------- D. COMPENSATION PLANS (INCENTIVE PLANS) Management occasionally will propose to adopt an incentive plan which will become effective in the event of a takeover or merger. These plans are commonly known as "golden parachutes" or "tin parachutes" as they are specifically designed to grossly or unduly benefit a select few in management who would most likely lose their jobs in an acquisition. Shareholders should be allowed to vote on all plans of this type. Resolution: On a case by case basis, vote AGAINST attempts by management to --------------------------------------------------------------------------- adopt proposals that are specifically designed to grossly or unduly benefit --------------------------------------------------------------------------- members of executive management in the event of an acquisition. --------------------------------------------------------------- E. GREENMAIL EAI would not support management in the payment of greenmail. Resolution: ----------- EAI would vote FOR any shareholder resolution that would eliminate the ---------------------------------------------------------------------- possibility of the payment of greenmail. ---------------------------------------- F. CUMULATIVE VOTING Cumulative voting entitles stockholders to as many votes as equal the number of shares they own multiplied by the number of directors being elected. According to this set of rules, a shareholder can cast all votes towards a single director, or any two or more. This is a proposal usually made by a minority shareholder seeking to elect a director to the Board who sympathizes with a special interest. It also can be used by management that owns a large percentage of the company to ensure that their appointed directors are elected. Resolution: Cumulative voting tends to serve special ---------------------------------------------------- interests and not those of shareholders, therefore EAI will vote AGAINST any ---------------------------------------------------------------------------- proposals establishing cumulative voting and For any proposal to eliminate -------------------------------------------------------------------------- it. --- G. PROPOSALS DESIGNED TO DISCOURAGE MERGERS & ACQUISTIONS IN ADVANCE These provisions direct Board members to weigh socioeconomic and legal as well as financial factors when evaluation takeover bids. This catchall apparently means that the perceived interests of customers, suppliers, managers, etc. would have to be considered along with those of the shareholder. These proposals may be worded: "amendments to instruct the Board to consider certain factors when evaluation an acquisition proposal". Directors are elected to primarily to promote and protect shareholder interests. Directors should not allow other considerations to dilute or deviated from those interests. Resolution: EAI will vote AGAINST proposals ------------------------------------------- that would discourage the most productive use of corporate assets in -------------------------------------------------------------------- advance. -------- H. CONFIDENTIAL VOTING A company that does not have a secret ballot provision had the ability to see the proxy votes before the annual meeting. In this way, management is able to know before the final outcome how their proposals are being accepted. If a proposal is not going their way, management has the ability to call shareholders to attempt to convince them to change their votes. Elections should take place in normal democratic process which includes the secret ballot. Elections without the secret ballot can lead to coercion of shareholders, employees, and other corporate partners. Resolution: Vote FOR -------------------- proposals to establish secret ballot voting. -------------------------------------------- I. DISCLOSURE Resolution: EAI will vote AGAINST proposals that would require any kind of -------------------------------------------------------------- unnecessary disclosure of business records. EAI will vote For proposals that ---------------------------------------------------------------------------- require disclosure of records concerning unfair labor practices or records -------------------------------------------------------------------------- dealing with the public safety. ------------------------------- J. SWEETENERS Resolution: EAI will vote AGAINST proposals that include what are called ------------------------------------------------------------------------ "sweeteners" used to entice shareholders to vote for a proposal that -------------------------------------------------------------------- includes other items that may not be in the shareholders' best interest. For ---------------------------------------------------------------------------- instance, including a stock split in the same proposal as a classified ---------------------------------------------------------------------- Board, or declaring an extraordinary dividend in the same proposal ------------------------------------------------------------------ installing a shareholders' rights plan (Poison Pill). ----------------------------------------------------- K. CHANGING THE STATE OF INCORPORATION If management sets forth a proposal to change the State of Incorporation, the reason for the change is usually to take advantage of another state's liberal corporation laws, especially regarding mergers, takeovers, and anti-shareholder measures. Many companies view the redomestication in another jurisdiction as an opportune time to put new anti-shareholder measures on the books or to purge their charter and bylaws of inconvenient shareholder rights, written consent, cumulative voting, etc. Resolution: ON -------------- A CASE BY CASE BASIS, EAI will vote AGAINST proposals changing the State of --------------------------------------------------------------------------- Incorporation for the purposes of their anti-shareholder provisions and will ---------------------------------------------------------------------------- support shareholder proposals calling for reincorporation into a ---------------------------------------------------------------- jurisdiction more favorable to shareholder democracy. ----------------------------------------------------- L. EQUAL ACCESS TO PROXY STATEMENTS EAI supports stockholders' rights to equal access to the proxy statement, in the same manner that management has access. Stockholders are owners of a corporation and should not be bound by timing deadlines and other obstacles that presently shareholders must abide by in sponsoring proposals in a proxy statement. The Board should not have the ability to arbitrarily prevent a shareholder proposal from appearing in the proxy statement. Resolution: EAI --------------- will support any proposal calling for equal access to proxy statements. ----------------------------------------------------------------------- M. ABSTENTION VOTES EAI supports changes in the method of accounting for abstention votes. Abstention votes should not be considered as shares "represented" or "cast" at an annual meeting. Only those shares cast favoring or opposing a proposal -------------------- should be included in the total votes cast to determine if a majority vote has been achieved. Votes cast abstaining should not be included in total votes cast. Resolution: EAI will support any proposal to change a company's --------------------------------------------------------------- by-laws or articles of incorporation to reflect the proper account for ---------------------------------------------------------------------- abstention votes. ----------------- III. OTHER ISSUES On other major issues involving questions of community interest, moral and social concern, fiduciary trust and respect for the law such as: A. Human Rights B. Nuclear Issues C. Defense Issues D. Social Responsibility EAI, in general supports the position of management. Exceptions to this policy include: 1. SOUTH AFRICA EAI will actively encourage those corporations that have South African interests to adopt and adhere to the Statement of Principles for South Africa, formerly known as the Sullivan Principles, and to take further actions to promote responsible corporate activity. 2. NORTHERN IRELAND EAI will actively encourage U.S. companies in Northern Ireland to adopt and adhere to the MacBride Principles, and to take further actions to promote responsible corporate activity. GRANTHAM, MAYO, VAN OTTERLOO & CO. LLC GMO AUSTRALASIA LLC (TOGETHER "GMO") PROXY VOTING POLICIES AND PROCEDURES I.INTRODUCTION AND GENERAL PRINCIPLES GMO provides investment advisory services primarily to institutional, including both ERISA and non-ERISA clients, and commercial clients. GMO understands that proxy voting is an integral aspect of security ownership. Accordingly, in cases where GMO has been delegated authority to vote proxies, that function must be conducted with the same degree of prudence and loyalty accorded any fiduciary or other obligation of an investment manager. This policy permits clients of GMO to: (1) delegate to GMO the responsibility and authority to vote proxies on their behalf according to GMO's proxy voting polices and guidelines; (2) delegate to GMO the responsibility and authority to vote proxies on their behalf according to the particular client's own proxy voting policies and guidelines; or (3) elect to vote proxies themselves. In instances where clients elect to vote their own proxies, GMO shall not be responsible for voting proxies on behalf of such clients. GMO believes that the following policies and procedures are reasonably designed to ensure that proxy matters are conducted in the best interest of its clients, in accordance with GMO's fiduciary duties, applicable rules under the Investment Advisers Act of 1940 and fiduciary standards and responsibilities for ERISA clients set out in the Department of Labor interpretations. II.PROXY VOTING GUIDELINES GMO has engaged Institutional Shareholder Services, Inc. ("ISS") as its proxy voting agent to: 1) research and make voting recommendations or, for matters for which GMO has so delegated, to make the voting determinations; 2) ensure that proxies are voted and submitted in a timely manner; 3) handle other administrative functions of proxy voting; 4) maintain records of proxy statements received in connection with proxy votes and provide copies of such proxy statements promptly upon request; 5) maintain records of votes cast; and 6) provide recommendations with respect to proxy voting matters in general. Proxies will be voted in accordance with the voting recommendations contained in the applicable domestic or global ISS Proxy Voting Manual, as in effect from time to time. Copies of the current domestic and global ISS proxy voting guidelines are attached to these Voting Policies and Procedures as Exhibit A. GMO reserves the right to amend any of ISS's guidelines in the future. If any such changes are made an amended Proxy Voting Policies and Procedures will be made available for clients. Except in instances where a GMO client retains voting authority, GMO will instruct custodians of client accounts to forward all proxy statements and materials received in respect of client accounts to ISS. III.PROXY VOTING PROCEDURES GMO has a Corporate Actions Group with responsibility for administering the proxy voting process, including: 1) Implementing and updating the applicable domestic and global ISS proxy voting guidelines; 2) Overseeing the proxy voting process; and 3) Providing periodic reports to GMO's Compliance Department and clients as requested. There may be circumstances under which a portfolio manager or other GMO investment professional ("GMO Investment Professional") believes that it is in the best interest of a client or clients to vote proxies in a manner inconsistent with the recommendation of ISS. In such an event, the GMO Investment Professional will inform GMO's Corporate Actions Group of its decision to vote such proxy in a manner inconsistent with the recommendation of ISS. GMO's Corporate Actions Group will report to GMO's Compliance Department no less than quarterly any instance where a GMO Investment Professional has decided to vote a proxy on behalf of a client in that manner. IV.CONFLICTS OF INTEREST As ISS will vote proxies in accordance with the proxy voting guidelines described in Section II, GMO believes that this process is reasonably designed to address conflicts of interest that may arise between GMO and a client as to how proxies are voted. In instances where GMO has the responsibility and authority to vote proxies on behalf of its clients for shares of GMO Trust, a registered mutual fund for which GMO serves as the investment adviser, there may be instances where a conflict of interest exists. Accordingly, GMO will (i) vote such proxies in the best interests of its clients with respect to routine matters, including proxies relating to the election of Trustees; and (ii) with respect to matters where a conflict of interest exists between GMO and GMO Trust, such as proxies relating to a new or amended investment management contract between GMO Trust and GMO, or a re-organization of a series of GMO Trust, GMO will either (a) vote such proxies in the same proportion as the votes cast with respect to that proxy, or (b) seek instructions from its clients. In addition, if GMO is aware that one of the following conditions exists with respect to a proxy, GMO shall consider such event a potential material conflict of interest: 1) GMO has a business relationship or potential relationship with the issuer; 2) GMO has a business relationship with the proponent of the proxy proposal; or 3) GMO members, employees or consultants have a personal or other business relationship with the participants in the proxy contest, such as corporate directors or director candidates. In the event of a potential material conflict of interest, GMO will (i) vote such proxy according to the specific recommendation of ISS; (ii) abstain; or (iii) request that the client votes such proxy. All such instances shall be reported to GMO's Compliance Department at least quarterly. V.RECORDKEEPING GMO will maintain records relating to the implementation of these proxy voting policies and procedures, including: 1) a copy of these policies and procedures which shall be made available to clients, upon request; 2) a record of each vote cast (which ISS maintains on GMO's behalf); and 3) each written client request for proxy records and GMO's written response to any client request for such records. Such proxy voting records shall be maintained for a period of five years. VI.REPORTING GMO's Compliance Department will provide GMO's Conflict of Interest Committee with periodic reports that include a summary of instances where GMO has (i) voted proxies in a manner inconsistent with the recommendation of ISS, (ii) voted proxies in circumstances in which a material conflict of interest may exist as set forth in Section IV, and (iii) voted proxies of shares of GMO Trust on behalf of its clients. VII.DISCLOSURE Except as otherwise required by law, GMO has a general policy of not disclosing to any issuer or third party how GMO or its voting delegate voted a client's proxy. Effective: August 6, 2003 ISS PROXY VOTING GUIDELINES SUMMARY The following is a concise summary of ISS's proxy voting policy guidelines. 1.AUDITORS Vote FOR proposals to ratify auditors, unless any of the following apply: . . An auditor has a financial interest in or association with the company, and is therefore not independent . . Fees for non-audit services are excessive, or . . There is reason to believe that the independent auditor has rendered an opinion which is neither accurate nor indicative of the company's financial position. 2.BOARD OF DIRECTORS VOTING ON DIRECTOR NOMINEES IN UNCONTESTED ELECTIONS Votes on director nominees should be made on a CASE-BY-CASE basis, examining the following factors: independence of the board and key board committees attendance at board meetings corporate governance provisions and takeover activity, long-term company performance responsiveness to shareholder proposals, any egregious board actions, and any excessive non-audit fees or other potential auditor conflicts. CLASSIFICATION/DECLASSIFICATION OF THE BOARD Vote AGAINST proposals to classify the board. Vote FOR proposals to repeal classified boards and to elect all directors annually. INDEPENDENT CHAIRMAN (SEPARATE CHAIRMAN/CEO) Vote on a CASE-BY-CASE basis shareholder proposals requiring that the positions of chairman and CEO be held separately. Because some companies have governance structures in place that counterbalance a combined position, certain factors should be taken into account in determining whether the proposal warrants support. These factors include the presence of a lead director, board and committee independence, governance guidelines, company performance, and annual review by outside directors of CEO pay. MAJORITY OF INDEPENDENT DIRECTORS/ESTABLISHMENT OF COMMITTEES Vote FOR shareholder proposals asking that a majority or more of directors be independent unless the board composition already meets the proposed threshold by ISS's definition of independence. Vote FOR shareholder proposals asking that board audit, compensation, and/or nominating committees be composed exclusively of independent directors if they currently do not meet that standard. 3. SHAREHOLDER RIGHTS SHAREHOLDER ABILITY TO ACT BY WRITTEN CONSENT Vote AGAINST proposals to restrict or prohibit shareholder ability to take action by written consent. Vote FOR proposals to allow or make easier shareholder action by written consent . SHAREHOLDER ABILITY TO CALL SPECIAL MEETINGS Vote AGAINST proposals to restrict or prohibit shareholder ability to call special meetings. Vote FOR proposals that remove restrictions on the right of shareholders to act independently of management. SUPERMAJORITY VOTE REQUIREMENTS Vote AGAINST proposals to require a supermajority shareholder vote. Vote FOR proposals to lower supermajority vote requirements. CUMULATIVE VOTING Vote AGAINST proposals to eliminate cumulative voting. Vote proposals to restore or permit cumulative voting on a CASE-BY-CASE basis relative to the company's other governance provisions. CONFIDENTIAL VOTING Vote FOR shareholder proposals requesting that corporations adopt confidential voting, use independent vote tabulators and use independent inspectors of election, as long as the proposal includes a provision for proxy contests as follows: In the case of a contested election, management should be permitted to request that the dissident group honor its confidential voting policy. If the dissidents agree, the policy remains in place. If the dissidents will not agree, the confidential voting policy is waived. Vote FOR management proposals to adopt confidential voting. 4. PROXY CONTESTS VOTING FOR DIRECTOR NOMINEES IN CONTESTED ELECTIONS Votes in a contested election of directors must be evaluated on a CASE-BY-CASE basis, considering the factors that include the long-term financial performance, management's track record, qualifications of director nominees (both slates), and an evaluation of what each side is offering shareholders. REIMBURSING PROXY SOLICITATION EXPENSES Vote CASE-BY-CASE. Where ISS recommends in favor of the dissidents, we also recommend voting for reimbursing proxy solicitation expenses. 5. POISON PILLS Vote FOR shareholder proposals that ask a company to submit its poison pill for shareholder ratification. Review on a CASE-BY-CASE basis shareholder proposals to redeem a company's poison pill and management proposals to ratify a poison pill. 6. MERGERS AND CORPORATE RESTRUCTURINGS Vote CASE-BY-CASE on mergers and corporate restructurings based on such features as the fairness opinion, pricing, strategic rationale, and the negotiating process. 7. REINCORPORATION PROPOSALS Proposals to change a company's state of incorporation should be evaluated on a CASE-BY-CASE basis, giving consideration to both financial and corporate governance concerns, including the reasons for reincorporating, a comparison of the governance provisions, and a comparison of the jurisdictional laws. Vote FOR reincorporation when the economic factors outweigh any neutral or negative governance changes. 8. CAPITAL STRUCTURE COMMON STOCK AUTHORIZATION Votes on proposals to increase the number of shares of common stock authorized for issuance are determined on a CASE-BY-CASE basis using a model developed by ISS. Vote AGAINST proposals at companies with dual-class capital structures to increase the number of authorized shares of the class of stock that has superior voting rights. Vote FOR proposals to approve increases beyond the allowable increase when a company's shares are in danger of being delisted or if a company's ability to continue to operate as a going concern is uncertain. DUAL-CLASS STOCK Vote AGAINST proposals to create a new class of common stock with superior voting rights. Vote FOR proposals to create a new class of nonvoting or subvoting common stock if: . . It is intended for financing purposes with minimal or no dilution to current shareholders . . It is not designed to preserve the voting power of an insider or significant shareholder 9. EXECUTIVE AND DIRECTOR COMPENSATION Votes with respect to compensation plans should be determined on a CASE-BY-CASE basis. Our methodology for reviewing compensation plans primarily focuses on the transfer of shareholder wealth (the dollar cost of pay plans to shareholders instead of simply focusing on voting power dilution). Using the expanded compensation data disclosed under the SEC's rules, ISS will value every award type. ISS will include in its analyses an estimated dollar cost for the proposed plan and all continuing plans. This cost, dilution to shareholders' equity, will also be expressed as a percentage figure for the transfer of shareholder wealth, and will be considered long with dilution to voting power. Once ISS determines the estimated cost of the plan, we compare it to a company-specific dilution cap. Vote AGAINST equity plans that explicitly permit repricing or where the company has a history of repricing without shareholder approval. MANAGEMENT PROPOSALS SEEKING APPROVAL TO REPRICE OPTIONS Votes on management proposals seeking approval to reprice options are evaluated on a CASE-BY-CASE basis giving consideration to the following: . . Historic trading patterns . . Rationale for the repricing . . Value-for-value exchange . . Option vesting . . Term of the option . . Exercise price . . Participation EMPLOYEE STOCK PURCHASE PLANS Votes on employee stock purchase plans should be determined on a CASE-BY-CASE basis. Vote FOR employee stock purchase plans where all of the following apply: . . Purchase price is at least 85 percent of fair market value . . Offering period is 27 months or less, and . . Potential voting power dilution (VPD) is ten percent or less. Vote AGAINST employee stock purchase plans where any of the opposite conditions obtain. SHAREHOLDER PROPOSALS ON COMPENSATION Vote on a CASE-BY-CASE basis for all other shareholder proposals regarding executive and director pay, taking into account company performance, pay level versus peers, pay level versus industry, and long term corporate outlook. 10.SOCIAL AND ENVIRONMENTAL ISSUES These issues cover a wide range of topics, including consumer and public safety, environment and energy, general corporate issues, labor standards and human rights, military business, and workplace diversity. In general, vote CASE-BY-CASE. While a wide variety of factors goes into each analysis, the overall principal guiding all vote recommendations focuses on how the proposal will enhance the economic value of the company. CONCISE SUMMARY OF ISS GLOBAL PROXY VOTING GUIDELINES Following is a concise summary of general policies for voting global proxies. In addition, ISS has country- and market-specific policies, which are not captured below. FINANCIAL RESULTS/DIRECTOR AND AUDITOR REPORTS Vote FOR approval of financial statements and director and auditor reports, unless: . . there are concerns about the accounts presented or audit procedures used; or . . the company is not responsive to shareholder questions about specific items that should be publicly disclosed. . APPOINTMENT OF AUDITORS AND AUDITOR COMPENSATION Vote FOR the reelection of auditors and proposals authorizing the board to fix auditor fees, unless: . . there are serious concerns about the accounts presented or the audit procedures used; . . the auditors are being changed without explanation; or . . nonaudit-related fees are substantial or are routinely in excess of standard annual audit fees. Vote AGAINST the appointment of external auditors if they have previously served the company in an executive capacity or can otherwise be considered affiliated with the company. ABSTAIN if a company changes its auditor and fails to provide shareholders with an explanation for the change. APPOINTMENT OF INTERNAL STATUTORY AUDITORS Vote FOR the appointment or reelection of statutory auditors, unless: . . there are serious concerns about the statutory reports presented or the audit procedures used; . . questions exist concerning any of the statutory auditors being appointed; or . . the auditors have previously served the company in an executive capacity or can otherwise be considered affiliated with the company. ALLOCATION OF INCOME Vote FOR approval of the allocation of income, unless: . . the dividend payout ratio has been consistently below 30 percent without adequate explanation; or . . the payout is excessive given the company's financial position. STOCK (SCRIP) DIVIDEND ALTERNATIVE Vote FOR most stock (scrip) dividend proposals. Vote AGAINST proposals that do not allow for a cash option unless management demonstrates that the cash option is harmful to shareholder value. AMENDMENTS TO ARTICLES OF ASSOCIATION Vote amendments to the articles of association on a CASE-BY-CASE basis. CHANGE IN COMPANY FISCAL TERM Vote FOR resolutions to change a company's fiscal term unless a company's motivation for the change is to postpone its AGM. LOWER DISCLOSURE THRESHOLD FOR STOCK OWNERSHIP Vote AGAINST resolutions to lower the stock ownership disclosure threshold below five percent unless specific reasons exist to implement a lower threshold. AMEND QUORUM REQUIREMENTS Vote proposals to amend quorum requirements for shareholder meetings on a CASE-BY-CASE basis. TRANSACT OTHER BUSINESS Vote AGAINST other business when it appears as a voting item. DIRECTOR ELECTIONS Vote FOR management nominees in the election of directors, unless: . . there are clear concerns about the past performance of the company or the board; or . . the board fails to meet minimum corporate governance standards. Vote FOR individual nominees unless there are specific concerns about the individual, such as criminal wrongdoing or breach of fiduciary responsibilities. Vote AGAINST shareholder nominees unless they demonstrate a clear ability to contribute positively to board deliberations. Vote AGAINST individual directors if they cannot provide an explanation for repeated absences at board meetings (in countries where this information is disclosed). DIRECTOR COMPENSATION Vote FOR proposals to award cash fees to nonexecutive directors unless the amounts are excessive relative to other companies in the country or industry. Vote nonexecutive director compensation proposals that include both cash and share-based components on a CASE-BY-CASE basis. Vote proposals that bundle compensation for both nonexecutive and executive directors into a single resolution on a CASE-BY-CASE basis. Vote AGAINST proposals to introduce retirement benefits for nonexecutive directors. DISCHARGE OF BOARD AND MANAGEMENT Vote FOR discharge of the board and management, unless: . . there are serious questions about actions of the board or management for the year in question; or . . legal action is being taken against the board by other shareholders. DIRECTOR, OFFICER, AND AUDITOR INDEMNIFICATION AND LIABILITY PROVISIONS Vote proposals seeking indemnification and liability protection for directors and officers on a CASE-BY-CASE basis. Vote AGAINST proposals to indemnify auditors. BOARD STRUCTURE Vote FOR proposals to fix board size. Vote AGAINST the introduction of classified boards and mandatory retirement ages for directors. Vote AGAINST proposals to alter board structure or size in the context of a fight for control of the company or the board. SHARE ISSUANCE REQUESTS General Issuances: Vote FOR issuance requests with preemptive rights to a maximum of 100 percent over currently issued capital. Vote FOR issuance requests without preemptive rights to a maximum of 20 percent of currently issued capital. Specific Issuances: Vote on a CASE-BY-CASE basis on all requests, with or without preemptive rights. INCREASES IN AUTHORIZED CAPITAL Vote FOR nonspecific proposals to increase authorized capital up to 100 percent over the current authorization unless the increase would leave the company with less than 30 percent of its new authorization outstanding. Vote FOR specific proposals to increase authorized capital to any amount, unless: . . the specific purpose of the increase (such as a share-based acquisition or merger) does not meet ISS guidelines for the purpose being proposed; or . . the increase would leave the company with less than 30 percent of its new authorization outstanding after adjusting for all proposed issuances (and less than 25 percent for companies in Japan). Vote AGAINST proposals to adopt unlimited capital authorizations. REDUCTION OF CAPITAL Vote FOR proposals to reduce capital for routine accounting purposes unless the terms are unfavorable to shareholders. Vote proposals to reduce capital in connection with corporate restructuring on a CASE-BY-CASE basis. CAPITAL STRUCTURES Vote FOR resolutions that seek to maintain or convert to a one share, one vote capital structure. Vote AGAINST requests for the creation or continuation of dual class capital structures or the creation of new or additional supervoting shares. PREFERRED STOCK Vote FOR the creation of a new class of preferred stock or for issuances of preferred stock up to 50 percent of issued capital unless the terms of the preferred stock would adversely affect the rights of existing shareholders. Vote FOR the creation/issuance of convertible preferred stock as long as the maximum number of common shares that could be issued upon conversion meets ISS's guidelines on equity issuance requests. Vote AGAINST the creation of a new class of preference shares that would carry superior voting rights to the common shares. Vote AGAINST the creation of blank check preferred stock unless the board clearly states that the authorization will not be used to thwart a takeover bid. Vote proposals to increase blank check preferred authorizations on a CASE-BY-CASE basis. DEBT ISSUANCE REQUESTS Vote nonconvertible debt issuance requests on a CASE-BY-CASE basis, with or without preemptive rights. Vote FOR the creation/issuance of convertible debt instruments as long as the maximum number of common shares that could be issued upon conversion meets ISS's guidelines on equity issuance requests. Vote FOR proposals to restructure existing debt arrangements unless the terms of the restructuring would adversely affect the rights of shareholders. PLEDGING OF ASSETS FOR DEBT Vote proposals to approve the pledging of assets for debt on a CASE-BY-CASE basis. INCREASE IN BORROWING POWERS Vote proposals to approve increases in a company's borrowing powers on a CASE-BY-CASE basis. SHARE REPURCHASE PLANS: Vote FOR share repurchase plans, unless: . . clear evidence of past abuse of the authority is available; or . . the plan contains no safeguards against selective buybacks. REISSUANCE OF SHARES REPURCHASED: Vote FOR requests to reissue any repurchased shares unless there is clear evidence of abuse of this authority in the past. CAPITALIZATION OF RESERVES FOR BONUS ISSUES/INCREASE IN PAR VALUE: Vote FOR requests to capitalize reserves for bonus issues of shares or to increase par value. REORGANIZATIONS/RESTRUCTURINGS: Vote reorganizations and restructurings on a CASE-BY-CASE basis. MERGERS AND ACQUISITIONS: Vote FOR mergers and acquisitions, unless: . . the impact on earnings or voting rights for one class of shareholders is disproportionate to the relative contributions of the group; or . . the company's structure following the acquisition or merger does not reflect good corporate governance. Vote AGAINST if the companies do not provide sufficient information upon request to make an informed voting decision. ABSTAIN if there is insufficient information available to make an informed voting decision. MANDATORY TAKEOVER BID WAIVERS: Vote proposals to waive mandatory takeover bid requirements on a CASE-BY-CASE basis. REINCORPORATION PROPOSALS: Vote reincorporation proposals on a CASE-BY-CASE basis. EXPANSION OF BUSINESS ACTIVITIES: Vote FOR resolutions to expand business activities unless the new business takes the company into risky areas. RELATED-PARTY TRANSACTIONS: Vote related-party transactions on a CASE-BY-CASE basis. COMPENSATION PLANS: Vote compensation plans on a CASE-BY-CASE basis. ANTITAKEOVER MECHANISMS: Vote AGAINST all antitakeover proposals unless they are structured in such a way that they give shareholders the ultimate decision on any proposal or offer. SHAREHOLDER PROPOSALS: Vote all shareholder proposals on a CASE-BY-CASE basis. Vote FOR proposals that would improve the company's corporate governance or business profile at a reasonable cost. Vote AGAINST proposals that limit the company's business activities or capabilities or result in significant costs being incurred with little or no benefit. JPMORGAN ASSET MANAGEMENT GLOBAL PROXY VOTING PROCEDURES AND GUIDELINES SUMMARY 2005 EDITION APRIL 6, 2005 As an investment adviser, J.P. Morgan Investment Management Inc. ("J.P. Morgan") may be granted by its clients the authority to vote the proxies of the securities held in client portfolios. To ensure that the proxies are voted in the best interests of its clients, J.P. Morgan and its affiliated advisers have adopted detailed proxy voting procedures ("Procedures") that incorporate detailed proxy guidelines ("Guidelines") for voting proxies on specific types of issues. J.P. Morgan is part of a global asset management organization with the capability to invest in securities of issuers located around the globe. Because the regulatory framework and the business cultures and practices vary from region to region the Guidelines are customized for each region to take into account such variations. Separate Guidelines cover the regions of (1) North America, (2) Europe, (3) Asia (ex-Japan) and (4) Japan, respectively. As a general rule, in routine proxies of a particular security, the guidelines of the region in which the issuer of such security is organized will be applied. Pursuant to the Procedures, most routine proxy matters will be voted in accordance with the Guidelines, which have been developed with the objective of encouraging corporate action that enhances shareholder value. For proxy matters that are not covered by the Guidelines, matters that require a case-by-case determination or where a vote contrary to the Guidelines is considered appropriate, the Procedures require a certification and review process to be completed before the vote is cast. That process is designed to identify actual or potential material conflicts of interest and ensure that the proxy vote is cast in the best interests of clients. To oversee and monitor the proxy-voting process, J.P. Morgan has established a proxy committee and appointed a proxy administrator in each global location where proxies are voted. The primary function of each proxy committee is to review periodically general proxy-voting matters, review and approve the Guidelines annually, and provide advice and recommendations on general proxy-voting matters as well as on specific voting issues implemented by J.P. Morgan. The procedures permit an independent voting service; currently Institutional Shareholder Services, Inc. in the United States, to perform certain services otherwise carried out or coordinated by the proxy administrator. MELLON FINANCIAL CORPORATION PROXY VOTING POLICY (APPROVED 08/20/04) 1. SCOPE OF POLICY - This Proxy Voting Policy has been adopted by the investment advisory subsidiaries of Mellon Financial Corporation ("Mellon"), the investment companies advised by such subsidiaries (the "Funds"), and the banking subsidiaries of Mellon (Mellon's investment advisory and banking subsidiaries are hereinafter referred to individually as a "Subsidiary" and collectively as the "Subsidiaries"). 2. FIDUCIARY DUTY - We recognize that an investment adviser is a fiduciary that owes its clients a duty of utmost good faith and full and fair disclosure of all material facts. We further recognize that the right to vote proxies is an asset, just as the economic investment represented by the shares is an asset. An investment adviser's duty of loyalty precludes the adviser from subrogating its clients' interests to its own. Accordingly, in voting proxies, we will seek to act solely in the best financial and economic interests of our clients, including the Funds and their shareholders, and for the exclusive benefit of pension and other employee benefit plan participants. With regard to voting proxies of foreign companies, Adviser weighs the cost of voting, and potential inability to sell, the shares against the benefit of voting the shares to determine whether or not to vote. 3. LONG-TERM PERSPECTIVE - We recognize that management of a publicly-held company may need protection from the market's frequent focus on short-term considerations, so as to be able to concentrate on such long-term goals as productivity and development of competitive products and services. 4. LIMITED ROLE OF SHAREHOLDERS - We believe that a shareholder's role in the governance of a publicly-held company is generally limited to monitoring the performance of the company and its managers and voting on matters which properly come to a shareholder vote. We will carefully review proposals that would limit shareholder control or could affect shareholder values. 5. ANTI-TAKEOVER PROPOSALS - We generally will oppose proposals that seem designed to insulate management unnecessarily from the wishes of a majority of the shareholders and that would lead to a determination of a company's future by a minority of its shareholders. We will generally support proposals that seem to have as their primary purpose providing management with temporary or short-term insulation from outside influences so as to enable them to bargain effectively with potential suitors and otherwise achieve identified long-term goals to the extent such proposals are discrete and not bundled with other proposals. 6. "SOCIAL" ISSUES - On questions of social responsibility where economic performance does not appear to be an issue, we will attempt to ensure that management reasonably responds to the social issues. Responsiveness will be measured by management's efforts to address the particular social issue including, where appropriate, assessment of the implications of the proposal to the ongoing operations of the company. We will pay particular attention to repeat issues where management has failed in the intervening period to take actions previously committed to. With respect to clients having investment policies that require proxies to be cast in a certain manner on particular social responsibility issues, proposals relating to such issues will be evaluated and voted separately by the client's portfolio manager in accordance with such policies, rather than pursuant to the procedures set forth in section 7. 7. PROXY VOTING PROCESS - Every voting proposal is reviewed, categorized and analyzed in accordance with our written guidelines in effect from time to time. Our guidelines are reviewed periodically and updated as necessary to reflect new issues and any changes in our policies on specific issues. Items that can be categorized will be voted in accordance with any applicable guidelines or referred to the Mellon Proxy Policy Committee (the "Committee"), if the applicable guidelines so require. Proposals that cannot be categorized under the guidelines will be referred to the Committee for discussion and vote. Additionally, the Committee may review any proposal where it has identified a particular company, particular industry or particular issue for special scrutiny. The Committee will also consider specific interests and issues raised by a Subsidiary to the Committee, which interests and issues may require that a vote for an account managed by a Subsidiary be cast differently from the collective vote in order to act in the best interests of such account's beneficial owners. 8. MATERIAL CONFLICTS OF INTEREST - We recognize our duty to vote proxies in the best interests of our clients. We seek to avoid material conflicts of interest through the establishment of our Committee structure, which applies detailed, pre-determined proxy voting guidelines in an objective and consistent manner across client accounts, based on internal and external research and recommendations provided by a third party vendor, and without consideration of any client relationship factors. Further, we engage a third party as an independent fiduciary to vote all proxies for Mellon securities and Fund securities. 9. SECURITIES LENDING - We seek to balance the economic benefits of engaging in lending securities against the inability to vote on proxy proposals to determine whether to recall shares, unless a plan fiduciary retains the right to direct us to recall shares. 10. RECORDKEEPING - We will keep, or cause our agents to keep, the records for each voting proposal required by law. 11. DISCLOSURE - We will furnish a copy of this Proxy Voting Policy and any related procedures, or a description thereof, to investment advisory clients as required by law. In addition, we will furnish a copy of this Proxy Voting Policy, any related procedures, and our voting guidelines to investment advisory clients upon request. The Funds shall include this Proxy Voting Policy and any related procedures, or a description thereof, in their Statements of Additional Information, and shall disclose their proxy votes, as required by law. We recognize that the applicable trust or account document, the applicable client agreement, the Employee Retirement Income Security Act of 1974 (ERISA) and certain laws may require disclosure of other information relating to proxy voting in certain circumstances. This information will only be disclosed to those who have an interest in the account for which shares are voted, and after the vote is recorded. MORGAN STANLEY INVESTMENT MANAGEMENT PROXY VOTING POLICY AND PROCEDURES I. POLICY STATEMENT Introduction - Morgan Stanley Investment Management's ("MSIM") policy and ------------ procedures for voting proxies ("Policy") with respect to securities held in the accounts of clients applies to those MSIM entities that provide discretionary investment management services and for which a MSIM entity has authority to vote proxies. The Policy will be reviewed and, updated, as necessary, to address new or revised proxy voting issues. The MSIM entities covered by the Policy currently include the following: Morgan Stanley Investment Advisors Inc., Morgan Stanley AIP GP LP, Morgan Stanley Investment Management Inc., Morgan Stanley Investment Management Limited, Morgan Stanley Investment Management Company, Morgan Stanley Asset & Investment Trust Management Co., Limited, Morgan Stanley Investment Management Private Limited, Morgan Stanley Hedge Fund Partners GP LP, Morgan Stanley Hedge Fund Partners LP, Van Kampen Asset Management, and Van Kampen Advisors Inc. (each an "MSIM Affiliate" and collectively referred to as the "MSIM Affiliates"). Each MSIM Affiliate will use its best efforts to vote proxies as part of its authority to manage, acquire and dispose of account assets. With respect to the MSIM registered management investment companies (Van Kampen, Institutional and Advisor Funds)(collectively referred to herein as the "MSIM Funds"), each MSIM Affiliate will vote proxies pursuant to authority granted under its applicable investment advisory agreement or, in the absence of such authority, as authorized by the Board of Directors or Trustees of the MSIM Funds. A MSIM Affiliate will not vote proxies if the "named fiduciary" for an ERISA account has reserved the authority for itself, or in the case of an account not governed by ERISA, the investment management or investment advisory agreement does not authorize the MSIM Affiliate to vote proxies. MSIM Affiliates will, in a prudent and diligent manner, vote proxies in the best interests of clients, including beneficiaries of and participants in a client's benefit plan(s) for which the MSIM Affiliates manage assets, consistent with the objective of maximizing long-term investment returns ("Client Proxy Standard"). In certain situations, a client or its fiduciary may provide a MSIM Affiliate with a proxy voting policy. In these situations, the MSIM Affiliate will comply with the client's policy unless to do so would be inconsistent with applicable laws or regulations or the MSIM Affiliate's fiduciary responsibility. Proxy Research Services - Institutional Shareholder Services ("ISS") and Glass ----------------------- Lewis (together with other proxy research providers as MSIM Affiliates may retain from time to time, the "Research Providers") are independent advisers that specialize in providing a variety of fiduciary-level proxy-related services to institutional investment managers, plan sponsors, custodians, consultants, and other institutional investors. The services provided include in-depth research, global issuer analysis, and voting recommendations. While the MSIM Affiliates may review and utilize the recommendations of the Research Providers in making proxy voting decisions, they are in no way obligated to follow such recommendations. In addition to research, ISS provides vote execution, reporting, and recordkeeping. MSIM's Proxy Review Committee (see Section IV.A. below) will carefully monitor and supervise the services provided by the Research Providers. Voting Proxies for Certain Non-U.S. Companies - While the proxy voting process --------------------------------------------- is well established in the United States and other developed markets with a number of tools and services available to assist an investment manager, voting proxies of non-U.S. companies located in certain jurisdictions, particularly emerging markets, may involve a number of problems that may restrict or prevent a MSIM Affiliate's ability to vote such proxies. These problems include, but are not limited to: (i) proxy statements and ballots being written in a language other than English; (ii) untimely and/or inadequate notice of shareholder meetings; (iii) restrictions on the ability of holders outside the issuer's jurisdiction of organization to exercise votes; (iv) requirements to vote proxies in person, (v) the imposition of restrictions on the sale of the securities for a period of time in proximity to the shareholder meeting; and (vi) requirements to provide local agents with power of attorney to facilitate the MSIM Affiliate's voting instructions. As a result, clients' non-U.S. proxies will be voted on a best efforts basis only, after weighing the costs and benefits to MSIM's clients of voting such proxies, consistent with the Client Proxy Standard. ISS has been retained to provide assistance to the MSIM Affiliates in connection with voting their clients' non-U.S. proxies. II.GENERAL PROXY VOTING GUIDELINES ---------------------------------- To ensure consistency in voting proxies on behalf of its clients, MSIM Affiliates will follow (subject to any exception set forth herein) this Policy, including the guidelines set forth below. These guidelines address a broad range of issues, including board size and composition, executive compensation, anti-takeover proposals, capital structure proposals and social responsibility issues and are meant to be general voting parameters on issues that arise most frequently. The MSIM Affiliates, however, may, pursuant to the procedures set forth in Section IV. below, vote in a manner that is not in accordance with the following general guidelines, provided the vote is approved by the Proxy Review Committee and is consistent with the Client Proxy Standard. A MSIM Affiliate will not generally vote a proxy if it has sold the affected security between the record date and the meeting date. III.GUIDELINES -------------- A. CORPORATE GOVERNANCE MATTERS. The following proposals will generally be voted as indicated below, unless otherwise determined by the Proxy Review Committee. i. General. -------- 1.Generally, routine management proposals will be supported. The following are examples of routine management proposals: . . Approval of financial statements, director and auditor reports. . . General updating/corrective amendments to the charter. . . Proposals related to the conduct of the annual meeting, except those proposals that relate to the "transaction of such other business which may come before the meeting." 2. Proposals to eliminate cumulative voting generally will be supported; proposals to establish cumulative voting in the election of directors will not be supported. 3. Proposals requiring confidential voting and independent tabulation of voting results will be supported. 4. Proposals requiring a U.S. company to have a separate Chairman and CEO will not be supported. Proposals requiring non-U.S. companies to have a separate Chairman and CEO will be supported. 5. Proposals by management of non-U.S. companies regarding items that are clearly related to the regular course of business will be supported. 6. Proposals to require the company to expense stock options will be supported. 7. Open-ended requests for adjournment generally will not be supported. However, where management specifically states the reason for requesting an adjournment and the requested adjournment is necessary to permit a proposal that would otherwise be supported under this Policy to be carried out (i.e. an uncontested corporate transaction), the adjournment request will be supported. 8. Proposals to declassify the Board of Directors (if management supports a classified board) generally will not be supported. 9. Proposal requiring that the company prepare reports that are costly to provide or that would require duplicative efforts or expenditures that are of a non-business nature or would provide no pertinent information from the perspective of institutional shareholders generally will not be supported. ii. Election of Directors. In situations where no conflict exists and where ---------------------- no specific governance deficiency has been noted, unless otherwise determined by the Proxy Review Committee, proxies will be voted in support of nominees of management. 1.The following proposals generally will be supported: . . Proposals requiring that a certain percentage (up to 66 2/3%) of the company's board members be independent directors. . . Proposals requiring that members of the company's compensation, nominating and audit committees be comprised of independent or unaffiliated directors. 2. Unless otherwise determined by the Proxy Review Committee, a withhold vote will be made in the following circumstances: (a)If a company's board is not comprised of a majority of disinsterested directors, a withhold vote will be made for interested directors. A director nominee may be deemed to be interested if the nominee has, or any time during the previous five years had, a relationship with the issuer (e.g., investment banker, counsel or other professional service provider, or familial relationship with a senior officer of the issuer) that may impair his or her independence; (b) If a nominee who is interested is standing for election as a member of the company's compensation, nominating or audit committees; (c) A direct conflict exists between the interests of the nominee and the public shareholders; (d) Where the nominees standing for election have not taken action to implement generally accepted governance practices for which there is a "bright line" test. These would include elimination of dead hand or slow hand poison pills, requiring audit, compensation or nominating committees to be composed of independent directors and requiring a majority independent board; (e) A nominee has failed to attend at least 75% of board meetings within a given year without a reasonable excuse; or (f) A nominee serves on the board of directors for more than six companies (excluding investment companies). iii. Auditors -------- 1. Generally, management proposals for selection or ratification of auditors will be supported. However, such proposals may not be supported if the audit fees are excessive. Generally, to determine if audit fees are excessive, a 50% test will be applied for audit fees in excess of $1 million: if audit fees are $1 million or more, non-audit fees should less than 50% of the total fees paid to the auditor. If audit fees are less than $1 million, the fees will be reviewed case by case by the Proxy Review Committee. 2. Proposals requiring auditors to attend the annual meeting of shareholders will be supported. 3. Proposals to indemnify auditors will not be supported. iv. Anti-Takeover Matters --------------------- 1. Proposals to modify or rescind existing supermajority vote requirements to amend the charter or bylaws will be supported; proposals to amend by-laws to require a supermajority shareholder vote to pass or repeal certain provisions will not be supported. 2. Proposals relating to the adoption of anti-greenmail provisions will be supported, provided that the proposal: (i) defines greenmail; (ii) prohibits buyback offers to large block holders (holders of at least 1% of the outstanding shares and in certain cases, a greater amount, as determined by the Proxy Review Committee) not made to all shareholders or not approved by disinterested shareholders; and (iii) contains no anti-takeover measures or other provisions restricting the rights of shareholders. 3. Proposals requiring shareholder approval or ratification of a shareholder rights plan or poison pill will be supported. B. CAPITALIZATION CHANGES. The following proposals generally will be voted as indicated below, unless otherwise determined by the Proxy Review Committee. 1. The following proposals generally will be supported:. Proposals relating to capitalization changes that eliminate other classes of stock and/or eliminate unequal voting rights. . Proposals to increase the authorization of existing classes of common stock (or securities convertible into common stock) if: (i) a clear and legitimate business purpose is stated; (ii) the number of shares requested is reasonable in relation to the purpose for which authorization is requested; and (iii) the authorization does not exceed 100% of shares currently authorized and at least 30% of the new authorization will be outstanding. . Proposals to create a new class of preferred stock or for issuances of preferred stock up to 50% of issued capital. . Proposals for share repurchase plans. . Proposals to reduce the number of authorized shares of common or preferred stock, or to eliminate classes of preferred stock. . Proposals to effect stock splits. . Proposals to effect reverse stock splits if management proportionately reduces the authorized share amount set forth in the corporate charter. Reverse stock splits that do not adjust proportionately to the authorized share amount generally will be approved if the resulting increase in authorized shares coincides with the proxy guidelines set forth above for common stock increases. 2. The following proposals generally will not be supported (notwithstanding management support). . Proposals relating to capitalization changes that add classes of stock which substantially dilute the voting interests of existing shareholders. . Proposals to increase the authorized number of shares of existing classes of stock that carry preemptive rights or supervoting rights. . Proposals to create "blank check" preferred stock. . Proposals relating to changes in capitalization by 100% or more. C. COMPENSATION. The following proposals generally will be voted as indicated below, unless otherwise determined by the Proxy Review Committee. 1. The following proposals generally will be supported: . Proposals relating to director fees, provided the amounts are not excessive relative to other companies in the country or industry. . Proposals for employee stock purchase plans that permit discounts up to 15%, but only for grants that are part of a broad-based employee plan, including all non-executive employees. . Proposals for the establishment of employee stock option plans and other employee ownership plans, provided that our research does not indicate that approval of the plan would be against shareholder interest. . Proposals for the establishment of employee retirement and severance plans, provided that our research does not indicate that approval of the plan would be against shareholder interest. 2. Blanket proposals requiring shareholder approval of all severance agreements will not be supported, however, proposals that require shareholder approval for agreements in excess of three times the annual compensation (salary and bonus) generally will be supported. 3. Blanket proposals requiring shareholder approval of executive compensation generally will not be supported. 4. Proposals that request or require disclosure of executive compensation in addition to the disclosure required by the Securities and Exchange Commission ("SEC") regulations generally will not be supported. D. OTHER RECURRING ITEMS. The following proposals generally will be voted as indicated below, unless otherwise determined by the Proxy Review Committee. 1. Proposals to add restrictions related to social, political, environmental or special interest issues that do not relate directly to the business of the company and which do not appear to be directed specifically to the business or financial interest of the company generally will not be supported. 2. Proposals requiring adherence to workplace standards that are not required or customary in market(s) to which the proposals relate will not be supported. E. ITEMS TO BE REVIEWED BY THE PROXY REVIEW COMMITTEE The following types of non-routine proposals, which potentially may have a substantive financial or best interest impact on an issuer, will be voted as determined by the Proxy Review Committee. i. Corporate Transactions ---------------------- . Proposals relating to mergers, acquisitions and other special corporate transactions (i.e., takeovers, spin-offs, sales of assets, reorganizations, restructurings and recapitalizations) will be examined on a case-by-case basis. In all cases, Research Providers' research and analysis will be used along with MSIM Affiliates' research and analysis, including, among other things, MSIM internal company-specific knowledge. Proposals for mergers or other significant transactions that are friendly, approved by the Research Providers, and where there is no portfolio manager objection, generally will be supported. ii. Compensation ------------ . Proposals relating to change-in-control provisions in non-salary compensation plans, employment contracts, and severance agreements that benefit management and would be costly to shareholders if triggered. With respect to proposals related to severance and change of control situations, MSIM Affiliates will support a maximum of three times salary and bonus. . Proposals relating to Executive/Director stock option plans. Generally, stock option plans should be incentive based. The Proxy Review Committee will evaluate the the quantitative criteria used by a Research Provider when considering such Research Provider's recommendation. If the Proxy Review Committee determines that the criteria used by the Research Provider is reasonable, the proposal will be supported if it falls within a 5% band above the Research Provider's threshold. . Compensation proposals that allow for discounted stock options that have not been offered to employees in general. iii. Other ----- . Proposals for higher dividend payouts. . Proposals recommending set retirement ages or requiring specific levels of stock ownership by directors. . Proposals for election of directors, where a director nominee is related to MSIM (i.e. on an MSIM Fund's Board of Directors/Trustees or part of MSIM senior management) must be considered by the Proxy Review Committee. If the proposal relates to a director nominee who is on a Van Kampen Fund's Board of Directors/Trustees, to the extent that the shares of the relevant company are held by a Van Kampen Fund, the Van Kampen Board shall vote the proxies with respect to those shares, to the extent practicable. In the event that the Committee cannot contact the Van Kampen Board in advance of the shareholder meeting, the Committee will vote such shares pursuant to the Proxy Voting Policy. . Proposals requiring diversity of board membership relating to broad based social, religious or ethnic groups. . Proposals to limit directors' liability and/or broaden indemnification of directors. Generally, the Proxy Review Committee will support such proposals provided that the officers and directors are eligible for indemnification and liability protection if they have acted in good faith on company business and were found innocent of any civil or criminal charges for duties performed on behalf of the company. IV. ADMINISTRATION OF POLICY A. PROXY REVIEW COMMITTEE 1. The MSIM Proxy Review Committee ("Committee") is responsible for creating and implementing the Policy and, in this regard, has expressly adopted it. (a) The Committee, which is appointed by MSIM's Chief Investment Officer ("CIO"), consists of senior investment professionals who represent the different investment disciplines and geographic locations of the firm. The Committee is responsible for establishing MSIM's Policy and determining how MSIM will vote proxies on an ongoing basis. (b) The Committee will periodically review and have the authority to amend, as necessary, the Policy and establish and direct voting positions consistent with the Client Proxy Standard. (c) The Committee will meet at least monthly to (among other matters): (1) address any outstanding issues relating to the Policy and (2) review proposals at upcoming shareholder meetings of MSIM portfolio companies in accordance with this Policy including, as appropriate, the voting results of prior shareholder meetings of the same issuer where a similar proposal was presented to shareholders. The Committee, or its designee, will timely communicate to ISS MSIM's Policy (and any amendments to them and/or any additional guidelines or procedures it may adopt). (d) The Committee will meet on an ad hoc basis to (among other matters): (1) authorize "split voting" (i.e., allowing certain shares of the same issuer that are the subject of the same proxy solicitation and held by one or more MSIM portfolios to be voted differently than other shares) and/or "override voting" (i.e., voting all MSIM portfolio shares in a manner contrary to the Policy); (2) review and approve upcoming votes, as appropriate, for matters for which specific direction has been provided in this Policy; and (3) determine how to vote matters for which specific direction has not been provided in this Policy. Split votes generally will not be approved within a single Global Investor Group investment team. The Committee may take into account Research Providers' recommendations and research as well as any other relevant information they may request or receive, including portfolio manager and/or analyst research, as applicable. Generally, proxies related to securities held in accounts that are managed pursuant to quantitative, index or index-like strategies ("Index Strategies") will be voted in the same manner as those held in actively managed accounts. Because accounts managed using Index Strategies are passively managed accounts, research from portfolio managers and/or analysts related to securities held in these accounts may not be available. If the affected securities are held only in accounts that are managed pursuant to Index Strategies, and the proxy relates to a matter that is not described in this Policy, the Committee will consider all available information from the Research Providers, and to the extent that the holdings are significant, from the portfolio managers and/or analysts. (e) In addition to the procedures discussed above, if the Committee determines that an issue raises a potential material conflict of interest, or gives rise to the appearance of a potential material conflict of interest, the Committee will request a special committee to review, and recommend a course of action with respect to, the conflict(s) in question ("Special Committee"). The Special Committee shall be comprised of the Chairperson of the Proxy Review Committee, the Compliance Director for the area of the firm involved or his/her designee, a senior portfolio manager (if practicable, one who is a member of the Proxy Review Committee) designated by the Proxy Review Committee, and MSIM's Chief Investment Officer or his/her designee. The Special Committee may request the assistance of MSIM's General Counsel or his/her designee and will have sole discretion to cast a vote. In addition to the research provided by Research Providers, the Special Committee may request analysis from MSIM Affiliate investment professionals and outside sources to the extent it deems appropriate. (f) The Committee and the Special Committee, or their designee(s), will document in writing all of their decisions and actions, which documentation will be maintained by the Committee and the Special Committee, or their designee(s), for a period of at least 6 years. To the extent these decisions relate to a security held by a MSIM U.S. registered investment company, the Committee and Special Committee, or their designee(s), will report their decisions to each applicable Board of Trustees/Directors of those investment companies at each Board's next regularly scheduled Board meeting. The report will contain information concerning decisions made by the Committee and Special Committee during the most recently ended calendar quarter immediately preceding the Board meeting. (g) The Committee and Special Committee, or their designee(s), will timely communicate to applicable portfolio managers, the Compliance Departments and, as necessary, to ISS, decisions of the Committee and Special Committee so that, among other things, ISS will vote proxies consistent with their decisions. B. IDENTIFICATION OF MATERIAL CONFLICTS OF INTEREST 1. If there is a possibility that a vote may involve a material conflict of interest, the vote must be decided by the Special Committee in consultation with MSIM's General Counsel or his/her designee. 2. A material conflict of interest could exist in the following situations, among others: (a) The issuer soliciting the vote is a client of MSIM or an affiliate of MSIM and the vote is on a material matter affecting the issuer; (b) The proxy relates to Morgan Stanley common stock or any other security issued by Morgan Stanley or its affiliates; or (c) Morgan Stanley has a material pecuniary interest in the matter submitted for a vote (e.g., acting as a financial advisor to a party to a merger or acquisition for which Morgan Stanley will be paid a success fee if completed). C. PROXY VOTING REPORTS (a) MSIM will promptly provide a copy of this Policy to any client requesting them. MSIM will also, upon client request, promptly provide a report indicating how each proxy was voted with respect to securities held in that client's account. (b) MSIM's legal department is responsible for filing an annual Form N-PX on behalf of each registered management investment company for which such filing is required, indicating how all proxies were voted with respect to such investment company's holdings. NEUBERGER BERMAN, LLC NEUBERGER BERMAN MANAGEMENT INC. PROXY VOTING POLICIES AND PROCEDURES NON-SOCIALLY RESPONSIVE CLIENTS I. INTRODUCTION AND GENERAL PRINCIPLES A) Neuberger Berman, LLC and Neuberger Berman Management Inc. (collectively, "NB") have been delegated the authority and responsibility to vote the proxies of their respective investment advisory clients, including both ERISA and non-ERISA clients. B) NB understands that proxy voting is an integral aspect of investment management. Accordingly, proxy voting must be conducted with the same degree of prudence and loyalty accorded any fiduciary or other obligation of an investment manager. C) NB believes that the following policies and procedures are reasonably expected to ensure that proxy matters are conducted in the best interest of clients, in accordance with NB's fiduciary duties, applicable rules under the Investment Advisers Act of 1940 and fiduciary standards and responsibilities for ERISA clients set out in Department of Labor interpretations. D) In instances where NB does not have authority to vote client proxies, it is the responsibility of the client to instruct the relevant custody bank or banks to mail proxy material directly to such client. E) In all circumstances, NB will comply with specific client directions to vote proxies, whether or not such client directions specify voting proxies in a manner that is different from NB's policies and procedures. F) There may be circumstances under which NB may abstain from voting a client proxy for cost reasons (e.g., non-U.S. securities). NB understands that it must weigh the costs and benefits of voting proxy proposals relating to foreign securities and make an informed decision with respect to whether voting a given proxy proposal is prudent and solely in the interests of the client and, in the case of an ERISA client, the plan's participants and beneficiaries. NB's decision in such circumstances will take into account the effect that the proxy vote, either by itself or together with other votes, is expected to have on the value of the client's investment and whether this expected effect would outweigh the cost of voting. II. RESPONSIBILITY AND OVERSIGHT A) NB has designated a Proxy Committee with the responsibility for administering and overseeing the proxy voting process, including: 1) developing, authorizing, implementing and updating NB's policies and procedures; 2) overseeing the proxy voting process; and 3) engaging and overseeing any third-party vendors as voting delegate to review, monitor and/or vote proxies. B) Such Proxy Committee will meet as frequently and in such manner as necessary or appropriate to fulfill its responsibilities. C) The members of the Proxy Committee will be appointed from time to time and will include the Chief Investment Officer, a senior portfolio manager and senior members of the Legal and Compliance and Portfolio Administration Departments. D) In the event that one or more members of the Proxy Committee are not independent with respect to a particular matter, the Proxy Committee shall appoint an independent subcommittee of the Proxy Committee, which will have full authority to act upon such matter. III. PROXY VOTING GUIDELINES A) NB has determined that, except as set forth below, proxies will be voted in accordance with the voting recommendations contained in the applicable domestic or global ISS Proxy Voting Manual, as in effect from time to time. A summary of the current applicable ISS proxy voting guidelines is attached to these NB Voting Policies and Procedures as Exhibit A. B) Except as set forth below, in the event the foregoing proxy voting guidelines do not address how a proxy should be voted, the proxy will be voted in accordance with ISS recommendations. In the event that ISS refrains from making a recommendation, the Proxy Committee will follow the procedures set forth in Section V, Paragraph D. C) There may be circumstances under which the Chief Investment Officer, a portfolio manager or other NB investment professional ("NB Investment Professional") believes that it is in the best interest of a client or clients to vote proxies in a manner inconsistent with the foregoing proxy voting guidelines or in a manner inconsistent with ISS recommendations. In such event, the procedures set forth in Section V, Paragraph C will be followed. IV. PROXY VOTING PROCEDURES A) NB will vote client proxies in accordance with a client's specific request even if it is in a manner inconsistent with NB's policies and procedures. Such specific requests must be made in writing by the individual client or by an authorized officer, representative or named fiduciary of a client. B) At the recommendation of the Proxy Committee, NB has engaged ISS as its voting delegate to: 1) research and make voting determinations in accordance with the proxy voting guidelines described in Section III; 2) vote and submit proxies in a timely manner; 3) handle other administrative functions of proxy voting; 4) maintain records of proxy statements received in connection with proxy votes and provide copies of such proxy statements promptly upon request; 5) maintain records of votes cast; and 6) provide recommendations with respect to proxy voting matters in general. C) Except in instances where clients have retained voting authority, NB will instruct custodians of client accounts to forward all proxy statements and materials received in respect of client accounts to ISS. D) Notwithstanding the foregoing, NB retains final authority and fiduciary responsibility for proxy voting. V. CONFLICTS OF INTEREST A) NB has obtained a copy of ISS Policies, Procedures and Practices regarding potential conflicts of interest that could arise in ISS proxy voting services to NB as a result of business conducted by ISS. NB believes that potential conflicts of interest by ISS are minimized by these Policies, Procedures and Practices, a copy of which is attached hereto as Exhibit B. B) ISS will vote proxies in accordance with the proxy voting guidelines described in Section III or as ISS recommends. NB believes that this process is reasonably designed to address material conflicts of interest that may arise between NB and a client as to how proxies are voted. C) In the event that an NB Investment Professional believes that it is in the best interest of a client or clients to vote proxies in a manner inconsistent with the proxy voting guidelines described in Section III or in a manner inconsistent with ISS recommendations, such NB Investment Professional will contact a member of the Proxy Committee and complete and sign a questionnaire in the form adopted by the Proxy Committee from time to time. Such questionnaire will require specific information, including the reasons the NB Investment Professional believes a proxy vote in this manner is in the best interest of a client or clients and disclosure of specific ownership, business or personal relationship or other matters that may raise a potential material conflict of interest between NB and the client or clients with respect to the voting of the proxy in that manner. The Proxy Committee will review the questionnaire completed by the NB Investment Professional and consider such other matters as it deems appropriate to determine that there is no material conflict of interest between NB and the client or clients with respect to the voting of the proxy in that manner. The Proxy Committee shall document its consideration of such other matters in a form adopted by the Proxy Committee from time to time. In the event that the Proxy Committee determines that such vote will not present a material conflict between NB and the client or clients, the Proxy Committee will make a determination whether to vote such proxy as recommended by the NB Investment Professional. In the event of a determination to vote the proxy as recommended by the NB Investment Professional, an authorized member of the Proxy Committee will instruct ISS to vote in such manner with respect to such client or clients. In the event that the Proxy Committee determines that the voting of a proxy as recommended by the NB Investment Professional presents a material conflict of interest between NB and the client or clients with respect to the voting of the proxy, the Proxy Committee will: (i) take no further action, in which case ISS shall vote such proxy in accordance with the proxy voting guidelines described in Section III or as ISS recommends; (ii) disclose such conflict to the client or clients and obtain written direction from the client or clients as to how to vote the proxy; (iii) suggest that the client or clients engage another party to determine how to vote the proxy; or (iv) engage another independent third party to determine how to vote the proxy. D) In the event that the proxy voting guidelines described in Section III do not address how a proxy should be voted and ISS refrains from making a recommendation as to how such proxy should be voted, the Proxy Committee will make a determination as to how the proxy should be voted. After determining how it believes the proxy should be voted, the Proxy Committee will consider such matters as it deems appropriate to determine that there is no material conflict of interest between NB and the client or clients with respect to the voting of the proxy in that manner. The Proxy Committee shall document its consideration of such matters in a form adopted by the Proxy Committee from time to time. In the event that the Proxy Committee determines that such vote will not present a material conflict between NB and the client, an authorized member of the Proxy Committee will instruct ISS to vote in such manner with respect to such client or clients. In the event that the Proxy Committee determines that such vote presents a material conflict of interest between NB and the client or clients with respect to the voting of the proxy, the Proxy Committee will: (i) disclose such conflict to the client or clients and obtain written direction from the client or clients as to how to vote the proxy; (ii) suggest that the client or clients engage another party to determine how proxies should be voted; or (iii) engage another independent third party to determine how proxies should be voted. E) Material conflicts cannot be resolved by simply abstaining from voting. VI. RECORDKEEPING NB will maintain records relating to the implementation of these proxy voting policies and procedures, including: 1) a copy of these policies and procedures, which shall be made available to clients upon request; 2) proxy statements received regarding client securities (which will be satisfied by relying on EDGAR or ISS); 3) a record of each vote cast (which ISS maintains on NB's behalf); 4) a copy of each questionnaire completed by any NB Investment Professional under Section V above; 5) any other document created by NB that was material to making a decision how to vote proxies on behalf of a client or that memorializes the basis for that decision; and 6) each written client request for proxy voting records and NB's written response to any client request (written or oral) for such records. Such proxy voting books and records shall be maintained in an easily accessible place for a period of five years, the first two by the Proxy Committee member who represents the Portfolio Administration Department. VII. DISCLOSURE Except as otherwise required by law or with the consent of the client, NB has a general policy of not disclosing to any issuer or third party how NB or its voting delegate voted a client's proxy. EFFECTIVE JUNE 2003 POST ADVISORY GROUP, LLC PROXY AND CORPORATE ACTION VOTING POLICIES AND PROCEDURES POLICY Post Advisory Group, LLC ("Post") acts as discretionary investment adviser for various clients, including clients governed by the Employee Retirement Income Security Act of 1974 ("ERISA") and registered open-end investment companies ("mutual funds"). While Post primarily manages fixed income securities, it does often hold a limited amount of voting securities (or securities for which shareholder action is solicited) in a client account. Thus, unless a client (including a "named fiduciary" under ERISA) specifically reserves the right to vote its own proxies or to take shareholder action in other corporate actions, Post will vote all proxies or act on all other actions received in sufficient time prior to their deadlines as part of its full discretionary authority over the assets. Corporate actions may include, for example and without limitation, tender offers or exchanges, bankruptcy proceedings, and class actions. When voting proxies or acting on corporate actions for clients, Post's utmost concern is that all decisions be made solely in the best interest of the shareholder (for ERISA accounts, plan beneficiaries and participants, in accordance with the letter and spirit of ERISA). Post will act in a manner deemed prudent and diligent and which is intended to enhance the economic value of the assets of the account. PURPOSE The purpose of these Proxy Voting and Corporate Action Policies and Procedures is to memorialize the procedures and policies adopted by Post to enable it to comply with its accepted responsibilities and the requirements of Rule 206(4)-6 under the Investment Advisers Act of 1940, as amended ("Advisers Act"). PROCEDURES Post's Operations Department is ultimately responsible for ensuring that all proxies received by Post are voted in a timely manner and voted consistently across all portfolios. Although many proxy proposals can be voted in accordance with our established guidelines, we recognize that some proposals require special consideration, which may dictate that we make an exception to our broad guidelines. Where a proxy proposal raises a material conflict of interest between Post's interests and the client's, Post will disclose the conflict to the relevant clients and obtain their consent to the proposed vote prior to voting the securities. When a client does not respond to such a conflict disclosure request or denies the request, Post will abstain from voting the securities held by that client's account. The Operations Department is also responsible for ensuring that all corporate actions received by Post are addressed in a timely manner and consistent action is taken across all portfolios. RECORD KEEPING In accordance with Rule 204-2 under the Advisers Act, Post will maintain for the time periods set forth in the Rule (i) these proxy voting procedures and policies, and all amendments thereto; (ii) all proxy statements received regarding client securities (provided, however, that Post may rely on the proxy statement filed on EDGAR as its records); (iii) a record of all votes cast on behalf of clients; (iv) records of all client requests for proxy voting information; (v) any documents prepared by the adviser that were material to making a decision how to vote or that memorialized the basis for the decision; and (vi) all records relating to requests made to clients regarding conflicts of interest in voting the proxy. Post will describe in its Part II of Form ADV (or other brochure fulfilling the requirement of Rule 204-3) its proxy voting policies and procedures and the manner in which clients may obtain information on how Post voted their securities. Clients may obtain information on how their securities were voted or a copy of our Policies and Procedures by written request addressed to Post. Post will coordinate with the relevant mutual fund service providers to assist in the provision of all information required to be filed by such mutual funds on Form N-PX. GUIDELINES Each proxy issue will be considered individually. The following guidelines are a partial list to be used in evaluating voting proposals contained in the proxy statements, but will not be used as rigid rules. VOTE AGAINST a) Issues regarding Board entrenchment and anti-takeover measures such as the following: (i) Proposals to stagger board members' terms; (ii) Proposals to limit the ability of shareholders to call special meetings; (iii) Proposals to require super majority votes; (iv) Proposals requesting excessive increases in authorized common or preferred shares where management provides no explanation for the use or need of these additional shares; (v) Proposals regarding "fair price" provisions; (vi) Proposals regarding "poison pill" provisions; and (vii) Permitting "green mail." b) Providing cumulative voting rights. VOTE FOR a) Election of directors recommended by management, except if there is a proxy fight. b) Election of auditors recommended by management, unless seeking to replace if there exists a dispute over policies. c) Date and place of annual meeting. d) Rotation of annual meeting place. e) Limitation on charitable contributions or fees paid to lawyers. f) Ratification of directors' actions on routine matters since previous annual meeting. g) Confidential voting. h) Limiting directors' liability. CASE-BY-CASE Proposals to: (1 Pay directors solely in stock. (2) Eliminate director mandatory retirement policy. (3) Mandatory retirement age for directors. (4) Rotate annual meeting location/date. (5) Option and stock grants to management and directors. (6) Allowing indemnification of directors and/or officers after reviewing the applicable state laws and extent of protection requested. PRINCIPAL GLOBAL INVESTORS, LLC ("PGI")* POLICY ON PROXY VOTING FOR INVESTMENT ADVISORY CLIENTS PGI has adopted the policies and procedures set out below regarding the voting of proxies on securities held in client accounts (the "Policy"). These policies and procedures are designed to ensure that where PGI has the authority to vote proxies, PGI complies with its legal, fiduciary, and contractual obligations. GUIDING PRINCIPLES Proxy voting and the analysis of corporate governance issues in general are important elements of the portfolio management services we provide to our advisory clients who have authorized us to address these matters on their behalf. Our guiding principles in performing proxy voting are to make decisions that (i) favor proposals that tend to maximize a company's shareholder value and (ii) are not influenced by conflicts of interest. These principles reflect PGI's belief that sound corporate governance will create a framework within which a company can be managed in the interests of its shareholders. PUBLIC EQUITY INVESTMENTS To implement these guiding principles for investments in publicly-traded equities, we follow the Institutional Shareholder Services ("ISS") Standard Proxy Voting Guidelines (the "Guidelines"), except in circumstances as described below. The Guidelines embody the positions and factors PGI generally considers important in casting proxy votes. They address a wide variety of individual topics, including, among other matters, shareholder voting rights, anti-takeover defenses, board structures, the election of directors, executive and director compensation,reorganizations, mergers, and various shareholder proposals. Recognizing the complexity and fact-specific nature of many corporate governance issues, the Guidelines often do not direct a particular voting outcome, but instead identify factors ISS considers in determining how the vote should be cast. In connection with each proxy vote, ISS prepares a written analysis and recommendation (an "ISS Recommendation") that reflects ISS's application of Guidelines to the particular proxy issues. Where the Guidelines do not direct a particular response and instead list relevant factors, the ISS Recommendation will reflect ISS's own evaluation of the factors. As explained more fully below, however, each PGI equity portfolio management team ("Portfolio Management Team") may on any particular proxy vote decide to diverge from the Guidelines or an ISS Recommendation. In such cases, our procedures require: (i) the requesting Portfolio Management Team to set forth the reasons for their decision; (ii) the approval of the lead Portfolio Manager for the requesting Portfolio Management Team; (iii) notification to the Compliance Department and other appropriate PGI personnel; (iv) a determination that the decision is not influenced by any conflict of interest; and (v) the creation of a written record reflecting the process. The principles and positions reflected in this Policy are designed to guide us in voting proxies, and not necessarily in making investment decisions. Portfolio Management Teams base their determinations of whether to invest in a particular company on a variety of factors, and while corporate governance may be one such factor, it may not be the Senior management of PGI periodically reviews this Policy, including our use of the Guidelines, to ensure it continues to be consistent with our guiding principles. Implementation by Portfolio Management Teams GENERAL OVERVIEW Our Portfolio Management Teams have decided to generally follow the Guidelines and ISS Recommendations, based on such Portfolio Management Teams' investment philosophy and approach to portfolio construction, as well as the evaluation of ISS's services and methodology in analyzing shareholder and corporate governance matters. Nevertheless, our Portfolio Management Teams retain the authority to revisit this position, with respect to both their general approach to proxy voting (subject to the approval of PGI senior management) and any specific shareholder vote (subject to the approval process described in this policy). Use of Third-Party Service Providers We utilize independent service providers, such as ISS, to assist us in developing substantive proxy voting positions. ISS also updates and revises the Guidelines on a periodic basis, and any such revisions are reviewed by PGI to determine whether they are consistent with our guiding principles. In addition, ISS assists us in the proxy voting process by providing operational, recordkeeping and reporting services. PGI's decision to retain ISS to perform the services described in this Policy is based principally on the view the services ISS provides will result in proxy voting decisions that are consistent with our guiding principles. PGI management is responsible for reviewing our relationship with ISS and for evaluating the quality and effectiveness of the various services provided by ISS to assist us in satisfying our proxy voting responsibilities. PGI may hire other service providers to replace or supplement ISS with respect to any of the services PGI currently receives from ISS. In addition, individual Portfolio Management Teams may supplement the information and analyses ISS provides from other sources. Conflicts of Interest Pursuant to this Policy, PGI has implemented procedures designed to prevent conflicts of interest from influencing its proxy voting decisions. These procedures include our use of the Guidelines and ISS Recommendations. Proxy votes cast by PGI in accordance with the Guidelines and ISS Recommendations will not be viewed as being the product of any conflicts of interest because PGI casts such votes in accordance with a pre-determined policy based upon the recommendations of an independent third party. Our procedures also prohibit the influence of conflicts of interest where a Portfolio Management Team decides to vote against an ISS Recommendation. In any particular case, the approval process for a decision to vote against an ISS Recommendation, as described above, may include consultation with the client whose account may be affected by the conflict as well as an inquiry by PGI management into potential conflicts of interest., PGI senior management will not approve decisions that are based on the influence of such conflicts. FIXED INCOME AND PRIVATE INVESTMENTS Voting decisions with respect to client investments in fixed income securities and the securities of privately-held issuers generally will be made by the relevant portfolio managers based on their assessment of the particular transactions or other matters at issue. EXTERNAL MANAGERS Where PGI places client assets with managers outside of PGI, whether through separate accounts, funds-of-funds or other structures, such external managers generally will be responsible for voting proxies in accordance with the managers' own policies. PGI may, however, retain such responsibilities where it deems appropriate. CLIENT DIRECTION Clients may choose to vote proxies themselves, in which case they must arrange for their custodians to send proxy materials directly to them. PGI can also accommodate individual clients that have developed their own guidelines with ISS or another proxy service. Clients may also discuss with PGI the possibility of receiving individualized reports or other individualized services regarding proxy voting conducted on their behalf. APPENDIX XV-A PROXY VOTING POLICIES AND PROCEDURES FOR PRINCIPAL INVESTORS FUND PRINCIPAL VARIABLE CONTRACTS FUND PRINCIPAL RETAIL FUNDS (DECEMBER 15, 2003) It is each fund's policy to delegate authority to its advisor or sub-advisor, as appropriate, to vote proxy ballots relating to the fund's portfolio securities in accordance with the advisor's or sub-advisor's voting policies and procedures. The advisor or sub-advisor must provide, on a quarterly basis: 1) Written affirmation that all proxies voted during the preceding calendar quarter, other than those specifically identified by the advisor or sub-advisor, were voted in a manner consistent with the advisor's or sub-advisor's voting policies and procedures. In order to monitor the potential effect of conflicts of interest of an advisor or sub-advisor, the advisor or sub-advisor will identify any proxies the advisor or sub-advisor voted in a manner inconsistent with its policies and procedures. The advisor or sub-advisor shall list each such vote, explain why the advisor or sub-advisor voted in a manner contrary to its policies and procedures, state whether the advisor or sub-advisor's vote was consistent with the recommendation to the advisor or sub-advisor of a third party and, if so, identify the third party; and 2) Written notification of any changes to the advisor's or sub-advisor's proxy voting policies and procedures made during the preceding calendar quarter. The advisor or sub-advisor must provide, no later than July 31 of each year, the following information regarding each proxy vote cast during the 12-month period ended June 30 for each fund portfolio or portion of fund portfolio for which it serves as investment advisor, in a format acceptable to fund management: 1) Identification of the issuer of the security; 2) Exchange ticker symbol of the security; 3) CUSIP number of the security; 4) The date of the shareholder meeting; 5) A brief description of the subject of the vote; 6) Whether the proposal was put forward by the issuer or a shareholder; 7) Whether and how the vote was cast; 8) Whether the vote was cast for or against management of the issuer. PRINCIPAL REAL ESTATE INVESTORS, LLC POLICY ON PROXY VOTING FOR INVESTMENT ADVISORY CLIENTS PREI has adopted the policies and procedures set out below regarding the voting of proxies on securities held in client accounts (the "Policy"). These policies and procedures are designed to ensure that where PREI has the authority to vote proxies, PREI complies with its legal, fiduciary, and contractual obligations. GUIDING PRINCIPLES Proxy voting and the analysis of corporate governance issues in general are important elements of the portfolio management services we provide to our advisory clients who have authorized us to address these matters on their behalf. Our guiding principles in performing proxy voting are to make decisions that (i) favor proposals that tend to maximize a company's shareholder value and (ii) are not influenced by conflicts of interest. These principles reflect PREI's belief that sound corporate governance will create a framework within which a company can be managed in the interests of its shareholders. PUBLIC EQUITY INVESTMENTS To implement these guiding principles for investments in publicly-traded equities, we follow the Institutional Shareholder Services ("ISS") Standard Proxy Voting Guidelines (the "Guidelines"), except in circumstances as described below. The Guidelines embody the positions and factors PREI generally considers important in casting proxy votes. They address a wide variety of individual topics, including, among other matters, shareholder voting rights, anti-takeover defenses, board structures, the election of directors, executive and director compensation, reorganizations, mergers, and various shareholder proposals. Recognizing the complexity and fact-specific nature of many corporate governance issues, the Guidelines often do not direct a particular voting outcome, but instead identify factors ISS considers in determining how the vote should be cast. In connection with each proxy vote, ISS prepares a written analysis and recommendation (an "ISS Recommendation") that reflects ISS's application of Guidelines to the particular proxy issues. Where the Guidelines do not direct a particular response and instead list relevant factors, the ISS Recommendation will reflect ISS's own evaluation of the factors. As explained more fully below, however, each PREI equity portfolio management team ("Portfolio Management Team") may on any particular proxy vote decide to diverge from the Guidelines or an ISS Recommendation. In such cases, our procedures require: (i) the requesting Portfolio Management Team to set forth the reasons for their decision; (ii) the approval of the lead Portfolio Manager for the requesting Portfolio Management Team; (iii) notification to the Compliance Department and other appropriate PREI personnel; (iv) a determination that the decision is not influenced by any conflict of interest; and (v) the creation of a written record reflecting the process. The principles and positions reflected in this Policy are designed to guide us in voting proxies, and not necessarily in making investment decisions. Portfolio Management Teams base their determinations of whether to invest in a particular company on a variety of factors, and while corporate governance may be one such factor, it may not be the primary consideration. Senior management of PREI periodically reviews this Policy, including our use of the Guidelines, to ensure it continues to be consistent with our guiding principles. Implementation by Portfolio Management Teams General Overview Our Portfolio Management Teams have decided to generally follow the Guidelines and ISS Recommendations, based on such Portfolio Management Teams' investment philosophy and approach to portfolio construction, as well as the evaluation of ISS's services and methodology in analyzing shareholder and corporate governance matters. Nevertheless, our Portfolio Management Teams retain the authority to revisit this position, with respect to both their general approach to proxy voting (subject to the approval of PREI senior management) and any specific shareholder vote (subject to the approval process described in this policy). Use of Third-Party Service Providers We utilize independent service providers, such as ISS, to assist us in developing substantive proxy voting positions. ISS also updates and revises the Guidelines on a periodic basis, and any such revisions are reviewed by PREI to determine whether they are consistent with our guiding principles. In addition, ISS assists us in the proxy voting process by providing operational, recordkeeping and reporting services. PREI's decision to retain ISS to perform the services described in this Policy is based principally on the view the services ISS provides will result in proxy voting decisions that are consistent with our guiding principles. PREI management is responsible for reviewing our relationship with ISS and for evaluating the quality and effectiveness of the various services provided by ISS to assist us in satisfying our proxy voting responsibilities. PREI may hire other service providers to replace or supplement ISS with respect to any of the services PREI currently receives from ISS. In addition, individual Portfolio Management Teams may supplement the information and analyses ISS provides from other sources. Conflicts of Interest Pursuant to this Policy, PREI has implemented procedures designed to prevent conflicts of interest from influencing its proxy voting decisions. These procedures include our use of the Guidelines and ISS Recommendations. Proxy votes cast by PREI in accordance with the Guidelines and ISS Recommendations will not be viewed as being the product of any conflicts of interest because PREI casts such votes in accordance with a pre-determined policy based upon the recommendations of an independent third party. Our procedures also prohibit the influence of conflicts of interest where a Portfolio Management Team decides to vote against an ISS Recommendation. In any particular case, the approval process for a decision to vote against an ISS Recommendation, as described above, may include consultation with the client whose account may be affected by the conflict as well as an inquiry by PREI management into potential conflicts of interest., PREI senior management will not approve decisions that are based on the influence of such conflicts. FIXED INCOME AND PRIVATE INVESTMENTS Voting decisions with respect to client investments in fixed income securities and the securities of privately-held issuers generally will be made by the relevant portfolio managers based on their assessment of the particular transactions or other matters at issue. EXTERNAL MANAGERS Where PREI places client assets with managers outside of PREI, whether through separate accounts, funds-of-funds or other structures, such external managers generally will be responsible for voting proxies in accordance with the managers' own policies. PREI may, however, retain such responsibilities where it deems appropriate. CLIENT DIRECTION Clients may choose to vote proxies themselves, in which case they must arrange for their custodians to send proxy materials directly to them. PREI can also accommodate individual clients that have developed their own guidelines with ISS or another proxy service. Clients may also discuss with PREI the possibility of receiving individualized reports or other individualized services regarding proxy voting conducted on their behalf. SPECTRUM ASSET MANAGEMENT, INC. POLICY ON PROXY VOTING FOR INVESTMENT ADVISORY CLIENTS GENERAL POLICY Spectrum, an investment adviser registered with the Securities and Exchange Commission, acts as investment advisor for various types of client accounts (e.g. employee benefit plans, governmental plans, mutual funds, insurance company separate accounts, corporate pension plans, endowments and foundations). While Spectrum receives few proxies for the preferred shares it manages, Spectrum nonetheless will, when delegated the authority by a client, vote these shares per the following policy voting standards and processes: STANDARDS: Spectrum's standards aim to ensure the following in keeping with the best interests of its clients: . . That Spectrum act solely in the interest of clients in providing for ultimate long-term stockholder value. . . That Spectrum act without undue influence from individuals or groups who may have an economic interest in the outcome of a proxy vote. . . That custodian bank is aware of our fiduciary duty to vote proxies on behalf of others - Spectrum relies on the best efforts of its custodian bank to deliver all proxies we are entitled to vote. . . That Spectrum will exercise its right to vote all proxies on behalf of its clients (or permit clients to vote their interest, as the case(s) may be). . . That Spectrum will implement a reasonable and sound basis to vote proxies. PROCESSES: A. Following ISS' Recommendations Spectrum has selected Institutional Shareholder Services (ISS) to assist it with its proxy voting responsibilities. Spectrum follows ISS Standard Proxy Voting guidelines (the "Guidelines"). The Guidelines embody the positions and factors Spectrum generally considers important in casting proxy votes. They address a wide variety of individual topics, including, among other matters, shareholder voting rights, anti-takeover defenses, board structures, the election of directors, executive and director compensation, reorganizations, mergers, and various shareholder proposals. Recognizing the complexity and fact-specific nature of many corporate governance issues, the Guidelines often do not direct a particular voting outcome, but instead identify factors ISS considers in determining how the vote should be cast. In connection with each proxy vote, ISS prepares a written analysis and recommendation (an "ISS Recommendation") that reflects ISS's application of Guidelines to the particular proxy issues. Where the Guidelines do not direct a particular response and instead list relevant factors, the ISS Recommendation will reflect ISS's own evaluation of the factors. Spectrum may on any particular proxy vote decide to diverge from the Guidelines or an ISS Recommendation. In such cases, our procedures require: (i) the requesting Portfolio Manager to set forth the reasons for their decision; (ii) the approval of the Chief Investment Officer; (iii) notification to the Compliance Department and other appropriate Principal Global Investors personnel; (iv) a determination that the decision is not influenced by any conflict of interest; and (v) the creation of a written record reflecting the process. Spectrum generally votes proxies in accordance with ISS' recommendations. When Spectrum follows ISS' recommendations, it need not follow the conflict of interest procedures in Section B, below. From time to time ISS may have a business relationship or affiliation with one or more issuers held in Spectrum client accounts, while also providing voting recommendations on these issuers' securities. Because this practice may present a conflict of interest for ISS, Spectrum's Chief Compliance Officer will require from ISS at least annually additional information, or a certification that ISS has adopted policies and procedures to detect and mitigate such conflicts of interest in issuing voting recommendations. Spectrum may obtain voting recommendations from two proxy voting services as an additional check on the independence of the ISS' voting recommendations. B. Disregarding ISS' Recommendations Should Spectrum determine not to follow ISS' recommendation for a particular proxy, Spectrum will use the following procedures for identifying and resolving a material conflict of interest, and will use the Proxy Voting Guidelines (below) in determining how to vote. Spectrum will classify proxy vote issues into three broad categories: Routine Administrative Items, Special Interest Issues, and Issues Having the Potential for Significant Economic Impact. Once the Senior Portfolio Manager has analyzed and identified each issue as belonging in a particular category, and disclosed the conflict of interests to affected clients and obtained their consents prior to voting, Spectrum will cast the client's vote(s) in accordance with the philosophy and decision guidelines developed for that category. New and unfamiliar issues are constantly appearing in the proxy voting process. As new issues arise, we will make every effort to classify them among the following three categories. If we believe it would be informative to do so, we may revise this document to reflect how we evaluate such issues. Due to timing delays, logistical hurdles and high costs associated with procuring and voting international proxies, Spectrum has elected to approach international proxy voting on the basis of achieving "best efforts at a reasonable cost." As a fiduciary, Spectrum owes its clients an undivided duty of loyalty. We strive to avoid even the appearance of a conflict that may compromise the trust our clients have placed in it. Identifying a Conflict of Interest. There may be a material conflict of ----------------------------------- interest when Spectrum votes a proxy solicited by an issuer whose retirement plan or fund we manage or with whom Spectrum, an affiliate, or an officer or director of Spectrum or of an affiliate has any other material business or personal relationship that may affect how we vote the issuer's proxy. To avoid any perceived material conflict of interest, the following procedures have been established for use when Spectrum encounters a potential material conflict to ensure that voting decisions are based on a clients' best interest and are not the product of a material conflict. Monitoring for Conflicts of Interest. All employees of Spectrum are responsible ------------------------------------- for monitoring for conflicts of interest and referring any that may be material to the CCO for resolution. At least annually, the CCO, will take reasonable steps to evaluate the nature of Spectrum's material business relationships (and those of its affiliates) with any company whose preferred securities are held in client accounts (a "portfolio company") to assess which, if any, could give rise to a conflict of interest. CCO's review will focus on the following three categories: . . Business Relationships - The CCO will consider whether Spectrum (or an affiliate) has a substantial business relationship with a portfolio company or a proponent of a proxy proposal relating to the portfolio company (e.g., an employee group), such that failure to vote in favor of management (or the proponent) could harm the adviser's relationship with the company (or proponent). For example, if Spectrum manages money for the portfolio company or an employee group, manages pension assets, leases office space from the company, or provides other material services to the portfolio company, the CCO will review whether such relationships may give rise to a conflict of interest. . . Personal Relationships - The CCO will consider whether any senior executives or portfolio managers (or similar persons at Spectrum's affiliates) have a personal relationship with other proponents of proxy proposals, participants in proxy contests, corporate directors, or candidates for directorships that might give rise to a conflict of interest. . . Familial Relationships - The CCO will consider whether any senior executives or portfolio managers (or similar persons at Spectrum's affiliates) have a familial relationship relating to a portfolio company (e.g., a spouse or other relative who serves as a director of a portfolio company, is a candidate for such a position, or is employed by a portfolio company in a senior position). In monitoring for conflicts of interest, the CCO will consider all information reasonably available to it about any material business, personal, or familial relationship involving Spectrum (and its affiliates) and a portfolio company, including the following: . . A list of clients that are also public companies, which is prepared and updated by the Operations Department and retained in the Compliance Department. . . Publicly available information. . . Information generally known within Spectrum. . . Information actually known by senior executives or portfolio managers. When considering a proxy proposal, investment professionals involved in the decision-making process must disclose any potential material conflict that they are aware of to CCO prior to any substantive discussion of a proxy matter. .Information obtained periodically from those persons whom CCO reasonably believes could be affected by a conflict arising from a personal or familial relationship (e.g., portfolio managers, senior management). The CCO may, at her discretion, assign day-to-day responsibility for monitoring for conflicts to a designated person. With respect to monitoring of affiliates, the CCO in conjunction with PGI's CCO and/or Director of Compliance may rely on information barriers between Spectrum and its affiliates in determining the scope of its monitoring of conflicts involving affiliates. Determining Whether a Conflict of Interest is "Material" - On a regular basis, -------------------------------------------------------- CCO will monitor conflicts of interest to determine whether any may be "material" and therefore should be referred to PGI for resolution. The SEC has not provided any specific guidance as to what types of conflicts may be "material" for purposes of proxy voting, so therefore it would be appropriate to look to the traditional materiality analysis under the federal securities laws, i.e., that a "material" matter is one that is reasonably likely to be viewed as important by the average shareholder. Whether a conflict may be material in any case will, of course, depend on the facts and circumstances. However, in considering the materiality of a conflict, Spectrum will use the following two-step approach: 1) Financial Materiality - The most likely indicator of materiality in most cases will be the dollar amount involved with the relationship in question. For purposes of proxy voting, each committee will presume that a conflict is not material unless it involves at least 5% of Spectrum's annual revenues or a minimum dollar amount $1,000,000. Different percentages or dollar amounts may be used depending on the proximity of the conflict (e.g., a higher number if the conflict arises through an affiliate rather than directly with Spectrum). 2) Non-Financial Materiality - A non-financial conflict of interest might be material (e.g., conflicts involving personal or familial relationships) and should be evaluated on the facts of each case. If the CCO has any question as to whether a particular conflict is material, it should presume the conflict to be material and refer it to the PGI's CCO for resolution. As in the case of monitoring conflicts, the CCO may appoint a designated person or subgroup of Spectrum's investment team to determine whether potential conflicts of interest may be material. Resolving a Material Conflict of Interest - When an employee of Spectrum refers a potential material conflict of interest to the CCO, the CCO will determine whether a material conflict of interest exists based on the facts and circumstances of each particular situation. If the CCO determines that no material conflict of interest exists, no further action is necessary and the CCO will notify management accordingly. If the CCO determines that a material conflict exists, CCO must disclose the conflict to affected clients and obtain consent from each to the manner in which Spectrum proposes to vote. Clients may obtain information about how we voted proxies on their behalf by contacting Spectrum's Compliance Department. PROXY VOTING GUIDELINES ----------------------- CATEGORY I: ROUTINE ADMINISTRATIVE ITEMS ----------------------------------------- Philosophy: Spectrum is willing to defer to management on matters of a routine ----------- administrative nature. We feel management is best suited to make those decisions which are essential to the ongoing operation of the company and which do not have a major economic impact on the corporation and its shareholders. Examples of issues on which we will normally defer to management's recommendation include: 1) selection of auditors 2) increasing the authorized number of common shares 3) election of unopposed directors CATEGORY II: SPECIAL INTEREST ISSUES ------------------------------------- Philosophy: While there are many social, political, environmental and other ----------- special interest issues that are worthy of public attention, we do not believe the corporate proxy process is the appropriate arena in which to achieve gains in these areas. In recent history, proxy issues of this sort have included such matters as sales to the military, doing business in South Africa, and environmental responsibility. Our primary responsibility in voting proxies is to provide for the greatest long-term value for Spectrum's clients. We are opposed to proposals which involve an economic cost to the corporation, or which restrict the freedom of management to operate in the best interest of the corporation and its shareholders. However, in general we will abstain from voting on shareholder social, political and environmental proposals because their long-term impact on share value cannot be calculated with any reasonable degree of confidence. CATEGORY III: ISSUES HAVING THE POTENTIAL FOR SIGNIFICANT ECONOMIC IMPACT -------------------------------------------------------------------------- Philosophy: Spectrum is not willing to defer to management on proposals which ----------- have the potential for major economic impact on the corporation and the value of its shares. We believe such issues should be carefully analyzed and decided by the owners of the corporation. Presented below are examples of issues which we believe have the potential for significant economic impact on shareholder value. 1) Classification of Board of Directors. Rather than electing all directors ------------------------------------- annually, these provisions stagger a board, generally into three annual classes, and call for only one-third to be elected each year. Staggered boards may help to ensure leadership continuity, but they also serve as defensive mechanisms. Classifying the board makes it more difficult to change control of a company through a proxy contest involving election of directors. In general, we vote on a case by case basis on proposals for staggered boards, but generally favor annual elections of all directors. 2) Cumulative Voting of Directors. Most corporations provide that shareholders ------------------------------ are entitled to cast one vote for each director for each share owned - the one share, one vote standard. The process of cumulative voting, on the other hand, permits shareholders to distribute the total number of votes they have in any manner they wish when electing directors. Shareholders may possibly elect a minority representative to a corporate board by this process, ensuring representation for all sizes of shareholders. Outside shareholder involvement can encourage management to maximize share value. We generally support cumulative voting of directors. 3) Prevention of Greenmail. These proposals seek to prevent the practice of ------------------------ "greenmail", or targeted share repurchases by management of company stock from individuals or groups seeking control of the company. Since only the hostile party receives payment, usually at a substantial premium over the market value of its shares, the practice discriminates against all other shareholders. By making greenmail payments, management transfers significant sums of corporate cash to one entity, most often for the primary purpose of saving their jobs. Shareholders are left with an asset-depleted and often less competitive company. We think that if a corporation offers to buy back its stock, the offer should be made to all shareholders, not just to a select group or individual. We are opposed to greenmail and will support greenmail prevention proposals. 4) Supermajority Provisions. These corporate charter amendments generally ------------------------- require that a very high percentage of share votes (70-81%) be cast affirmatively to approve a merger, unless the board of directors has approved it in advance. These provisions have the potential to give management veto power over merging with another company, even though a majority of shareholders favor the merger. In most cases we believe requiring supermajority approval of mergers places too much veto power in the hands of management and other minority shareholders, at the expense of the majority shareholders, and we oppose such provisions. 5) Defensive Strategies. These proposals will be analyzed on a case by case --------------------- basis to determine the effect on shareholder value. Our decision will be based on whether the proposal enhances long-term economic value. 6) Business Combinations or Restructuring. These proposals will be analyzed on --------------------------------------- a case by case basis to determine the effect on shareholder value. Our decision will be based on whether the proposal enhances long-term economic value. 7) Executive and Director Compensation. These proposals will be analyzed on a ----------------------------------- case by case basis to determine the effect on shareholder value. Our decision will be based on whether the proposal enhances long-term economic value. Policy Established May, 2003 Revised January, 2006 T. ROWE PRICE ASSOCIATES, INC T. ROWE PRICE INTERNATIONAL, INC T. ROWE PRICE STABLE ASSET MANAGEMENT, INC T. ROWE PRICE GLOBAL INVESTMENT SERVICES, LTD T. ROWE PRICE GLOBAL ASSET MANAGEMENT, LTD PROXY VOTING POLICIES AND PROCEDURES RESPONSIBILITY TO VOTE PROXIES RESPONSIBILITY TO VOTE PROXIES T. Rowe Price Associates, Inc., T. Rowe Price International, Inc., T. Rowe Price Global Investment Services Limited, and T. Rowe Price Global Asset Management Limited ("T. Rowe Price") recognize and adhere to the principle that one of the privileges of owning stock in a company is the right to vote in the election of the company's directors and on matters affecting certain important aspects of the company's structure and operations that are submitted to shareholder vote. As an investment adviser with a fiduciary responsibility to its clients, T. Rowe Price analyzes the proxy statements of issuers whose stock is owned by the U.S.-registered investment companies which it sponsors and serves as investment adviser ("T. Rowe Price Funds") and by institutional and private counsel clients who have requested that T. Rowe Price be involved in the proxy process. T. Rowe Price has assumed the responsibility for voting proxies on behalf of the T. Rowe Price Funds and certain counsel clients who have delegated such responsibility to T. Rowe Price. In addition, T. Rowe Price makes recommendations regarding proxy voting to counsel clients who have not delegated the voting responsibility but who have requested voting advice. T. Rowe Price has adopted these Proxy Voting Policies and Procedures ("Policies and Procedures") for the purpose of establishing formal policies and procedures for performing and documenting its fiduciary duty with regard to the voting of client proxies. FIDUCIARY CONSIDERATIONS. . It is the policy of T. Rowe Price that decisions with respect to proxy issues will be made in light of the anticipated impact of the issue on the desirability of investing in the portfolio company from the viewpoint of the particular client or Price Fund. Proxies are voted solely in the interests of the client, Price Fund shareholders or, where employee benefit plan assets are involved, in the interests of plan participants and beneficiaries. Our intent has always been to vote proxies, where possible to do so, in a manner consistent with our fiduciary obligations and responsibilities. Practicalities and costs involved with international investing may make it impossible at times, and at other times disadvantageous, to vote proxies in every instance. CONSIDERATION GIVEN MANAGEMENT RECOMMENDATIONS. . One of the primary factors T. Rowe Price considers when determining the desirability of investing in a particular company is the quality and depth of its management. The Policies and Procedures were developed with the recognition that a company's management is entrusted with the day-to-day operations of the company, as well as its long-term direction and strategic planning, subject to the oversight of the company's board of directors. Accordingly, T. Rowe Price believes that the recommendation of management on most issues should be given weight in determining how proxy issues should be voted. However, the position of the company's management will not be supported in any situation where it is found to be not in the best interests of the client, and the portfolio manager may always elect to vote contrary to management when he or she believes a particular proxy proposal may adversely affect the investment merits of owning stock in a portfolio company. ADMINISTRATION OF POLICIES AND PROCEDURES PROXY COMMITTEE. . T. Rowe Price's Proxy Committee ("Proxy Committee") is responsible for establishing positions with respect to corporate governance and other proxy issues, including those involving social responsibility issues. The Proxy Committee also reviews questions and responds to inquiries from clients and mutual fund shareholders pertaining to proxy issues of corporate responsibility. While the Proxy Committee sets voting guidelines and serves as a resource for T. Rowe Price portfolio management, it does not have proxy voting authority for any Price Fund or counsel client. Rather, this responsibility is held by the Chairperson of the Fund's Investment Advisory Committee or counsel client's portfolio manager. INVESTMENT SERVICES GROUP. . The Investment Services Group ("Investment Services Group") is responsible for administering the proxy voting process as set forth in the Policies and Procedures. PROXY ADMINISTRATOR. . The Investment Services Group will assign a Proxy Administrator ("Proxy Administrator") who will be responsible for ensuring that all meeting notices are reviewed and important proxy matters are communicated to the portfolio managers and regional managers for consideration. HOW PROXIES ARE REVIEWED, PROCESSED AND VOTED In order to facilitate the proxy voting process, T. Rowe Price has retained Institutional Shareholder Services ("ISS") as an expert in the proxy voting and corporate governance area. ISS specializes in providing a variety of fiduciary-level proxy advisory and voting services. These services include in-depth research, analysis, and voting recommendations as well as vote execution, reporting, auditing and consulting assistance for the handling of proxy voting responsibility and corporate governance-related efforts. While the Proxy Committee relies upon ISS research in establishing T. Rowe Price's proxy voting guidelines, and many of our guidelines are consistent with ISS positions, T. Rowe Price does at times deviate from ISS recommendations on general policy issues or specific proxy proposals. MEETING NOTIFICATION T. Rowe Price utilizes ISS' voting agent services to notify us of upcoming shareholder meetings for portfolio companies held in client accounts and to transmit votes to the various custodian banks of our clients. ISS tracks and reconciles T. Rowe Price holdings against incoming proxy ballots. If ballots do not arrive on time, ISS procures them from the appropriate custodian or proxy distribution agent. Meeting and record date information is updated daily, and transmitted to T. Rowe Price through ProxyMaster.com, an ISS web-based application. ISS is also responsible for maintaining copies of all proxy statements received by issuers and to promptly provide such materials to T. Rowe Price upon request. VOTE DETERMINATION ISS provides comprehensive summaries of proxy proposals (including social responsibility issues), publications discussing key proxy voting issues, and specific vote recommendations regarding portfolio company proxies to assist in the proxy research process. Upon request, portfolio managers may receive any or all of the above-mentioned research materials to assist in the vote determination process. The final authority and responsibility for proxy voting decisions remains with T. Rowe Price. Decisions with respect to proxy matters are made primarily in light of the anticipated impact of the issue on the desirability of investing in the company from the viewpoint of our clients. Portfolio managers may decide to vote their proxies consistent with T. Rowe Price's policies as set by the Proxy Committee and instruct our Proxy Administrator to vote all proxies accordingly. In such cases, he or she may request to review the vote recommendations and sign-off on all the proxies before the votes are cast, or may choose only to sign-off on those votes cast against management. The portfolio managers are also given the option of reviewing and determining the votes on all proxies without utilizing the vote guidelines of the Proxy Committee. In all cases, the portfolio managers may elect to receive current reports summarizing all proxy votes in his or her client accounts. Portfolio managers who vote their proxies inconsistent with T. Rowe Price guidelines are required to document the rationale for their vote. The Proxy Administrator is responsible for maintaining this documentation and assuring that it adequately reflects the basis for any vote which is cast in opposition to T. Rowe Price policy. T. ROWE PRICE VOTING POLICIES Specific voting guidelines have been adopted by the Proxy Committee for routine anti-takeover, executive compensation and corporate governance proposals, as well as other common shareholder proposals, and are available to clients upon request. The following is a summary of the significant T. Rowe Price policies: Election of Directors - T. Rowe Price generally supports slates with a majority of independent directors. T. Rowe Price withholds votes for outside directors that do not meet certain criteria relating to their independence or their inability to dedicate sufficient time to their board duties due to their commitments to other boards. We also withhold votes for inside directors serving on compensation, nominating and audit committees and for directors who miss more than one-fourth of the scheduled board meetings. We vote against management efforts to stagger board member terms by withholding votes from directors because a staggered board may act as a deterrent to takeover proposals. T. Rowe Price supports shareholder proposals calling for a majority vote threshold for the election of directors. .Anti-takeover and Corporate Governance Issues - T. Rowe Price generally opposes anti-takeover measures since they adversely impact shareholder rights and limit the ability of shareholders to act on possible transactions. Such anti-takeover mechanisms include classified boards, supermajority voting requirements, dual share classes, and poison pills. We also oppose proposals that give management a "blank check" to create new classes of stock with disparate rights and privileges. We generally support proposals to permit cumulative voting and those that seek to prevent potential acquirers from receiving a takeover premium for their shares. When voting on corporate governance proposals, T. Rowe Price will consider the dilutive impact to shareholders and the effect on shareholder rights. With respect to proposals for the approval of a company's auditor, we typically oppose auditors who have a significant non-audit relationship with the company. .Executive Compensation Issues - T. Rowe Price's goal is to assure that a company's equity-based compensation plan is aligned with shareholders' long-term interests. While we evaluate most plans on a case-by-case basis, T. Rowe Price generally opposes compensation packages that provide what we view as excessive awards to a few senior executives or that contain excessively dilutive stock option grants based on a number of criteria such as the costs associated with the plan, plan features, burn rates which are excessive in relation to the company's peers, dilution to shareholders and comparability to plans in the company's peer group. We generally oppose efforts to reprice options in the event of a decline in value of the underlying stock. .Social and Corporate Responsibility Issues - Vote determinations for corporate responsibility issues are made by the Proxy Committee using ISS voting recommendations. T. Rowe Price generally votes with a company's management on the following social issues unless the issue has substantial economic implications for the company's business and operations which have not been adequately addressed by management: . . Corporate environmental practices; . . Board diversity; . . Employment practices and employment opportunity; . . Military, nuclear power and related energy issues; . . Tobacco, alcohol, infant formula and safety in advertising practices; . . Economic conversion and diversification; . . International labor practices and operating policies; . . Genetically-modified foods; . . Animal rights; and . . Political contributions/activities and charitable contributions. Global Portfolio Companies - ISS applies a two-tier approach to determining and applying global proxy voting policies. The first tier establishes baseline policy guidelines for the most fundamental issues, which span the corporate governance spectrum without regard to a company's domicile. The second tier takes into account various idiosyncrasies of different countries, making allowances for standard market practices, as long as they do not violate the fundamental goals of good corporate governance. The goal is to enhance shareholder value through effective use of shareholder franchise, recognizing that application of policies developed for U.S. corporate governance issues are not necessarily appropriate for foreign markets. The Proxy Committee has reviewed ISS' general global policies and has developed international proxy voting guidelines which in most instances are consistent with ISS recommendations. Votes Against Company Management - Where ISS recommends a vote against management on any particular proxy issue, the Proxy Administrator ensures that the portfolio manager reviews such recommendations before a vote is cast. Consequently, if a portfolio manager believes that management's view on a particular proxy proposal may adversely affect the investment merits of owning stock in a particular company, he/she may elect to vote contrary to management. Also, our research analysts are asked to present their voting recommendations in such situations to our portfolio managers. Index and Passively Managed Accounts - Proxy voting for index and other passively-managed portfolios is administered by the Investment Services Group using ISS voting recommendations when their recommendations are consistent with T. Rowe Price's policies as set by the Proxy Committee. If a portfolio company is held in both an actively managed account and an index account, the index account will default to the vote as determined by the actively managed proxy voting process. Divided Votes - In the unusual situation where a decision is made which is contrary to the policies established by the Proxy Committee, or differs from the vote for any other client or Price Fund, the Investment Services Group advises the portfolio managers involved of the divided vote. The persons representing opposing views may wish to confer to discuss their positions. Opposing votes will be cast only if it is determined to be prudent to do so in light of each client's investment program and objectives. In such instances, it is the normal practice for the portfolio manager to document the reasons for the vote if it is against T. Rowe Price policy. The Proxy Administrator is responsible for assuring that adequate documentation is maintained to reflect the basis for any vote which is cast in opposition to T. Rowe Price policy. Shareblocking - Shareblocking is the practice in certain foreign countries of "freezing" shares for trading purposes in order to vote proxies relating to those shares. In markets where shareblocking applies, the custodian or sub-custodian automatically freezes shares prior to a shareholder meeting once a proxy has been voted. Shareblocking typically takes place between one and fifteen (15) days before the shareholder meeting, depending on the market. In markets where shareblocking applies, there is a potential for a pending trade to fail if trade settlement takes place during the blocking period. Depending upon market practice and regulations, shares can sometimes be unblocked, allowing the trade to settle but negating the proxy vote. T. Rowe Price's policy is generally to vote all shares in shareblocking countries unless, in its experience, trade settlement would be unduly restricted. Securities on Loan - The T. Rowe Price Funds and our institutional clients may participate in securities lending programs to generate income. Generally, the voting rights pass with the securities on loan; however, lending agreements give the lender the right to terminate the loan and pull back the loaned shares provided sufficient notice is given to the custodian bank in advance of the voting deadline. T. Rowe Price's policy is generally not to vote securities on loan unless the portfolio manager has knowledge of a material voting event that could affect the value of the loaned securities. In this event, the portfolio manager has the discretion to instruct the Proxy Administrator to pull back the loaned securities in order to cast a vote at an upcoming shareholder meeting. VOTE EXECUTION AND MONITORING OF VOTING PROCESS Once the vote has been determined, the Proxy Administrator enters votes electronically into ISS's ProxyMaster system. ISS then transmits the votes to the proxy agents or custodian banks and sends electronic confirmation to T. Rowe Price indicating that the votes were successfully transmitted. On a daily basis, the Proxy Administrator queries the ProxyMaster system to determine newly announced meetings and meetings not yet voted. When the date of the stockholders' meeting is approaching, the Proxy Administrator contacts the applicable portfolio manager if the vote for a particular client or Price Fund has not yet been recorded in the computer system. Should a portfolio manager wish to change a vote already submitted, the portfolio manager may do so up until the deadline for vote submission, which varies depending on the company's domicile. MONITORING AND RESOLVING CONFLICTS OF INTEREST The Proxy Committee is also responsible for monitoring and resolving possible material conflicts between the interests of T. Rowe Price and those of its clients with respect to proxy voting. We have adopted safeguards to ensure that our proxy voting is not influenced by interests other than those of our fund shareholders. While membership on the Proxy Committee is diverse, it does not include individuals whose primary duties relate to client relationship management, marketing, or sales. Since T. Rowe Price's voting guidelines are pre-determined by the Proxy Committee using recommendations from ISS, an independent third party, application of the T. Rowe Price guidelines by fund portfolio managers to vote fund proxies should in most instances adequately address any possible conflicts of interest. However, the Proxy Committee reviews all proxy votes that are inconsistent with T. Rowe Price guidelines to determine whether the portfolio manager's voting rationale appears reasonable. The Proxy Committee also assesses whether any business or other relationships between T. Rowe Price and a portfolio company could have influenced an inconsistent vote on that company's proxy. Issues raising possible conflicts of interest are referred to designated members of the Proxy Committee for immediate resolution prior to the time T. Rowe Price casts its vote. With respect to personal conflicts of interest, T. Rowe Price's Code of Ethics and Conduct requires all employees to avoid placing themselves in a "compromising position" in which their interests may conflict with those of our clients and restricts their ability to engage in certain outside business activities. Portfolio managers or Proxy Committee members with a personal conflict of interest regarding a particular proxy vote must recuse themselves and not participate in the voting decisions with respect to that proxy. Specific Conflict of Interest Situations - Voting of T. Rowe Price Group, Inc. common stock (sym: TROW) by certain T. Rowe Price Index Funds will be done in all instances in accordance with T. Rowe Price policy and votes inconsistent with policy will not be permitted. In addition, T. Rowe Price has voting authority for proxies of the holdings of certain T. Rowe Price funds that invest in other T. Rowe Price funds. In cases where the underlying fund of a T. Rowe Price fund-of -funds holds a proxy vote, T. Rowe Price will mirror vote the fund shares held by the fund-of-funds in the same proportion as the votes cast by the shareholders of the underlying funds. REPORTING AND RECORD RETENTION Vote Summary Reports will be generated for each client that requests T. Rowe Price to furnish proxy voting records. The report specifies the portfolio companies, meeting dates, proxy proposals, and votes which have been cast for the client during the period and the position taken with respect to each issue. Reports normally cover quarterly or annual periods. All client requests for proxy information will be recorded and fulfilled by the Proxy Administrator. T. Rowe Price retains proxy solicitation materials, memoranda regarding votes cast in opposition to the position of a company's management, and documentation on shares voted differently. In addition, any document which is material to a proxy voting decision such as the T. Rowe Price voting guidelines, Proxy Committee meeting materials, and other internal research relating to voting decisions will be kept. Proxy statements received from issuers (other than those which are available on the SEC's EDGAR database) are kept by ISS in its capacity as voting agent and are available upon request. All proxy voting materials and supporting documentation are retained for six years. UBS GLOBAL ASSET MANAGEMENT GLOBAL CORPORATE GOVERNANCE PHILOSOPHY AND PROXY VOTING GUIDELINES AND POLICY POLICY SUMMARY Underlying our voting and corporate governance policies we have three fundamental objectives: 1) We seek to act in the best financial interests of our clients to protect and enhance the long-term value of their investments. 2) In order to do this effectively, we aim to utilize the full weight of our clients' shareholding inmaking our views felt. 3) As investors, we have a strong commercial interest in ensuring that the companies in which we invest are successful. We actively pursue this interest by promoting best practice in the boardroom. To achieve these objectives, we have implemented this Policy, which we believe is reasonably designed to guide our exercise of voting rights and the taking of other appropriate actions, within our ability, and to support and encourage sound corporate governanace practice. This Policy is being implemented globally to harmonize our philosophies across UBS Global Asset Management offices worldwide and theregby maximize our ability to influence the companies we invest in. However, this Policy is also supplemented by the UBS Global Asset Management Local Proxy and Corporate Governance Guidelines to permit individual regions or countries with UBS Global Asset Management the flexibility to vote or take other actions consistent with their local laws or standards where necessary. RISKS ADDRESSED BY THIS POLICY The policy is designed to address the following risks: . Failure to provided required disclosures for investment advisers and registered investment companies . Failure to vote proxies in best interest of clients and funds . Failure to identify and address conflicts of interest . Failure to provide adequate oversight of third party service providers TABLE OF CONTENTS Global Voting and Corporate Governance Policy A) General Corporate Governance Benchmarks 2 B) Proxy Voting Guidelines oe Macro Rationales 4 C) Proxy Voting Disclosure Guidelines 8 D) Proxy Voting Conflict Guidelines 9 E) Special Disclosure Guidelines for Registered Investment Companies 9 F) Documentation 11 G) Compliance Dates 11 H) Other Policies 12 I) Disclosures 12 GLOBALPROXY VOTING AND CORPORATE GOVERNANCE POLICY PHILOSOPHY Our philosophy, guidelines and policy are based on our active investment style and structure whereby we have detailed knowledge of the investments we make on behalf of our clients and therefore are in a position to judge what is in the best interests of our clients as shareholders. We believe voting rights have economic value and must be treated accordingly. Proxy votes that impact the economic value of client investments involve the exercise of fiduciary responsibility. Good corporate governance should, in the long term, lead toward both better corporate performance and improved shareholder value.Thus, we expect board members of companies we have invested in (the -company" or -companies") to act in the service of the shareholders, view themselves as stewards of the financial assets of the company, exercise good judgment and practice diligent oversight with the management of the company. A) General Corporate Governance Benchmarks UBS Global Asset Management (US) Inc. and UBS Global Asset Management (Americas) Inc. (collectively, -UBS Global AM") will evaluate issues that may have an impact on the economic value of client investments during the time period it expects to hold the investment.While there is no absolute set of rules that determine appropriate governance under all circumstances and no set of rules will guarantee ethical behavior, there are certain benchmarks, which, if substantial progress is made toward, give evidence of good corporate governance. Therefore, we will generally exercise voting rights on behalf of clients in accordance with this policy. PRINCIPLE 1: INDEPENDENCE OF BOARD FROM COMPANY MANAGEMENT GUIDELINES: . Board exercises judgment independently of management. . Separate Chairman and Chief Executive. . Board has access to senior management members. . Board is comprised of a significant number of independent outsiders. . Outside directors meet independently. . CEO performance standards are in place. . CEO performance is reviewed annually by the full board. . CEO succession plan is in place. . Board involvement in ratifying major strategic initiatives. . Compensation, audit and nominating committees are led by a majority of outside directors. PRINCIPLE 2: QUALITY OF BOARD MEMBERSHIP GUIDELINES: . Board determines necessary board member skills, knowledge and experience. . Board conducts the screening and selection process for new directors. . Shareholders should have the ability to nominate directors. . Directors whose present job responsibilities change are reviewed as to the appropriateness of continued directorship. . Directors are reviewed every 3-5 years to determine appropriateness of continued directorship. . Board meets regularly (at least four times annually). PRINCIPLE 3: APPROPRIATE MANAGEMENT OF CHANGE IN CONTROL GUIDELINES: . Protocols should ensure that all bid approaches and material proposals by management are brought forward for board consideration. . Any contracts or structures, which impose financial constraints on changes in control, should require prior shareholder approval. . Employment contracts should not entrench management. . Management should not receive substantial rewards when employment contracts are terminated for performance reasons. PRINCIPLE 4: REMUNERATION POLICIES ARE ALIGNED WITH SHAREHOLDER INTERESTS GUIDELINES: . Executive remuneration should be commensurate with responsibilities and performance. . Incentive schemes should align management with shareholder objectives. . Employment policies should encourage significant shareholding by management and board members. . Incentive rewards should be proportionate to the successful achievement of predetermined financial targets. . Long-term incentives should be linked to transparent long-term performance criteria. . Dilution of shareholders' interests by share issuance arising from egregious employee share schemes and management incentives should be limited by shareholder resolution. PRINCIPLE 5: AUDITORS ARE INDEPENDENT GUIDELINES: . Auditors are approved by shareholders at the annual meeting. . Audit, consulting and other fees to the auditor are explicitly disclosed. . The Audit Committee should affirm the integrity of the audit has not been compromised by other services provided by the auditor firm. . Periodic (every 5 years) tender of the audit firm or audit partner. B) Proxy Voting Guidelines - Macro Rationales Macro Rationales are used to explain why we vote on each proxy issue.The Macro Rationales reflect our guidelines enabling voting consistency between offices yet allowing for flexibility so the local office can reflect specific knowledge of the company as it relates to a proposal. 1) General Guidelines .a. When our view of the issuer's management is favorable, we generally support current management initiatives. When our view is that changes to the management structure would probably increase shareholder value, we may not support existing management proposals. .b. If management's performance has been questionable we may abstain or vote against specific proxy proposals. .c. Where there is a clear conflict between management and shareholder interests, even in those cases where management has been doing a good job, we may elect to vote against management. .d. In general, we oppose proposals, which in our view, act to entrench management. .e. In some instances, even though we strongly support management, there are some corporate governance issues that, in spite of management objections, we believe should be subject to shareholder approval. .f. We will vote in favor of shareholder resolutions for confidential voting. 2) Board of Directors and Auditors .a. Unless our objection to management's recommendation is strenuous, if we believe auditors to be competent and professional, we support continuity in the appointed auditing firm subject to regular review. .b. We generally vote for proposals that seek to fix the size of the board and/or require shareholder approval to alter the size of the board and that allow shareholders to remove directors with or without cause. .c. We generally vote for proposals that permit shareholders to act by written consent and/or give the right to shareholders to call a special meeting. .d. We generally oppose proposals to limit or restrict shareholder ability to call special meetings. .e. We will vote for separation of Chairman and CEO if we believe it will lead to better company management, otherwise, we will support an outside lead director board structure. 3) Compensation .a. We will not try to micro-manage compensation schemes, however, we believe remuneration should not be excessive, and we will not support compensation plans that are poorly structured or otherwise egregious. .b. Senior management compensation should be set by independent directors according to industry standards, taking advice from benefits consultants where appropriate. .c. All senior management and board compensation should be disclosed within annual financial statements, including the value of fringe benefits, company pension contributions, deferred compensation and any company loans. .d. We may vote against a compensation or incentive program if it is not adequately tied to a company's fundamental financial performance;, is vague;, is not in line with market practices;, allows for option re-pricing;, does not have adequate performance hurdles; or is highly dilutive. .e. Where company and management's performance has been poor, we may object to the issuance of additional shares for option purposessuch that management is rewarded for poor performance or further entrenches its position. .f. Given the increased level of responsibility and oversight required of directors, it is reasonable to expect that compensation should increase commensurably.We consider that there should be an appropriate balance between fixed and variable elements of compensation and between short and long term incentives. 4) Governance Provisions .a. We believe that votes at company meetings should be determined on the basis of one share one vote. We will vote against cumulative voting proposals. .b. We believe that -poison pill" proposals, which dilute an issuer's stock when triggered by particular events, such as take over bids or buy-outs, should be voted on by the shareholders and will support attempts to bring them before the shareholders. .c. Any substantial new share issuance should require prior shareholder approval. .d. We believe proposals that authorize the issuance of new stock without defined terms or conditions and are intended to thwart a take-over or restrict effective control by shareholders should be discouraged. .e. We will support directives to increase the independence of the board of directors when we believe that the measures will improve shareholder value. .f. We generally do not oppose management's recommendation to implement a staggered board and generally support the regular re-election of directors on a rotational basis as it may provide some continuity of oversight. .g. We will support proposals that enable shareholders to directly nominate directors. 5) Capital Structure and Corporate Restructuring .a. It is difficult to direct where a company should incorporate, however, in instances where a move is motivated solely to entrench management or restrict effective corporate governance, we will vote accordingly. .b. In general we will oppose management initiatives to create dual classes of stock, which serves to insulate company management from shareholder opinion and action.We support shareholder proposals to eliminate dual class schemes. 6) Mergers, Tender Offers and Proxy Contests .a. Based on our analysis and research we will support proposals that increase shareholder value and vote against proposals that do not. 7) Social, Environmental, Political and Cultural .a. Depending on the situation, we do not typically vote to prohibit a company from doing business anywhere in the world. .b. There are occasional issues, we support, that encourage management to make changes or adopt more constructive policies with respect to social, environmental, political and other special interest issues, but in many cases we believe that the shareholder proposal may be too binding or restrict management's ability to find an optimal solution.While we wish to remain sensitive to these issues, we believe there are better ways to resolve them than through a proxy proposal.We prefer to address these issues through engagement. .c. Unless directed by clients to vote in favor of social, environmental, political and other special interest proposals, we are generally opposed to special interest proposals that involve an economic cost to the company or that restrict the freedom of management to operate in the best interest of the company and its shareholders. 8) Administrative and Operations .a. Occasionally, stockholder proposals, such as asking for reports and donations to the poor, are presented in a way that appear to be honest attempts at bringing up a worthwhile issue.Nevertheless, judgment must be exercised with care, as we do not expect our shareholder companies to be charitable institutions. .b. We are sympathetic to shareholders who are long-term holders of a company's stock, who desire to make concise statements about the long-term operations of the company in the proxy statement.However, because regulatory agencies do not require such actions, we may abstain unless we believe there are compelling reasons to vote for or against. 9) Miscellaneous .a. Where a client has given specific direction as to how to exercise voting rights on its behalf, we will vote in accordance with a client's direction. .b. Where we have determined that the voting of a particular proxy is of limited benefit to clients or where the costs of voting a proxy outweigh the benefit to clients, we may abstain or choose not to vote. Among others, such costs may include the cost of translating a proxy, a requirement to vote in person at a shareholders meeting or if the process of voting restricts our ability to sell for a period of time (an opportunity cost). .c. For holdings managed pursuant to quantitative, index or index-like strategies, we may delegate the authority to exercise voting rights for such strategies to an independent proxy voting and research service with the direction that the votes be exercised in accordance with this Policy. If such holdings are also held in an actively managed strategy, we will exercise the voting rights for the passive holdings according to the active strategy. .d. In certain instances when we do not have enough information we may choose to abstain or vote against a particular Proposal. C) Proxy Voting Disclosure Guidelines . UBS Global AM will disclose to clients, as required by the Investment Advisers Act of 1940, how they may obtain information about how we voted with respect to their securities. This disclosure may be made on Form ADV. . UBS Global AM will disclose to clients, as required by the Investment Advisers Act of 1940, these procedures and will furnish a copy of these procedures to any client upon request. This disclosure may be made on Form ADV. . Upon request or as required by law or regulation, UBS Global AMwill disclose to a client or a client's fiduciaries, the manner in which we exercised voting rights on behalf of the client. . Upon request, we will inform a client of our intended vote. Note, however, in some cases, because of the controversial nature of a particular proxy, our intended vote may not be available until just prior to the deadline.If the request involves a conflict due to the client's relationship with the company that has issued the proxy, the Legal and Compliance Department should be contacted immediately to ensure adherence to UBS Global AM Corporate Governance Principles. (See Proxy Voting Conflict Guidelines below.) . Other than as described herein, we will not disclose our voting intentions or make public statements to any third party (except electronically to our proxy vote processor or regulatory agencies) including but not limited to proxy solicitors, non-clients, the media, or other UBS divisions, but we may inform such parties of the provisions of our Policy.We may communicate with other shareholders regarding a specific proposal but will not disclose our voting intentions or agree to vote in concert with another shareholder without approval from the Chairman of the Global Corporate Governance Committeeand regional Legal and Compliance representative. . Any employee, officer or director of UBS Global AM receiving an inquiry directly from a company will notify the appropriate industry analyst and persons responsible for voting the company's proxies. . Proxy solicitors and company agents will not be provided with either our votes or the number of shares we own in a particular company. . In response to a proxy solicitor or company agent, we will acknowledge receipt of the proxy materials, inform them of our intent to vote or that we have voted, but not the result of the vote itself. . We may inform the company (not their agent) where we have decided to vote against any material resolution at their company. . The Chairman of the Global Corporate Governance Committee and the applicable Chair of the Local Corporate Governance Committee must approve exceptions to this disclosure policy. Nothing in this policy should be interpreted as to prevent dialogue with the company and its advisers by the industry analyst, proxy voting delegate or other appropriate senior investment personnel when a company approaches us to discuss governance issues or resolutions they wish to include in their proxy statement. D) Proxy Voting Conflict Guidelines In addition to the Proxy Voting Disclosure Guidelines above, UBS Global AM has implemented the following guidelines to address conflicts of interests that arise in connection with our exercise of voting rights on behalf of clients: . Under no circumstances will general business, sales or marketing issues influence our proxy votes. . UBS Global AM and its affiliates engaged in banking, broker-dealer and investment banking activities (-Affiliates") have policies in place prohibiting the sharing of certain sensitive information.These policies prohibit our personnel from disclosing information regarding our voting intentions to any Affiliate.Any of our personnel involved in the proxy voting process who are contacted by an Affiliate regarding the manner in which we intend to vote on a specific issue, must terminate the contact and notify the Legal and Compliance Department immediately.[Note:Legal and Compliance personnel may have contact with their counterparts working for an Affiliate on matters involving information barriers.] In the event of any issue arising in relation to Affiliates, the Chair of the Global Corporate Governance Committee must be advised, who will in turn advise the Chief Risk Officer. E) Special Disclosure Guidelines for Registered Investment Company Clients 1) Registration Statement (Open-End and Closed-End Funds)Management is responsible for ensuring the following: . That these procedures, which are the procedures used by the investment adviser on the Funds' behalf, are described in the Statement of Additional Information (SAI).Theprocedures may be described in the SAI or attached as an exhibit to the registration statement. . That the SAI disclosure includes the procedures that are used when a vote presents a conflict between the interests of Fund shareholders, on the one hand; and those of the Funds investment adviser, principal underwriter or any affiliated person of the Fund, its investment adviser or principal underwriter, on the other. . That the SAI disclosure states that information regarding how the Fund voted proxies during the most recent 12-month period ended June 30 is available (i) without charge, upon request, by calling a specified toll-free (or collect) telephone number; or on or through the Fund's website, or both; and (ii) on the Commission's website.If a request for the proxy voting record is received, the Fund must comply within three business days by first class mail. If website disclosure is elected, Form N-PX must be posted as soon as reasonably practicable after filing the report with the Commission, and must remain available on the website as long as the Fund discloses that it its available on the website. 2) Shareholder Annual and Semi-Annual Report (Open-End and Closed-End Funds) Management is responsible for ensuring the following: . That each Fund's shareholder report contain a statement that a description of these procedures is available (i) without charge, upon request, by calling a toll-free or collect telephone number; (ii) on the Fund's website, if applicable; and (iii) on the Commission's website.If a request for the proxy voting record is received, the Fund must comply within three business days by first class mail. . That the report contain a statement that information regarding how the Fund voted proxies during the most recent 12-month period ended June 30 is available (i) without charge, upon request, by calling a specified toll-free (or collect) telephone number; or on or through the Fund's website, or both; and .(ii) on the Commission's website. If a request for the proxy voting record is received, the Fund must comply within three business days by first class mail. If website disclosure is elected, Form N-PX must be posted as soon as reasonably practicable after filing the report with the Commission, and must remain available on the website as long as the Fund discloses that it its available on the website. 3) Form N-CSR (Closed-End Fund Annual Reports Only)Management is responsible for ensuring the following: . That these procedures are described in Form N-CSR. In lieu of describing the procedures, a copy of these procedures may simply be included with the filing.However, the SEC's preference is that the procedures be included directly in Form N-CSR and not attached as an exhibit to the N-CSR filing. . That the N-CSR disclosure includes the procedures that are used when a vote presents a conflict between the interests of Fund shareholders, on the one hand, and those of the Funds' investment adviser, principal underwriter or any affiliated person of the Fund, its investment adviser or principal underwriter, on the other. 4) Form N-PX (Open-End and Closed-End Funds) Management is responsible for ensuring the following: . That each Fund files its complete proxy voting record on Form N-PX for the 12 month period ended June 30 by no later than August 31 of each year. . Fund management is responsible for reporting to the Funds' Chief Compliance Officer any material issues that arise in connection with the voting of Fund proxies or the preparation, review and filing of the Funds' Form N-PX. 5) Oversight of Disclosure The Funds' Chief Compliance Officer shall be responsible for ensuring that the required disclosures listed in these procedures are implemented and complied with.The Funds' Chief Compliance Officer shall recommend to each Fund's Board any changes to these policies and procedures that he or she deems necessary or appropriate to ensure the Funds' compliance with relevant federal securities laws. RESPONSIBLE PARTIES The following parties will be responsible for implementing and enforcing this policy: THE CHIEF COMPLIANCE OFFICER AND HIS/HER DESIGNEES DOCUMENTATION Monitoring and testing of this policy will be documented in the following ways: . ANNUAL REVIEW BY THE FUNDS' AND UBS GLOBAL AM'S CHIEF COMPLIANCE OFFICER OF THE EFFECTIVENESS OF THESE PROCEDURES . ANNUAL REPORT OF FUNDS' CHIEF COMPLIANCE OFFICER REGARDING THE EFFECTIVENESS OF THESE PROCEDURES . PERIODIC REVIEW OF ANY PROXY SERVICE VENDOR BY THE CHIEF COMPLIANCE OFFICER . PERIODIC REVIEW OF PROXY VOTES BY THE VOTING COMMITTEE COMPLIANCE DATES The following compliance dates should be added to the Complaince Calendar: . FILE FORM N-PX BY AUGUST 31 FOR EACH REGISTERED INVESTMENT COMPANY CLIENT . ANNUAL REVIEW BY THE FUNDS' AND UBS GLOBAL AM'S CHIEF COMPLIANCE OFFICER OF THE EFFECTIVENESS OF THESE PROCEDURES . ANNUAL REPORT OF FUNDS' CHIEF COMPLIANCE OFFICER REGARDING THE EFFECTIVENESS OF THESE PROCEDURES . FORM N-CSR, SHAREHOLDER ANNUAL AND SEMI-ANNUAL REPORTS, AND ANNUAL UPDATES TO FUND REGISTRATION STATEMENTS AS APPLICABLE . PERIODIC REVIEW OF ANY PROXY SERVICE VENDOR BY THE CHIEF COMPLIANCE OFFICER . PERIODIC REVIEW OF PROXY VOTES BY THE PROXY VOTING COMMITTEE OTHER POLICIES Other policies that this policy may affect include: . RECORDKEEPING POLICY . AFFILIATED TRANSACTIONS POLICY . CODE OF ETHICS . SUPERVISION OF SERVICE PROVIDERS POLICY Other policies that may affect this policy include: . RECORDKEEPING POLICY . AFFILIATED TRANSACTIONS POLICY . CODE OF ETHICS . SUPERVISION OF SERVICE PROVIDERS POLICY 17244038 APPENDIX C PORTFOLIO MANAGER DISCLOSURES Information relating to the portfolio managers for each of the funds follows. FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Large Cap Value Name of Fund Marilyn Fedak, John Mahedy, John Phillips, Chris Marx Name of Portfolio Manager (Please use one form per Portfolio Manager per Fund/Account) AllianceBernstein L.P. Firm Name For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 26 19,569,405,957 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 31 949,214,413 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 239 10,449,652,880 ----------------------- ------------------------ or each of the categories, the number of accounts and the total assets in the accounts with respect to which advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 1 6,235,831,629 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 4 828,560,626 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. Investment Professional Conflict of Interest Disclosure As an investment adviser and fiduciary, AllianceBernstein owes its clients and shareholders an undivided duty of loyalty. We recognize that conflicts of interest are inherent in our business and accordingly have developed policies and procedures (including oversight monitoring) reasonably designed to detect, manage and mitigate the effects of actual or potential conflicts of interest in the area of employee personal trading, managing multiple accounts for multiple clients, including AllianceBernstein Mutual Funds, and allocating investment opportunities. Investment professionals, including portfolio managers and research analysts, are subject to the above-mentioned policies and oversight monitoring to ensure that all clients are treated equitably. We place the interests of our clients first and expect all of our employees to meet their fiduciary duties. Employee Personal Trading. AllianceBernstein has adopted a Code of Business Conduct and Ethics that is designed to detect and prevent conflicts of interest when investment professionals and other personnel of AllianceBernstein own, buy or sell securities which may be owned by, or bought or sold for, clients. Personal securities transactions by an employee may raise a potential conflict of interest when an employee owns or trades in a security that is owned or considered for purchase or sale by a client, or recommended for purchase or sale by an employee to a client. Subject to the reporting requirements and other limitations of its Code of Business Conduct and Ethics, AllianceBernstein permits its employees to engage in personal securities transactions, and also allows them to acquire investments in the AllianceBernstein Mutual Funds through direct purchase, 401K/profit sharing plan investment and/or notionally in connection with deferred incentive compensation awards. AllianceBernstein's Code of Ethics and Business Conduct requires disclosure of all personal accounts and maintenance of brokerage accounts with designated broker-dealers approved by AllianceBernstein. The Code also requires preclearance of all securities transactions and imposes a one-year holding period for securities purchased by employees to discourage short-term trading. Managing Multiple Accounts for Multiple Clients. AllianceBernstein has compliance policies and oversight monitoring in place to address conflicts of interest relating to the management of multiple accounts for multiple clients. Conflicts of interest may arise when an investment professional has responsibilities for the investments of more than one account because the investment professional may be unable to devote equal time and attention to each account. The investment professional or investment professional teams for each client may have responsibilities for managing all or a portion of the investments of multiple accounts with a common investment strategy, including other registered investment companies, unregistered investment vehicles, such as hedge funds, pension plans, separate accounts, collective trusts and charitable foundations. Among other things, AllianceBernstein's policies and procedures provide for the prompt dissemination to investment professionals of initial or changed investment recommendations by analysts so that investment professionals are better able to develop investment strategies for all accounts they manage. In addition, investment decisions by investment professionals are reviewed for the purpose of maintaining uniformity among similar accounts and ensuring that accounts are treated equitably. No investment professional that manages client accounts carrying performance fees is compensated directly or specifically for the performance of those accounts. Investment professional compensation reflects a broad contribution in multiple dimensions to long-term investment success for our clients and is not tied specifically to the performance of any particular client's account, nor is it directly tied to the level or change in level of assets under management. Allocating Investment Opportunities. AllianceBernstein has policies and procedures intended to address conflicts of interest relating to the allocation of investment opportunities. These policies and procedures are designed to ensure that information relevant to investment decisions is disseminated promptly within its portfolio management teams and investment opportunities are allocated equitably among different clients. The investment professionals at AllianceBernstein routinely are required to select and allocate investment opportunities among accounts. Portfolio holdings, position sizes, and industry and sector exposures tend to be similar across similar accounts, which minimizes the potential for conflicts of interest relating to the allocation of investment opportunities. Nevertheless, investment opportunities may be allocated differently among accounts due to the particular characteristics of an account, such as size of the account, cash position, tax status, risk tolerance and investment restrictions or for other reasons. AllianceBernstein's procedures are also designed to prevent potential conflicts of interest that may arise when AllianceBernstein has a particular financial incentive, such as a performance-based management fee, relating to an account. An investment professional may perceive that he or she has an incentive to devote more time to developing and analyzing investment strategies and opportunities or allocating securities preferentially to accounts for which AllianceBernstein could share in investment gains. To address these conflicts of interest, AllianceBernstein's policies and procedures require, among other things, the prompt dissemination to investment professionals of any initial or changed investment recommendations by analysts; the aggregation of orders to facilitate best execution for all accounts; price averaging for all aggregated orders; objective allocation for limited investment opportunities (e.g., on a rotational basis) to ensure fair and equitable allocation among accounts; and limitations on short sales of securities. These procedures also require documentation and review of justifications for any decisions to make investments only for select accounts or in a manner disproportionate to the size of the account. For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manager. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Portfolio Manager Compensation AllianceBernstein's compensation program for investment professionals is designed to be competitive and effective in order to attract and retain the highest caliber employees. The compensation program for investment professionals is designed to reflect their ability to generate long-term investment success for our clients, including shareholders of the AllianceBernstein Mutual Funds. Investment professionals do not receive any direct compensation based upon the investment returns of any individual client account, nor is compensation tied directly to the level or change in level of assets under management. Investment professionals' annual compensation is comprised of the following: (i) Fixed base salary: This is generally the smallest portion of compensation. The base salary is a relatively low, fixed salary within a similar range for all investment professionals. The base salary is determined at the outset of employment based on level of experience, does not change significantly from year to year and hence, is not particularly sensitive to performance. (ii)Discretionary incentive compensation in the form of an annual cash bonus: AllianceBernstein's overall profitability determines the total amount of incentive compensation available to investment professionals. This portion of compensation is determined subjectively based on qualitative and quantitative factors. In evaluating this component of an investment professional's compensation, AllianceBernstein considers the contribution to his/her team or discipline as it relates to that team's overall contribution to the long-term investment success, business results and strategy of AllianceBernstein. Quantitative factors considered include, among other things, relative investment performance (e.g., by comparison to competitor or peer group funds or similar styles of investments, and appropriate, broad-based or specific market indices), and consistency of performance. There are no specific formulas used to determine this part of an investment professional's compensation and the compensation is not tied to any pre-determined or specified level of performance. AllianceBernstein also considers qualitative factors such as the complexity and risk of investment strategies involved in the style or type of assets managed by the investment professional; success of marketing/business development efforts and client servicing; seniority/length of service with the firm; management and supervisory responsibilities; and fulfillment of AllianceBernstein's leadership criteria. (iii) Discretionary incentive compensation in the form of awards under AllianceBernstein's Partners Compensation Plan ("deferred awards"): AllianceBernstein's overall profitability determines the total amount of deferred awards available to investment professionals. The deferred awards are allocated among investment professionals based on criteria similar to those used to determine the annual cash bonus. There is no fixed formula for determining these amounts. Deferred awards, for which there are various investment options, vest over a four-year period and are generally forfeited if the employee resigns or AllianceBernstein terminates his/her employment. Investment options under the deferred awards plan include many of the same AllianceBernstein Mutual Funds offered to mutual fund investors, thereby creating a close alignment between the financial interests of the investment professionals and those of AllianceBernstein's clients and mutual fund shareholders with respect to the performance of those mutual funds. AllianceBernstein also permits deferred award recipients to allocate up to 50% of their award to investments in AllianceBernstein's publicly traded equity securities. (iv)Contributions under AllianceBernstein's Profit Sharing/401(k) Plan: The contributions are based on AllianceBernstein's overall profitability. The amount and allocation of the contributions are determined at the sole discretion of AllianceBernstein. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. /s/Jennifer Bergenfeld 3/23/06 __________________________________________ _______ (Signature of person authorized to (Date) sign on behalf of the Sub-Advisor) Jennifer Bergenfeld (Printed Name of person signing) Vice President & Counsel (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Equity Value Account Name of Fund/Account Brendan Healy Name of Portfolio Manager (Please use one form per Portfolio Manager per Fund/Account) American Century Firm Name For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the most recent practicable date). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 10 $6,892,739,511 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. N/A ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 3 $218,205,025 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 N/A ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 N/A ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 N/A ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. Certain conflicts of interest may arise in connection with the management of multiple portfolios. Potential conflicts include, for example, conflicts among investment strategies and conflicts in the allocation of investment opportunities. American Century has adopted policies and procedures that are designed to minimize the effects of these conflicts. Responsibility for managing American Century client portfolios is organized according to investment discipline. Investment disciplines include, for example, quantitative equity, small- and mid-cap growth, large-cap growth, value, international, fixed income, asset allocation, and sector funds. Within each discipline are one or more portfolio teams responsible for managing specific client portfolios. Generally, client portfolios with similar strategies are managed by the same team using the same objective, approach, and philosophy. Accordingly, portfolio holdings, position sizes, and industry and sector exposures tend to be similar across similar portfolios, which minimizes the potential for conflicts of interest. For each investment strategy, one portfolio is generally designated as the "policy portfolio." Other portfolios with similar investment objectives, guidelines and restrictions are referred to as "tracking portfolios." When managing policy and tracking portfolios, a portfolio team typically purchases and sells securities across all portfolios that the team manages. American Century's trading systems include various order entry programs that assist in the management of multiple portfolios, such as the ability to purchase or sell the same relative amount of one security across several funds. In some cases a tracking portfolio may have additional restrictions or limitations that cause it to be managed separately from the policy portfolio. Portfolio managers make purchase and sale decisions for such portfolios alongside the policy portfolio to the extent the overlap is appropriate, and separately, if the overlap is not. American Century may aggregate orders to purchase or sell the same security for multiple portfolios when it believes such aggregation is consistent with its duty to seek best execution on behalf of its clients. Orders of certain client portfolios may, by investment restriction or otherwise, be determined not available for aggregation. American Century has adopted policies and procedures to minimize the risk that a client portfolio could be systematically advantaged or disadvantaged in connection with the aggregation of orders. To the extent equity trades are aggregated, shares purchased or sold are generally allocated to the participating portfolios pro rata based on order size. Because initial public offerings (IPOs) are usually available in limited supply and in amounts too small to permit across-the-board pro rata allocations, American Century has adopted special procedures designed to promote a fair and equitable allocation of IPO securities among clients over time. Fixed income securities transactions are not executed through a centralized trading desk. Instead, portfolio teams are responsible for executing trades with broker/dealers in a predominantly dealer marketplace. Trade allocation decisions are made by the portfolio manager at the time of trade execution and orders entered on the fixed income order management system. Finally, investment of American Century's corporate assets in proprietary accounts may raise additional conflicts of interest. To mitigate these potential conflicts of interest, American Century has adopted policies and procedures intended to provide that trading in proprietary accounts is performed in a manner that does not give improper advantage to American Century to the detriment of client portfolios. For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. American Century portfolio manager compensation is structured to align the interests of portfolio managers with those of the shareholders whose assets they manage. It includes the components described below, each of which is determined with reference to a number of factors such as overall performance, market competition, and internal equity. Compensation is not directly tied to the value of assets held in client portfolios. Base Salary Portfolio managers receive base pay in the form of a fixed annual salary. Bonus A significant portion of portfolio manager compensation takes the form of an annual incentive bonus tied to performance. Bonus payments are determined by a combination of factors. One factor is fund investment performance. For policy portfolios, investment performance is measured by a combination of one- and three-year pre-tax performance relative to a pre-established, internally-customized peer group and/or market benchmark. Custom peer groups are constructed using all the funds in appropriate Lipper or Morningstar categories as a starting point. Funds are then eliminated from the peer group based on a standardized methodology designed to result in a final peer group that more closely represents the fund's true peers based on internal investment mandates and that is more stable (i.e., has less peer turnover) over the long-term. In cases where a portfolio manager has responsibility for more than one policy portfolio, the performance of each is assigned a percentage weight commensurate with the portfolio manager's level of responsibility. With regard to tracking portfolios, investment performance may be measured in a number of ways. The performance of the tracking portfolio may be measured against a customized peer group and/or market benchmark as described above for policy portfolios. Alternatively, the tracking portfolio may be evaluated relative to the performance of its policy portfolio, with the goal of matching the policy portfolio's performance as closely as possible. In some cases, the performance of a tracking portfolio is not separately considered; rather, the performance of the policy portfolio is the key metric. This is the case for the Principal Equity Value Account. A second factor in the bonus calculation relates to the performance of all American Century funds managed according to a particular investment style, such as U.S. growth or value. Performance is measured for each product individually as described above and then combined to create an overall composite for the product group. These composites may measure one-year performance (equal weighted) or a combination of one- and three-year performance (asset weighted) depending on the portfolio manager's responsibilities and products managed. This feature is designed to encourage effective teamwork among portfolio management teams in achieving long-term investment success for similarly styled portfolios. A portion of some portfolio managers' bonuses may be tied to individual performance goals, such as research projects and the development of new products. Finally, portfolio manager bonuses may occasionally be affected by extraordinarily positive or negative financial performance by American Century Companies, Inc. ("ACC"), the adviser's privately-held parent company. This feature has been designed to maintain investment performance as the primary component of portfolio manager bonuses while also providing a link to the adviser's ability to pay. Restricted Stock Plans Portfolio managers are eligible for grants of restricted stock of ACC. These grants are discretionary, and eligibility and availability can vary from year to year. The size of an individual's grant is determined by individual and product performance as well as other product-specific considerations. Grants can appreciate/depreciate in value based on the performance of the ACC stock during the restriction period (generally three years). Deferred Compensation Plans Portfolio managers are eligible for grants of deferred compensation. These grants are used in very limited situations, primarily for retention purposes. Grants are fixed and can appreciate/depreciate in value based on the performance of the American Century mutual funds in which the portfolio manager chooses to invest them. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. The portfolio manager did not own any shares of the fund as of December 31, 2005, the fund's most recent fiscal year end. /s/Ryan L. Blaine March 24, 2006 ---------------------------------------- -------------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Ryan L. Blaine -------------- (Printed Name of person signing) Corporate Counsel, American Century Investments (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Equity Value Account Name of Fund/Account Mark Mallon Name of Portfolio Manager (Please use one form per Portfolio Manager per Fund/Account) American Century Firm Name For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the most recent practicable date). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 10 $6,892,739,511 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. N/A ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 3 $218,205,025 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 N/A ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 N/A ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 N/A ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. Certain conflicts of interest may arise in connection with the management of multiple portfolios. Potential conflicts include, for example, conflicts among investment strategies and conflicts in the allocation of investment opportunities. American Century has adopted policies and procedures that are designed to minimize the effects of these conflicts. Responsibility for managing American Century client portfolios is organized according to investment discipline. Investment disciplines include, for example, quantitative equity, small- and mid-cap growth, large-cap growth, value, international, fixed income, asset allocation, and sector funds. Within each discipline are one or more portfolio teams responsible for managing specific client portfolios. Generally, client portfolios with similar strategies are managed by the same team using the same objective, approach, and philosophy. Accordingly, portfolio holdings, position sizes, and industry and sector exposures tend to be similar across similar portfolios, which minimizes the potential for conflicts of interest. For each investment strategy, one portfolio is generally designated as the "policy portfolio." Other portfolios with similar investment objectives, guidelines and restrictions are referred to as "tracking portfolios." When managing policy and tracking portfolios, a portfolio team typically purchases and sells securities across all portfolios that the team manages. American Century's trading systems include various order entry programs that assist in the management of multiple portfolios, such as the ability to purchase or sell the same relative amount of one security across several funds. In some cases a tracking portfolio may have additional restrictions or limitations that cause it to be managed separately from the policy portfolio. Portfolio managers make purchase and sale decisions for such portfolios alongside the policy portfolio to the extent the overlap is appropriate, and separately, if the overlap is not. American Century may aggregate orders to purchase or sell the same security for multiple portfolios when it believes such aggregation is consistent with its duty to seek best execution on behalf of its clients. Orders of certain client portfolios may, by investment restriction or otherwise, be determined not available for aggregation. American Century has adopted policies and procedures to minimize the risk that a client portfolio could be systematically advantaged or disadvantaged in connection with the aggregation of orders. To the extent equity trades are aggregated, shares purchased or sold are generally allocated to the participating portfolios pro rata based on order size. Because initial public offerings (IPOs) are usually available in limited supply and in amounts too small to permit across-the-board pro rata allocations, American Century has adopted special procedures designed to promote a fair and equitable allocation of IPO securities among clients over time. Fixed income securities transactions are not executed through a centralized trading desk. Instead, portfolio teams are responsible for executing trades with broker/dealers in a predominantly dealer marketplace. Trade allocation decisions are made by the portfolio manager at the time of trade execution and orders entered on the fixed income order management system. Finally, investment of American Century's corporate assets in proprietary accounts may raise additional conflicts of interest. To mitigate these potential conflicts of interest, American Century has adopted policies and procedures intended to provide that trading in proprietary accounts is performed in a manner that does not give improper advantage to American Century to the detriment of client portfolios. For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. American Century portfolio manager compensation is structured to align the interests of portfolio managers with those of the shareholders whose assets they manage. It includes the components described below, each of which is determined with reference to a number of factors such as overall performance, market competition, and internal equity. Compensation is not directly tied to the value of assets held in client portfolios. Base Salary Portfolio managers receive base pay in the form of a fixed annual salary. Bonus A significant portion of portfolio manager compensation takes the form of an annual incentive bonus tied to performance. Bonus payments are determined by a combination of factors. One factor is fund investment performance. For policy portfolios, investment performance is measured by a combination of one- and three-year pre-tax performance relative to a pre-established, internally-customized peer group and/or market benchmark. Custom peer groups are constructed using all the funds in appropriate Lipper or Morningstar categories as a starting point. Funds are then eliminated from the peer group based on a standardized methodology designed to result in a final peer group that more closely represents the fund's true peers based on internal investment mandates and that is more stable (i.e., has less peer turnover) over the long-term. In cases where a portfolio manager has responsibility for more than one policy portfolio, the performance of each is assigned a percentage weight commensurate with the portfolio manager's level of responsibility. With regard to tracking portfolios, investment performance may be measured in a number of ways. The performance of the tracking portfolio may be measured against a customized peer group and/or market benchmark as described above for policy portfolios. Alternatively, the tracking portfolio may be evaluated relative to the performance of its policy portfolio, with the goal of matching the policy portfolio's performance as closely as possible. In some cases, the performance of a tracking portfolio is not separately considered; rather, the performance of the policy portfolio is the key metric. This is the case for the Principal Equity Value Account. A second factor in the bonus calculation relates to the performance of all American Century funds managed according to a particular investment style, such as U.S. growth or value. Performance is measured for each product individually as described above and then combined to create an overall composite for the product group. These composites may measure one-year performance (equal weighted) or a combination of one- and three-year performance (asset weighted) depending on the portfolio manager's responsibilities and products managed. This feature is designed to encourage effective teamwork among portfolio management teams in achieving long-term investment success for similarly styled portfolios. A portion of some portfolio managers' bonuses may be tied to individual performance goals, such as research projects and the development of new products. Finally, portfolio manager bonuses may occasionally be affected by extraordinarily positive or negative financial performance by American Century Companies, Inc. ("ACC"), the adviser's privately-held parent company. This feature has been designed to maintain investment performance as the primary component of portfolio manager bonuses while also providing a link to the adviser's ability to pay. Restricted Stock Plans Portfolio managers are eligible for grants of restricted stock of ACC. These grants are discretionary, and eligibility and availability can vary from year to year. The size of an individual's grant is determined by individual and product performance as well as other product-specific considerations. Grants can appreciate/depreciate in value based on the performance of the ACC stock during the restriction period (generally three years). Deferred Compensation Plans Portfolio managers are eligible for grants of deferred compensation. These grants are used in very limited situations, primarily for retention purposes. Grants are fixed and can appreciate/depreciate in value based on the performance of the American Century mutual funds in which the portfolio manager chooses to invest them. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. The portfolio manager did not own any shares of the fund as of December 31, 2005, the fund's most recent fiscal year end. /s/Ryan L. Blaine March 23, 2006 ---------------------------------------- -------------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Ryan L. Blaine --------------- (Printed Name of person signing) Corporate Counsel, American Century Investments (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Equity Value Account Name of Fund/Account Charles Ritter Name of Portfolio Manager (Please use one form per Portfolio Manager per Fund/Account) American Century Firm Name For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the most recent practicable date). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 10 $6,892,739,511 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. N/A ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 3 $218,205,025 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 N/A ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 N/A ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 N/A ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. Certain conflicts of interest may arise in connection with the management of multiple portfolios. Potential conflicts include, for example, conflicts among investment strategies and conflicts in the allocation of investment opportunities. American Century has adopted policies and procedures that are designed to minimize the effects of these conflicts. Responsibility for managing American Century client portfolios is organized according to investment discipline. Investment disciplines include, for example, quantitative equity, small- and mid-cap growth, large-cap growth, value, international, fixed income, asset allocation, and sector funds. Within each discipline are one or more portfolio teams responsible for managing specific client portfolios. Generally, client portfolios with similar strategies are managed by the same team using the same objective, approach, and philosophy. Accordingly, portfolio holdings, position sizes, and industry and sector exposures tend to be similar across similar portfolios, which minimizes the potential for conflicts of interest. For each investment strategy, one portfolio is generally designated as the "policy portfolio." Other portfolios with similar investment objectives, guidelines and restrictions are referred to as "tracking portfolios." When managing policy and tracking portfolios, a portfolio team typically purchases and sells securities across all portfolios that the team manages. American Century's trading systems include various order entry programs that assist in the management of multiple portfolios, such as the ability to purchase or sell the same relative amount of one security across several funds. In some cases a tracking portfolio may have additional restrictions or limitations that cause it to be managed separately from the policy portfolio. Portfolio managers make purchase and sale decisions for such portfolios alongside the policy portfolio to the extent the overlap is appropriate, and separately, if the overlap is not. American Century may aggregate orders to purchase or sell the same security for multiple portfolios when it believes such aggregation is consistent with its duty to seek best execution on behalf of its clients. Orders of certain client portfolios may, by investment restriction or otherwise, be determined not available for aggregation. American Century has adopted policies and procedures to minimize the risk that a client portfolio could be systematically advantaged or disadvantaged in connection with the aggregation of orders. To the extent equity trades are aggregated, shares purchased or sold are generally allocated to the participating portfolios pro rata based on order size. Because initial public offerings (IPOs) are usually available in limited supply and in amounts too small to permit across-the-board pro rata allocations, American Century has adopted special procedures designed to promote a fair and equitable allocation of IPO securities among clients over time. Fixed income securities transactions are not executed through a centralized trading desk. Instead, portfolio teams are responsible for executing trades with broker/dealers in a predominantly dealer marketplace. Trade allocation decisions are made by the portfolio manager at the time of trade execution and orders entered on the fixed income order management system. Finally, investment of American Century's corporate assets in proprietary accounts may raise additional conflicts of interest. To mitigate these potential conflicts of interest, American Century has adopted policies and procedures intended to provide that trading in proprietary accounts is performed in a manner that does not give improper advantage to American Century to the detriment of client portfolios. For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. American Century portfolio manager compensation is structured to align the interests of portfolio managers with those of the shareholders whose assets they manage. It includes the components described below, each of which is determined with reference to a number of factors such as overall performance, market competition, and internal equity. Compensation is not directly tied to the value of assets held in client portfolios. Base Salary Portfolio managers receive base pay in the form of a fixed annual salary. Bonus A significant portion of portfolio manager compensation takes the form of an annual incentive bonus tied to performance. Bonus payments are determined by a combination of factors. One factor is fund investment performance. For policy portfolios, investment performance is measured by a combination of one- and three-year pre-tax performance relative to a pre-established, internally-customized peer group and/or market benchmark. Custom peer groups are constructed using all the funds in appropriate Lipper or Morningstar categories as a starting point. Funds are then eliminated from the peer group based on a standardized methodology designed to result in a final peer group that more closely represents the fund's true peers based on internal investment mandates and that is more stable (i.e., has less peer turnover) over the long-term. In cases where a portfolio manager has responsibility for more than one policy portfolio, the performance of each is assigned a percentage weight commensurate with the portfolio manager's level of responsibility. With regard to tracking portfolios, investment performance may be measured in a number of ways. The performance of the tracking portfolio may be measured against a customized peer group and/or market benchmark as described above for policy portfolios. Alternatively, the tracking portfolio may be evaluated relative to the performance of its policy portfolio, with the goal of matching the policy portfolio's performance as closely as possible. In some cases, the performance of a tracking portfolio is not separately considered; rather, the performance of the policy portfolio is the key metric. This is the case for the Principal Equity Value Account. A second factor in the bonus calculation relates to the performance of all American Century funds managed according to a particular investment style, such as U.S. growth or value. Performance is measured for each product individually as described above and then combined to create an overall composite for the product group. These composites may measure one-year performance (equal weighted) or a combination of one- and three-year performance (asset weighted) depending on the portfolio manager's responsibilities and products managed. This feature is designed to encourage effective teamwork among portfolio management teams in achieving long-term investment success for similarly styled portfolios. A portion of some portfolio managers' bonuses may be tied to individual performance goals, such as research projects and the development of new products. Finally, portfolio manager bonuses may occasionally be affected by extraordinarily positive or negative financial performance by American Century Companies, Inc. ("ACC"), the adviser's privately-held parent company. This feature has been designed to maintain investment performance as the primary component of portfolio manager bonuses while also providing a link to the adviser's ability to pay. Restricted Stock Plans Portfolio managers are eligible for grants of restricted stock of ACC. These grants are discretionary, and eligibility and availability can vary from year to year. The size of an individual's grant is determined by individual and product performance as well as other product-specific considerations. Grants can appreciate/depreciate in value based on the performance of the ACC stock during the restriction period (generally three years). Deferred Compensation Plans Portfolio managers are eligible for grants of deferred compensation. These grants are used in very limited situations, primarily for retention purposes. Grants are fixed and can appreciate/depreciate in value based on the performance of the American Century mutual funds in which the portfolio manager chooses to invest them. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. The portfolio manager did not own any shares of the fund as of December 31, 2005, the fund's most recent fiscal year end. /s/Ryan L. Blaine March 23, 2006 ---------------------------------------- -------------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Ryan L. Blaine -------------- (Printed Name of person signing) Corporate Counsel, American Century Investments (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal SmallCap growth Account (Variable Contracts) Fund, Inc. Name of Fund Joseph W. Garner Name of Portfolio Manager (Please use one form per Portfolio Manager per Fund/Account) Emerald Advisers, Inc. Firm Name For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 3 $472 mm ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 104 $1,893 mm ----------------------- ------------------------ or each of the categories, the number of accounts and the total assets in the accounts with respect to which advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manager. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Emerald has a company-wide compensation/incentive plan. A consulting firm aided in the development of this plan. The first stage was implemented in 1999, and included a salary grid structure for all employees and job titles. The firm's Compensation Committee (which includes members of Emerald's board of directors) can adjust an individual's salary based on actual job performance. The salary grid points were chosen in concert with the Consultant following an industry review and comparison survey. Emerald's marketing staff is paid commissions based on (1) new dollars flowing into the firm and (2) the retention of assets over the long-term. The second stage is a quarterly Bonus Plan that keys job performance to eligibility and amount. The "firm-wide" component, which mandates whether or not the firm as a whole will pay yearly bonuses, is tied to the firm's performance relative to the Russell 2000 Growth Index and was adopted beginning in 2000. Bonuses can range from zero to 200% of base salaries. If the firm's performance is sufficient to warrant bonus payments, the Compensation Committee decides on a percentage payout of the eligible bonus pool to each operating unit: Portfolio Management, Research, Marketing and Operations. Finally, each unit's Managing Director assigns specific employee bonus amounts from the eligible pool, based on quarterly performance reviews, and with a sign-off from the Compensation Committee. The final portion of the new plan is a Long-Term Incentive Plan. The Plan will award phantom stock to key employees, based on their job performance and the importance of their role within the organization. The Plan is completely discretionary and any phantom stock awards will be decided by the company's Compensation Committee. Prior to the implementation of the Plan, Emerald has consistently awarded or offered the purchase of direct equity ownership in the firm to key employees. Emerald believes it has a competitive compensation/incentive structure relative to its industry based both on the involvement of the Consultant and the fact that it has consistently retained its key senior management staff over the long-term. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None. Our portfolio managers are prohibited from purchasing shares of this fund. /s/Joseph W. Garner 3/27/06 ----------------------------------------- -------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Joseph W. Garner (Printed Name of person signing) Portfolio Manager/Dir. of Research (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Small Cap Growth Account (Variable Contracts) Fund, Inc. Name of Fund Kenneth G. Mertz II, CFA Name of Portfolio Manager (Please use one form per Portfolio Manager per Fund/Account) Emerald Advisers, Inc. Firm Name For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 3 $472 mm ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 104 $1,893 mm ----------------------- ------------------------ or each of the categories, the number of accounts and the total assets in the accounts with respect to which advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manager. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Emerald has a company-wide compensation/incentive plan. A consulting firm aided in the development of this plan. The first stage was implemented in 1999, and included a salary grid structure for all employees and job titles. The firm's Compensation Committee (which includes members of Emerald's board of directors) can adjust an individual's salary based on actual job performance. The salary grid points were chosen in concert with the Consultant following an industry review and comparison survey. Emerald's marketing staff is paid commissions based on (1) new dollars flowing into the firm and (2) the retention of assets over the long-term. The second stage is a quarterly Bonus Plan that keys job performance to eligibility and amount. The "firm-wide" component, which mandates whether or not the firm as a whole will pay yearly bonuses, is tied to the firm's performance relative to the Russell 2000 Growth Index and was adopted beginning in 2000. Bonuses can range from zero to 200% of base salaries. If the firm's performance is sufficient to warrant bonus payments, the Compensation Committee decides on a percentage payout of the eligible bonus pool to each operating unit: Portfolio Management, Research, Marketing and Operations. Finally, each unit's Managing Director assigns specific employee bonus amounts from the eligible pool, based on quarterly performance reviews, and with a sign-off from the Compensation Committee. The final portion of the new plan is a Long-Term Incentive Plan. The Plan will award phantom stock to key employees, based on their job performance and the importance of their role within the organization. The Plan is completely discretionary and any phantom stock awards will be decided by the company's Compensation Committee. Prior to the implementation of the Plan, Emerald has consistently awarded or offered the purchase of direct equity ownership in the firm to key employees. Emerald believes it has a competitive compensation/incentive structure relative to its industry based both on the involvement of the Consultant and the fact that it has consistently retained its key senior management staff over the long-term. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None. Our portfolio managers are prohibited from purchasing shares of this fund. /s/Kenneth G. Mertz, II 3/27/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Kenneth G. Mertz II, CFA (Printed Name of person signing) President & CIO (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Small Cap Growth Account (Variable Contracts) Fund, Inc. Name of Fund Stacey L. Sears Name of Portfolio Manager (Please use one form per Portfolio Manager per Fund/Account) Emerald Advisers, Inc. Firm Name For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 3 $472 mm ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 104 $1,893 mm ----------------------- ------------------------ or each of the categories, the number of accounts and the total assets in the accounts with respect to which advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manager. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Emerald has a company-wide compensation/incentive plan. A consulting firm aided in the development of this plan. The first stage was implemented in 1999, and included a salary grid structure for all employees and job titles. The firm's Compensation Committee (which includes members of Emerald's board of directors) can adjust an individual's salary based on actual job performance. The salary grid points were chosen in concert with the Consultant following an industry review and comparison survey. Emerald's marketing staff is paid commissions based on (1) new dollars flowing into the firm and (2) the retention of assets over the long-term. The second stage is a quarterly Bonus Plan that keys job performance to eligibility and amount. The "firm-wide" component, which mandates whether or not the firm as a whole will pay yearly bonuses, is tied to the firm's performance relative to the Russell 2000 Growth Index and was adopted beginning in 2000. Bonuses can range from zero to 200% of base salaries. If the firm's performance is sufficient to warrant bonus payments, the Compensation Committee decides on a percentage payout of the eligible bonus pool to each operating unit: Portfolio Management, Research, Marketing and Operations. Finally, each unit's Managing Director assigns specific employee bonus amounts from the eligible pool, based on quarterly performance reviews, and with a sign-off from the Compensation Committee. The final portion of the new plan is a Long-Term Incentive Plan. The Plan will award phantom stock to key employees, based on their job performance and the importance of their role within the organization. The Plan is completely discretionary and any phantom stock awards will be decided by the company's Compensation Committee. Prior to the implementation of the Plan, Emerald has consistently awarded or offered the purchase of direct equity ownership in the firm to key employees. Emerald believes it has a competitive compensation/incentive structure relative to its industry based both on the involvement of the Consultant and the fact that it has consistently retained its key senior management staff over the long-term. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None. Our portfolio managers are prohibited from purchasing shares of this fund. /s/Stacey L. Sears 3/27/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Stacey L. Sears (Printed Name of person signing) Portfolio Manager/Senior Vice President (Title of person signing) Logo Grantham, Mayo, Van Otterloo & Co. LLC 40 Rowes Whart - Boston, MA 02110 T: (617) 330-7500 - F: (617) 261-0134 - www.gmo.com March 23, 2006 Amy McCann Princor Financial Services Corporation 711 High Street, N-004-E20 Des Moines, IA 50392-2080 Dear Ms. McCann: I hereby certify that to the best of my knowledge, the information provided in the attached Portfolio Manager Questionnaire for the PVC - LargeCap Growth Equity account is accurate. Sincerely, /s/Brian Bellerby Brian Bellerby Compliance Specialist ------------------------------ ----------------------------------------------- --------------------------------------------------
Senior Member of Other registered investment companies managed Other pooled investment vehicles GMO Quantitative Division (including other non-GMO mutual fund managed (world-wide) subadvisory relationships) ------------------------------ ----------------------------------------------- -------------------------------------------------- ------------------------------ ------------------- --------------------------- ----------------- -------------------------------- Number of accounts Total assets Number of Total assets accounts ------------------------------ ------------------- --------------------------- ----------------- -------------------------------- ------------------------------ ------------------- --------------------------- ----------------- -------------------------------- Sam Wilderman 25 $21,029,754,610.31 6 $1,611,842,995.73 ------------------------------ ------------------- --------------------------- ----------------- -------------------------------- ------------------------------ ----------------------------------------------- -------------------------------------------------- Other registered investment Other pooled investment vehicles companies managed for which managed (world-wide) for which GMO GMO receives a performance- receives a performance-based fee based fee (including other non-GMO mutual fund subadvisory relationships) ------------------------------ ----------------------------------------------- -------------------------------------------------- ------------------------------ ------------------- --------------------------- ----------------- -------------------------------- Number of Total assets* Number of Total assets* accounts* accounts* ------------------------------ ------------------- --------------------------- ----------------- -------------------------------- ------------------------------ ------------------- --------------------------- ----------------- -------------------------------- Sam Wilderman 3 $4,289,764,993.92 5 $1,551,639,226.07 ------------------------------ ------------------- --------------------------- ----------------- -------------------------------- * Subset of accounts and assets noted above
------------------------------ ------------------------------------------------- Separate accounts managed (world-wide) ------------------------------ ------------------------------------------------- ------------------------------ -------------- ---------------------------------- Number of Total assets accounts ------------------------------ -------------- ---------------------------------- ------------------------------ -------------- ---------------------------------- Sam Wilderman 22 $3,028,078,801.06 ------------------------------ -------------- ---------------------------------- ------------------------------ ------------------------------------------------- Separate accounts managed (world-wide) for which GMO receives a performance-based fee ------------------------------ ------------------------------------------------- ------------------------------ -------------- ---------------------------------- Number of Total assets* accounts* ------------------------------ -------------- ---------------------------------- ------------------------------ -------------- ---------------------------------- Sam Wilderman 8 $1,473,310,270.77 ------------------------------ -------------- ---------------------------------- * Subset of accounts and assets noted above Description of material conflicts: Whenever a portfolio manager manages other accounts, including accounts that pay higher fees or accounts that pay performance-based fees, potential conflicts of interest exist, including potential conflicts between the investment strategy of the fund and the investment strategy of the other accounts and potential conflicts in the allocation of investment opportunities between the fund and such other accounts. GMO believes several factors limit the conflicts between the Fund and other similar stock accounts managed by the Fund's portfolio management team or individual members of the team. First, discipline and constraints are imposed because the investment programs of the Fund and other similar accounts are determined based on quantitative models. Second, all portfolio management team members are aware of and abide by GMO's trade allocation procedures, which seek to ensure fair allocation of investment opportunities among all accounts. Performance attribution with full transparency of holdings and identification of contributors to gains and losses act as important controls on conflicts that might otherwise exist. Performance dispersion among accounts employing the same investment strategy but with different fee structures is periodically examined by the Fund's portfolio management team and GMO's Investment Analysis team to ensure that any divergence in expected performance is adequately explained by differences in the client's investment guidelines and timing of cash flows. Description of the structure of, and the method used to determine, the compensation of each member of the fund's portfolio management team: The senior member of the Fund's portfolio management team is a member (partner) of GMO. Compensation for the senior member consists of a base salary, a partnership interest in the firm's profits and possibly an additional, discretionary, bonus. Compensation does not disproportionately reward out-performance by higher fee/performance fee products. GMO's Compensation Committee sets the senior member's base salary taking into account current industry norms and market data to ensure that the base salary is competitive. The Compensation Committee also determines the senior member's partnership interest, taking into account the senior member's contribution to GMO and GMO's mission statement. A discretionary bonus may be paid to recognize specific business contributions and to ensure that the total level of compensation is competitive with the market. Because each member's compensation is based on his individual performance, GMO does not have a typical percentage split among base salary, bonus and other compensation. Partnership interests in GMO are the primary incentive for senior level persons to continue employment at GMO. GMO believes that partnership interests provide the best incentive to maintain stability of portfolio management personnel. Dollar range of fund securities owned by each member of the fund's portfolio management team: As of the portfolios' most recently completed fiscal year, the senior member has no beneficial interest in the portfolios' shares. Principal Variable Contracts Fund, Inc. Small Cap Value Account Information as of December 31, 2005 ------------------------------------------------------------------------------------------------------------------------------------ Principal Variable Contracts Fund, Inc. Small Cap Value Account ("Fund") J.P. Morgan Investment Management, Inc. ("Adviser") ------------------------------------------------------------------------------------------------------------------------------------ ----------------------------- ------------------------------------------------------------------------ ----------------------------- (a)(1) Identify (a)(2) For each person identified in column (a)(1), (a)(3) For each of the categories in column (a)(2), portfolio manager(s) provide number of other accounts managed by the provide number of accounts and the total assets in the of the Adviser person within each category below and accounts with respect to which the advisory fee is to be named in the the total assets in the accounts managed within each based prospectus on the performance of the account Fund category below ------------------ ------------------------------------------------------------ ---------------------------------------------------- ------------------ -------------------- -------------------- ------------------ -------------- -------------------- ----------------
Registered Other Pooled Other Accounts Registered Other Pooled Other Accounts Investment Investment Investment Investment Companies Vehicles Companies Vehicles ------------------ -------------------- -------------------- ------------------ -------------- -------------------- ---------------- ------------------ ---------- --------- ---------- --------- ---------- ------- ------- ------ ------------ ------- --------- ------ Number Total Number Total Number Total Number Total Number Total Number Total of Assets of Assets Of Assets of Assets of Assets of Assets Accounts (mm) Accounts (mm) Accounts (mm) Accounts Accounts Accounts ------------------ ---------- --------- ---------- --------- ---------- ------- ------- ------ ------------ ------- --------- ------ ------------------ ---------- --------- ---------- --------- ---------- ------- ------- ------ ------------ ------- --------- ------ Christopher Blum 16 3,720.00 9 1,112.00 7 599.00 N/A N/A N/A N/A N/A N/A ------------------ ---------- --------- ---------- --------- ---------- ------- ------- ------ ------------ ------- --------- ------ ------------------ ---------- --------- ---------- --------- ---------- ------- ------- ------ ------------ ------- --------- ------ Dennis Ruhl 16 3,720.00 9 1,112.00 7 599.00 N/A N/A N/A N/A N/A N/A ------------------ ---------- --------- ---------- --------- ---------- ------- ------- ------ ------------ ------- --------- ------
(a)(4) Description of any Potential Material Conflicts of Interest that may arise in connection with the portfolio manager's management of the Fund and other accounts. The chart above shows the number, type and market value as of 12/31/05 of the accounts other than the Fund that are managed by the Fund's portfolio manager. The potential for conflicts of interest exists when portfolio managers manage other accounts with similar investment objectives and strategies as the Fund ("Similar Accounts"). Potential conflicts may include, for example, conflicts between investment strategies and conflicts in the allocation of investment opportunities. Responsibility for managing the Adviser's clients' portfolios is organized according to investment strategies within asset classes. Generally, client portfolios with similar strategies are managed by portfolio managers in the same portfolio management group using the same objectives, approach and philosophy. Therefore, portfolio holdings, relative position sizes and industry and sector exposures tend to be similar across similar portfolios, which minimizes the potential for conflicts of interest. The Adviser may receive more compensation with respect to certain Similar Accounts than that received with respect to the Fund or may receive compensation based in part on the performance of certain Similar Accounts. This may create a potential conflict of interest for the Adviser or its portfolio managers by providing an incentive to favor these Similar Accounts when, for example, placing securities transactions. In addition, the Adviser could be viewed as having a conflict of interest to the extent that the Adviser or an affiliate has a proprietary investment in Similar Accounts, the portfolio managers have personal investments in Similar Accounts or the Similar Accounts are investment options in the Adviser's employee benefit plans. Potential conflicts of interest may arise with both the aggregation and allocation of securities transactions and allocation of limited investment opportunities. Allocations of aggregated trades, particularly trade orders that were only partially completed due to limited availability, and allocation of investment opportunities generally, could raise a potential conflict of interest, as the Adviser may have an incentive to allocate securities that are expected to increase in value to favored accounts. Initial public offerings, in particular, are frequently of very limited availability. The Adviser may be perceived as causing accounts it manages to participate in an offering to increase the Adviser's overall allocation of securities in that offering. A potential conflict of interest also may be perceived to arise if transactions in one account closely follow related transactions in a different account, such as when a purchase increases the value of securities previously purchased by another account, or when a sale in one account lowers the sale price received in a sale by a second account. If the Adviser manages accounts that engage in short sales of securities of the type in which the Fund invests, the Adviser could be seen as harming the performance of the Fund for the benefit of the accounts engaging in short sales if the short sales cause the market value of the securities to fall. The Adviser has policies and procedures designed to manage these conflicts described above such as allocation of investment opportunities to achieve fair and equitable allocation of investment opportunities among its clients over time. For example: Orders for the same equity security are aggregated on a continual basis throughout each trading day consistent with the Adviser's duty of best execution for its clients. If aggregated trades are fully executed, accounts participating in the trade will be allocated their pro rata share on an average price basis. Partially completed orders generally will be allocated among the participating accounts on a pro-rata average price basis, subject to certain limited exceptions. For example, accounts that would receive a de minimis allocation relative to their size may be excluded from the order. Another exception may occur when thin markets or price volatility require that an aggregated order be completed in multiple executions over several days. If partial completion of the order would result in an uneconomic allocation to an account due to fixed transaction or custody costs, the adviser may exclude small orders until 50% of the total order is completed. Then the small orders will be executed. Following this procedure, small orders will lag in the early execution of the order, but will be completed before completion of the total order. Purchases of money market instruments and fixed income securities cannot always be allocated pro-rata across the accounts with the same investment strategy and objective. However, the Adviser attempts to mitigate any potential unfairness by basing non-pro rata allocations upon an objective predetermined criteria for the selection of investments and a disciplined process for allocating securities with similar duration, credit quality and liquidity in the good faith judgment of the Adviser so that fair and equitable allocation will occur over time. (b) Portfolio Manager Compensation The Adviser's portfolio managers participate in a competitive compensation program that is designed to attract and retain outstanding people and closely link the performance of investment professionals to client investment objectives. The total compensation program includes a base salary fixed from year to year and a variable performance bonus consisting of cash incentives and restricted stock and, in some cases, mandatory deferred compensation. These elements reflect individual performance and the performance of the Adviser's business as a whole. Each portfolio manager's performance is formally evaluated annually based on a variety of factors including the aggregate size and blended performance of the portfolios such portfolio manager manages. Individual contribution relative to client goals carries the highest impact. Portfolio manager compensation is primarily driven by meeting or exceeding clients' risk and return objectives, relative performance to competitors or competitive indices and compliance with firm policies and regulatory requirements. In evaluating each portfolio manager's performance with respect to the mutual funds he or she manages, the funds' pre-tax performance is compared to the appropriate market peer group and to each fund's benchmark index listed in the fund's prospectus over one, three and five year periods (or such shorter time as the portfolio manager has managed the fund). Investment performance is generally more heavily weighted to the long-term. Stock awards are granted as part of an employee's annual performance bonus and comprise from 0% to 35% of a portfolio manager's total award. As the level of incentive compensation increases, the percentage of compensation awarded in restricted stock also increases. Certain investment professionals may also be subject to a mandatory deferral of a portion of their compensation into proprietary mutual funds based on long-term sustained investment performance. (c) Ownership of Securities --------------------- --------- ------------- ------------------ -------------------- -------------------- ------------- -----------
Portfolio Manager None $1-$10,000 $10,001-$50,000 $50,001-$100,000 $100,001-$500,000 $500,001 - over $1,000,000 $1,000,000 --------------------- --------- ------------- ------------------ -------------------- -------------------- ------------- ----------- --------------------- --------- ------------- ------------------ -------------------- -------------------- ------------- ----------- Christopher Blum N/A N/A N/A N/A N/A N/A N/A --------------------- --------- ------------- ------------------ -------------------- -------------------- ------------- ----------- --------------------- --------- ------------- ------------------ -------------------- -------------------- ------------- ----------- Dennis Ruhl N/A N/A N/A N/A N/A N/A N/A --------------------- --------- ------------- ------------------ -------------------- -------------------- ------------- -----------
FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts - MidCap Growth Account Name of Fund Adam T. Logan, CFA Name of Portfolio Manager (Please use one form per Portfolio Manager per Fund/Account) Mellon Equity Associates, LLP Firm Name For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 5 1,134,580,049 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 11 348,534,393 ----------------------- ------------------------ or each of the categories, the number of accounts and the total assets in the accounts with respect to which advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manager. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Portfolio Manager Compensation The portfolio manager's cash compensation is comprised primarily of a market-based salary and an incentive compensation plan (annual and long term incentive). Funding for the MEA Annual Incentive Plan and Long Term Incentive Plan is through a pre-determined fixed percentage of overall company profitability. Therefore, all bonus awards are based initially on Company performance. The investment professionals are eligible to receive annual cash bonus awards from the incentive compensation plan. Annual awards are granted in March for the prior calendar year. Individual awards for investment professionals are discretionary, based on product performance, goals established at the beginning of each calendar year and a subjective evaluation of the portfolio manager's contribution to the overall investment process. Also considered in determining individual awards are team participation and general contributions to MEA. All portfolio managers are also eligible to participate in the MEA Long Term Incentive Plan. This plan provides for an annual award, payable in deferred cash that cliff vests after 3 years, with an interest rate equal to the average year over year earnings growth of MEA (capped at 20% per year). Management has discretion with respect to actual participation and award size. Mellon Elective Deferred Compensation Plan Portfolio managers whose compensation exceeds certain levels may elect to defer portions of their base salaries and/or incentive compensation pursuant to Mellon's elective deferred compensation plan. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Adam T. Logan 3/22/06 ----------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Adam T.Logan, CFA Portfolio Manager FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts - MidCap Growth Account Name of Fund John R. O'Toole, CFA Name of Portfolio Manager (Please use one form per Portfolio Manager per Fund/Account) Mellon Equity Associates, LLP Firm Name For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 6 1,794,152,374 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 3 94,479,651 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 21 479,705,885 ----------------------- ------------------------ or each of the categories, the number of accounts and the total assets in the accounts with respect to which advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 4 47,426,111 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manager. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. The portfolio manager's cash compensation is comprised primarily of a market-based salary and an incentive compensation plan (annual and long term incentive). Funding for the MEA Annual Incentive Plan and Long Term Incentive Plan is through a pre-determined fixed percentage of overall company profitability. Therefore, all bonus awards are based initially on Company performance. The investment professionals are eligible to receive annual cash bonus awards from the incentive compensation plan. Annual awards are granted in March for the prior calendar year. Individual awards for investment professionals are discretionary, based on product performance, goals established at the beginning of each calendar year and a subjective evaluation of the portfolio manager's contribution to the overall investment process. Also considered in determining individual awards are team participation and general contributions to MEA. All portfolio managers are also eligible to participate in the MEA Long Term Incentive Plan. This plan provides for an annual award, payable in deferred cash that cliff vests after 3 years, with an interest rate equal to the average year over year earnings growth of MEA (capped at 20% per year). Management has discretion with respect to actual participation and award size. Mellon Elective Deferred Compensation Plan Portfolio managers whose compensation exceeds certain levels may elect to defer portions of their base salaries and/or incentive compensation pursuant to Mellon's elective deferred compensation plan. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/John R. O'Toole 3/22/2006 ---------------------------------------- --------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) John R. O'Toole, CFA Senior Portfolio Manager FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts - SmallCap Value Fund I Name of Fund Ronald P. Gala, CFA Name of Portfolio Manager (Please use one form per Portfolio Manager per Fund/Account) Mellon Equity Associates, LLP Firm Name For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 6 1,087,796,112 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 13 1,089,771,722 ----------------------- ------------------------ or each of the categories, the number of accounts and the total assets in the accounts with respect to which advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 4 391,420,657 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manager. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Portfolio Manager Compensation The portfolio manager's cash compensation is comprised primarily of a market-based salary and an incentive compensation plan (annual and long term incentive). Funding for the MEA Annual Incentive Plan and Long Term Incentive Plan is through a pre-determined fixed percentage of overall company profitability. Therefore, all bonus awards are based initially on Company performance. The investment professionals are eligible to receive annual cash bonus awards from the incentive compensation plan. Annual awards are granted in March for the prior calendar year. Individual awards for investment professionals are discretionary, based on product performance, goals established at the beginning of each calendar year and a subjective evaluation of the portfolio manager's contribution to the overall investment process. Also considered in determining individual awards are team participation and general contributions to MEA. All portfolio managers are also eligible to participate in the MEA Long Term Incentive Plan. This plan provides for an annual award, payable in deferred cash that cliff vests after 3 years, with an interest rate equal to the average year over year earnings growth of MEA (capped at 20% per year). Management has discretion with respect to actual participation and award size. Mellon Elective Deferred Compensation Plan Portfolio managers whose compensation exceeds certain levels may elect to defer portions of their base salaries and/or incentive compensation pursuant to Mellon's elective deferred compensation plan. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Ronald P. Gala 3/22/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Ronald P. Gala, CFA Senior Portfolio Manager FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts - SmallCap Value Fund Name of Fund Peter D. Goslin, CFA Name of Portfolio Manager (Please use one form per Portfolio Manager per Fund/Account) Mellon Equity Associates, LLP Firm Name For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 4 306,620,708 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 1 181,524,761 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 7 222,035,381 ----------------------- ------------------------ or each of the categories, the number of accounts and the total assets in the accounts with respect to which advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manager. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Portfolio Manager Compensation The portfolio manager's cash compensation is comprised primarily of a market-based salary and an incentive compensation plan (annual and long term incentive). Funding for the MEA Annual Incentive Plan and Long Term Incentive Plan is through a pre-determined fixed percentage of overall company profitability. Therefore, all bonus awards are based initially on Company performance. The investment professionals are eligible to receive annual cash bonus awards from the incentive compensation plan. Annual awards are granted in March for the prior calendar year. Individual awards for investment professionals are discretionary, based on product performance, goals established at the beginning of each calendar year and a subjective evaluation of the portfolio manager's contribution to the overall investment process. Also considered in determining individual awards are team participation and general contributions to MEA. All portfolio managers are also eligible to participate in the MEA Long Term Incentive Plan. This plan provides for an annual award, payable in deferred cash that cliff vests after 3 years, with an interest rate equal to the average year over year earnings growth of MEA (capped at 20% per year). Management has discretion with respect to actual participation and award size. Mellon Elective Deferred Compensation Plan Portfolio managers whose compensation exceeds certain levels may elect to defer portions of their base salaries and/or incentive compensation pursuant to Mellon's elective deferred compensation plan. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Peter D. Goslin 3/22/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Peter D. Goslin, CFA Portfolio Manager FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE PVC - Asset Allocation Account Name of Fund Francine Bovich Name of Portfolio Manager (Please use one form per Portfolio Manager per Fund/Account) Morgan Stanley Investment Management Inc Firm Name For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 4 $653 million ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 1 $160 million ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 16 $5.7 billion ----------------------- ------------------------ or each of the categories, the number of accounts and the total assets in the accounts with respect to which advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 1 $216 million ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. Because the portfolio manager manages assets for other investment companies, pooled investment vehicles, and/or other accounts (including institutional clients, pension plans and certain high net worth individuals), there may be an incentive to favor one client over another resulting in conflicts of interest. For instance, the subadviser may receive fees from certain accounts that are higher than the fee it receives from the Asset Allocation Account, or it may receive a performance-based fee on certain accounts. In those instances, the portfolio manager may have an incentive to favor the higher and/or performance-based fee accounts over the Asset Allocation Account. The subadviser has adopted trade allocation and other policies and procedures that it believes are reasonably designed to address these and other conflicts of interest. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manager. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. PORTFOLIO MANAGER COMPENSATION STRUCTURE Portfolio managers receive a combination of base compensation and discretionary compensation, comprising a cash bonus and several deferred compensation programs described below. The methodology used to determine portfolio manager compensation is applied across all funds/accounts managed by the portfolio manager. BASE SALARY COMPENSATION. Generally, portfolio managers receive base salary compensation based on the level of their position with the subadviser. DISCRETIONARY COMPENSATION. In addition to base compensation, portfolio managers may receive discretionary compensation. Discretionary compensation can include: - CASH BONUS; - MORGAN STANLEY'S EQUITY INCENTIVE COMPENSATION PROGRAM (EICP) AWARDS -- a mandatory program that defers a portion of discretionary year-end compensation into restricted stock units or other awards based on Morgan Stanley common stock that are subject to vesting and other conditions; - INVESTMENT MANAGEMENT DEFERRED COMPENSATION PLAN (IMDCP) AWARDS -- a mandatory program that defers a portion of discretionary year-end compensation and notionally invests it in designated funds advised by the Subadviser or its affiliates. The award is subject to vesting and other conditions. Portfolio Managers must notionally invest a minimum of 25% to a maximum of 50% of the IMDCP deferral into a combination of the designated funds they manage that are included in the IMDCP fund menu. The Fund currently is not included in the IMDCP fund menu. - VOLUNTARY DEFERRED COMPENSATION PLANS -- voluntary programs that permit certain employees to elect to defer a portion of their discretionary year-end compensation and directly or notionally invest the deferred amount: (1) across a range of designated investment funds, including funds advised by the Subadviser or its affiliates; and/or (2) in Morgan Stanley stock units. Several factors determine discretionary compensation, which can vary by portfolio management team and circumstances. In order of relative importance, these factors include: - Investment performance. A portfolio manager's compensation is linked to the pre-tax investment performance of the funds/accounts managed by the portfolio manager. Investment performance is calculated for one-, three- and five-year periods measured against a fund's/account's primary benchmark (as set forth in the fund's prospectus), indices and/or peer groups, where applicable. Generally, the greatest weight is placed on the three- and five-year periods. - Revenues generated by the investment companies, pooled investment vehicles and other accounts managed by the portfolio manager. - Contribution to the business objectives of the Subadviser. - The dollar amount of assets managed by the portfolio manager. - Market compensation survey research by independent third parties. - Other qualitative factors, such as contributions to client objectives. - Performance of Morgan Stanley and Morgan Stanley Investment Management, and the overall performance of the Global Investor Group, a department within Morgan Stanley Investment Management that includes all investment professionals. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None- The portfolio manager does not hold shares of the Fund. The Fund is a variable annuity and does not match the investment objectives of the manager /s/Greg Dotzman 3/23/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Greg Dotzman (Printed Name of person signing) Associate - Fund Governance (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - MidCap Value Account Name of Fund Basu Mullick Name of Portfolio Manager (Please use one form per Portfolio Manager per Fund/Account) Neuberer Berman Management Inc. Firm Name For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of Decemer 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 13 $7,561 million ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 1 $15 million ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... ----------------------- ------------------------ or each of the categories, the number of accounts and the total assets in the accounts with respect to which advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. Actual or apparent conflicts of interest may arise when a portfolio manager has day-to-day management responsibilities with respect to more than one fund or other account. The management of multiple funds and accounts (including proprietary accounts) may give rise to potential conflicts of interest if the funds and accounts have different objectives, benchmarks, time horizons, and fees as the portfolio manager must allocate his time and investment ideas across multiple funds and accounts. The portfolio manager may execute transactions for another fund or account that may adversely impact the value of securities held by the Portfolio. Securities selected for funds or accounts other than the Portfolio may outperform the securities selected for the Portfolio. Neuberger Berman has adopted certain compliance procedures which are designed to address these types of conflicts. However, there is no guarantee that such procedures will detect each and every situation in which a conflict arises. For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manager. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. A portion of the compensation paid to each portfolio manager is determined by comparisons to pre-determined peer groups and benchmarks, as opposed to a system dependent on a percent of management fees. The portfolio managers are paid a base salary that is not dependent on performance. Each portfolio manager also has a "target bonus," which is set each year and can be increased or decreased prior to payment based in part on performance measured against the relevant peer group and benchmark. Performance is measured on a three-year rolling average in order to emphasize longer-term performance. There is also a subjective component to determining the bonus, which consists of the following factors: (i) the individual's willingness to work with the marketing and sales groups; (ii) his or her effectiveness in building a franchise; and (iii) client servicing. Senior management determines this component in appropriate cases. There are additional components that comprise the portfolio managers' compensation packages, including: (i) whether the manager was a partner/principal of Neuberger Berman prior to Neuberger Berman Inc.'s initial public offering; (ii) for more recent hires, incentives that may have been negotiated at the time the portfolio manager joined the Neuberger Berman complex; and (iii) the total amount of assets for which the portfolio manager is responsible. Our portfolio managers have always had a degree of independence that they would not get at other firms that have, for example, investment committees. We believe that our portfolio managers are retained not only through compensation and opportunities for advancement, but also by a collegial and stable money management environment. In addition, there are additional stock and option award programs available. We believe the measurement versus the peer groups on a three-year rolling average basis creates a meaningful disincentive to try and beat the peer group and benchmark in any given year by taking undue risks in portfolio management. The incentive is to be a solid performer over the longer-term, not necessarily to be a short-term winner in any given year. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None - Sub-advisory Relationship /s/Kevin A. Pemberton 4/5/2006 ---------------------------------------- --------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Kevin A. Pemberton (Printed Name of person signing) VP, Compliance Officer, Sub-advised Funds (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Balanced Account Dirk Laschanzky Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 10 $5,264,857,154 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 4 $7,930,953,104 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 4 $424,866,377 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for equity portfolio managers is 90% weighted to investment performance and 10% weighted to Principal Global Investors annual performance score. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers is measured for a period up to three years (shorter if the portfolio manager has managed the respective portfolio for a period less than three years). o Versus the peer group, incentive payout starts at 55th percentile and reaches 100% at the 25th percentile for the 1, 2, and 3-year periods. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Dirk Laschanzky 2/28/06 --------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Dirk Laschanzky (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Bond Account William C. Armstrong Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 3 $1,899,969,047 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 5 $6,769,048,641 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 17 $1,003,402,607 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 2 $1,068,531,167 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for fixed income portfolio managers is 80% weighted to investment performance and 20% weighted to Principal Global Investors annual performance score. The target incentive for fixed income portfolio managers ranges from 60% to 150% of actual base earnings, depending on job level. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers and a benchmark is measured for a period up to five years (shorter if the portfolio manager has managed the respective portfolio for a period less than five years). o Versus the peer group, 100% of target incentive is achieved if the portfolio performance is 35th percentile. No payout is realized if performance is below 50th percentile. 200% payout is achieved at 15th percentile or better for the respective period. o Versus the benchmark, 100% of target incentive is achieved at certain levels of outperformance, which vary by portfolio. No payout is realized for performance at or below the level of the benchmark. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/William C. Armstrong 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) William C. Armstrong (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Bond Account Timothy R. Warrick Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 3 $1,899,969,047 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 5 $6,769,048,641 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 21 $1,262,384,680 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 2 $1,068,531,167 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for fixed income portfolio managers is 80% weighted to investment performance and 20% weighted to Principal Global Investors annual performance score. The target incentive for fixed income portfolio managers ranges from 60% to 150% of actual base earnings, depending on job level. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers and a benchmark is measured for a period up to five years (shorter if the portfolio manager has managed the respective portfolio for a period less than five years). o Versus the peer group, 100% of target incentive is achieved if the portfolio performance is 35th percentile. No payout is realized if performance is below 50th percentile. 200% payout is achieved at 15th percentile or better for the respective period. o Versus the benchmark, 100% of target incentive is achieved at certain levels of outperformance, which vary by portfolio. No payout is realized for performance at or below the level of the benchmark. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Timothy R. Warrick 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Timothy R. Warrick (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Capital Value Account John Pihlblad Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 3 $1,668,394,133 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 2 $454,717,640 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for equity portfolio managers is 90% weighted to investment performance and 10% weighted to Principal Global Investors annual performance score. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers is measured for a period up to three years (shorter if the portfolio manager has managed the respective portfolio for a period less than three years). o Versus the peer group, incentive payout starts at 55th percentile and reaches 100% at the 25th percentile for the 1, 2, and 3-year periods. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/John Pihliblad 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) John Pihlblad (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - International Account Paul H. Blankenhagen Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 2 $861,706,178 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 2 $2,659,584,897 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 1 $46,737,158 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for equity portfolio managers is 90% weighted to investment performance and 10% weighted to Principal Global Investors annual performance score. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers is measured for a period up to three years (shorter if the portfolio manager has managed the respective portfolio for a period less than three years). o Versus the peer group, incentive payout starts at 55th percentile and reaches 100% at the 25th percentile for the 1, 2, and 3-year periods. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Paul H. Blankenhagen 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Paul H. Blankenhagen (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - International Account Juliet Cohn Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 2 $861,706,178 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 2 $2,659,584,897 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 3 $137,264,211 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for equity portfolio managers is 90% weighted to investment performance and 10% weighted to Principal Global Investors annual performance score. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers is measured for a period up to three years (shorter if the portfolio manager has managed the respective portfolio for a period less than three years). o Versus the peer group, incentive payout starts at 55th percentile and reaches 100% at the 25th percentile for the 1, 2, and 3-year periods. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Juliet Cohn 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Juliet Cohn (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - International Account Christopher Ibach Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 2 $861,706,178 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 2 $2,659,584,897 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 6 $228,129,902 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for equity portfolio managers is 90% weighted to investment performance and 10% weighted to Principal Global Investors annual performance score. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers is measured for a period up to three years (shorter if the portfolio manager has managed the respective portfolio for a period less than three years). o Versus the peer group, incentive payout starts at 55th percentile and reaches 100% at the 25th percentile for the 1, 2, and 3-year periods. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Christopher Ibach 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Christopher Ibach (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Equity Income Account Dirk Laschanzky Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 10 $5,264,857,154 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 4 $7,930,953,104 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 7 $424,866,377 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for equity portfolio managers is 90% weighted to investment performance and 10% weighted to Principal Global Investors annual performance score. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers is measured for a period up to three years (shorter if the portfolio manager has managed the respective portfolio for a period less than three years). o Versus the peer group, incentive payout starts at 55th percentile and reaches 100% at the 25th percentile for the 1, 2, and 3-year periods. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Dirk Laschanzky 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Dirk Laschanzky (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Government and High Quality Bond Account Brad Fredericks Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 2 $742,711,664 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 1 $994,252,672 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for fixed income portfolio managers is 80% weighted to investment performance and 20% weighted to Principal Global Investors annual performance score. The target incentive for fixed income portfolio managers ranges from 60% to 150% of actual base earnings, depending on job level. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers and a benchmark is measured for a period up to five years (shorter if the portfolio manager has managed the respective portfolio for a period less than five years). o Versus the peer group, 100% of target incentive is achieved if the portfolio performance is 35th percentile. No payout is realized if performance is below 50th percentile. 200% payout is achieved at 15th percentile or better for the respective period. o Versus the benchmark, 100% of target incentive is achieved at certain levels of outperformance, which vary by portfolio. No payout is realized for performance at or below the level of the benchmark. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Brad Fredericks 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Brad Fredericks (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Government and High Quality Bond Account Lisa A. Stange Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 2 $742,711,664 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 1 $994,252,672 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for fixed income portfolio managers is 80% weighted to investment performance and 20% weighted to Principal Global Investors annual performance score. The target incentive for fixed income portfolio managers ranges from 60% to 150% of actual base earnings, depending on job level. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers and a benchmark is measured for a period up to five years (shorter if the portfolio manager has managed the respective portfolio for a period less than five years). o Versus the peer group, 100% of target incentive is achieved if the portfolio performance is 35th percentile. No payout is realized if performance is below 50th percentile. 200% payout is achieved at 15th percentile or better for the respective period. o Versus the benchmark, 100% of target incentive is achieved at certain levels of outperformance, which vary by portfolio. No payout is realized for performance at or below the level of the benchmark. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Lisa A. Stange 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Lisa A. Stange (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - International Emerging Markets Account Michael A. Marusiak Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 2 $234,974,902 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 1 $601,235,650 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 9 $499,520,372 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for equity portfolio managers is 90% weighted to investment performance and 10% weighted to Principal Global Investors annual performance score. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers is measured for a period up to three years (shorter if the portfolio manager has managed the respective portfolio for a period less than three years). o Versus the peer group, incentive payout starts at 55th percentile and reaches 100% at the 25th percentile for the 1, 2, and 3-year periods. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Michael A. Marusiak 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Michael A. Marusiak (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - International Emerging Markets Account Michael L. Reynal Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 2 $234,974,902 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 1 $601,235,650 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 9 $499,520,372 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for equity portfolio managers is 90% weighted to investment performance and 10% weighted to Principal Global Investors annual performance score. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers is measured for a period up to three years (shorter if the portfolio manager has managed the respective portfolio for a period less than three years). o Versus the peer group, incentive payout starts at 55th percentile and reaches 100% at the 25th percentile for the 1, 2, and 3-year periods. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Michael L. Reynal 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Michael L. Reynal (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - International SmallCap Account Brian W. Pattinson Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 1 $143,478,735 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 1 $1,448,348,725 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 1 $315,215,060 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for equity portfolio managers is 90% weighted to investment performance and 10% weighted to Principal Global Investors annual performance score. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers is measured for a period up to three years (shorter if the portfolio manager has managed the respective portfolio for a period less than three years). o Versus the peer group, incentive payout starts at 55th percentile and reaches 100% at the 25th percentile for the 1, 2, and 3-year periods. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Brian W. Pattinson 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Brian W. Pattinson (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - LargeCap Stock Index Account Dirk Laschanzky Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 10 $5,264,857,154 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 4 $7,930,953,104 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 7 $424,866,377 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for equity portfolio managers is 90% weighted to investment performance and 10% weighted to Principal Global Investors annual performance score. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers is measured for a period up to three years (shorter if the portfolio manager has managed the respective portfolio for a period less than three years). o Versus the peer group, incentive payout starts at 55th percentile and reaches 100% at the 25th percentile for the 1, 2, and 3-year periods. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Dirk Laschanzky 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Dirk Laschanzky (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - LargeCap Stock Index Account Mariateresa Monaco Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 5 $1,375,695,071 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 4 $7,691,848,462 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for equity portfolio managers is 90% weighted to investment performance and 10% weighted to Principal Global Investors annual performance score. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers is measured for a period up to three years (shorter if the portfolio manager has managed the respective portfolio for a period less than three years). o Versus the peer group, incentive payout starts at 55th percentile and reaches 100% at the 25th percentile for the 1, 2, and 3-year periods. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Mariateresa Monaco 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Mariateresa Monaco (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - MidCap Account K. William Nolin Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 2 $1,190,642,993 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 3 $1,428,675,156 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for equity portfolio managers is 90% weighted to investment performance and 10% weighted to Principal Global Investors annual performance score. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers is measured for a period up to three years (shorter if the portfolio manager has managed the respective portfolio for a period less than three years). o Versus the peer group, incentive payout starts at 55th percentile and reaches 100% at the 25th percentile for the 1, 2, and 3-year periods. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/K. William Nolin 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) K. William Nolin (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Money Market Account Tracy Reeg Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 2 $848,957,600 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 1 $3,230,057,674 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for fixed income portfolio managers is 80% weighted to investment performance and 20% weighted to Principal Global Investors annual performance score. The target incentive for fixed income portfolio managers ranges from 60% to 150% of actual base earnings, depending on job level. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers and a benchmark is measured for a period up to five years (shorter if the portfolio manager has managed the respective portfolio for a period less than five years). o Versus the peer group, 100% of target incentive is achieved if the portfolio performance is 35th percentile. No payout is realized if performance is below 50th percentile. 200% payout is achieved at 15th percentile or better for the respective period. o Versus the benchmark, 100% of target incentive is achieved at certain levels of outperformance, which vary by portfolio. No payout is realized for performance at or below the level of the benchmark. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Tracy Reeg 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Tracy Reeg (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Money Market Account Alice Robertson Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 2 $848,957,600 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 1 $3,230,057,674 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for fixed income portfolio managers is 80% weighted to investment performance and 20% weighted to Principal Global Investors annual performance score. The target incentive for fixed income portfolio managers ranges from 60% to 150% of actual base earnings, depending on job level. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers and a benchmark is measured for a period up to five years (shorter if the portfolio manager has managed the respective portfolio for a period less than five years). o Versus the peer group, 100% of target incentive is achieved if the portfolio performance is 35th percentile. No payout is realized if performance is below 50th percentile. 200% payout is achieved at 15th percentile or better for the respective period. o Versus the benchmark, 100% of target incentive is achieved at certain levels of outperformance, which vary by portfolio. No payout is realized for performance at or below the level of the benchmark. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Alice Robertson 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Alice Robertson (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - LifeTime 2010 Account Dirk Laschanzky Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 10 $5,264,857,154 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 4 $7,930,953,104 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 7 $424,866,377 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for equity portfolio managers is 90% weighted to investment performance and 10% weighted to Principal Global Investors annual performance score. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers is measured for a period up to three years (shorter if the portfolio manager has managed the respective portfolio for a period less than three years). o Versus the peer group, incentive payout starts at 55th percentile and reaches 100% at the 25th percentile for the 1, 2, and 3-year periods. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Dirk Laschanzky 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Dirk Laschanzky (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - LifeTime 2020 Account Dirk Laschanzky Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 10 $5,264,857,154 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 4 $7,930,953,104 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 7 $424,866,377 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for equity portfolio managers is 90% weighted to investment performance and 10% weighted to Principal Global Investors annual performance score. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers is measured for a period up to three years (shorter if the portfolio manager has managed the respective portfolio for a period less than three years). o Versus the peer group, incentive payout starts at 55th percentile and reaches 100% at the 25th percentile for the 1, 2, and 3-year periods. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Dirk Laschanzky 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Dirk Laschanzky (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - LifeTime 2030 Account Dirk Laschanzky Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 10 $5,264,857,154 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 4 $7,930,953,104 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 7 $424,866,377 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for equity portfolio managers is 90% weighted to investment performance and 10% weighted to Principal Global Investors annual performance score. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers is measured for a period up to three years (shorter if the portfolio manager has managed the respective portfolio for a period less than three years). o Versus the peer group, incentive payout starts at 55th percentile and reaches 100% at the 25th percentile for the 1, 2, and 3-year periods. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Dirk laschanzky 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Dirk Laschanzky (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - LifeTime 2040 Account Dirk Laschanzky Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 10 $5,264,857,154 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 4 $7,930,953,104 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 7 $424,866,377 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for equity portfolio managers is 90% weighted to investment performance and 10% weighted to Principal Global Investors annual performance score. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers is measured for a period up to three years (shorter if the portfolio manager has managed the respective portfolio for a period less than three years). o Versus the peer group, incentive payout starts at 55th percentile and reaches 100% at the 25th percentile for the 1, 2, and 3-year periods. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Dirk Laschanzky 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Dirk Laschanzky (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - LifeTime 2050 Account Dirk Laschanzky Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 10 $5,264,857,154 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 4 $7,930,953,104 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 7 $424,866,377 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for equity portfolio managers is 90% weighted to investment performance and 10% weighted to Principal Global Investors annual performance score. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers is measured for a period up to three years (shorter if the portfolio manager has managed the respective portfolio for a period less than three years). o Versus the peer group, incentive payout starts at 55th percentile and reaches 100% at the 25th percentile for the 1, 2, and 3-year periods. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Dirk Laschanzky 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Dirk Laschanzky (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - LifeTime Strategic Income Account Dirk Laschanzky Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 10 $5,264,857,154 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 4 $7,930,953,104 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 7 $424,866,377 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for equity portfolio managers is 90% weighted to investment performance and 10% weighted to Principal Global Investors annual performance score. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers is measured for a period up to three years (shorter if the portfolio manager has managed the respective portfolio for a period less than three years). o Versus the peer group, incentive payout starts at 55th percentile and reaches 100% at the 25th percentile for the 1, 2, and 3-year periods. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Dirk Laschanzky 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Dirk Laschanzky (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Short-Term Bond Account Zeid Ayer Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 3 $351,785,678 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 3 $351,608,260 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 1 $10,758,257 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for fixed income portfolio managers is 80% weighted to investment performance and 20% weighted to Principal Global Investors annual performance score. The target incentive for fixed income portfolio managers ranges from 60% to 150% of actual base earnings, depending on job level. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers and a benchmark is measured for a period up to five years (shorter if the portfolio manager has managed the respective portfolio for a period less than five years). o Versus the peer group, 100% of target incentive is achieved if the portfolio performance is 35th percentile. No payout is realized if performance is below 50th percentile. 200% payout is achieved at 15th percentile or better for the respective period. o Versus the benchmark, 100% of target incentive is achieved at certain levels of outperformance, which vary by portfolio. No payout is realized for performance at or below the level of the benchmark. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Zeid Ayer 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Zeid Ayer (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Short-Term Bond Account Craig Dawson Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 3 $351,785,678 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 3 $351,608,260 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 1 $10,758,257 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for fixed income portfolio managers is 80% weighted to investment performance and 20% weighted to Principal Global Investors annual performance score. The target incentive for fixed income portfolio managers ranges from 60% to 150% of actual base earnings, depending on job level. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers and a benchmark is measured for a period up to five years (shorter if the portfolio manager has managed the respective portfolio for a period less than five years). o Versus the peer group, 100% of target incentive is achieved if the portfolio performance is 35th percentile. No payout is realized if performance is below 50th percentile. 200% payout is achieved at 15th percentile or better for the respective period. o Versus the benchmark, 100% of target incentive is achieved at certain levels of outperformance, which vary by portfolio. No payout is realized for performance at or below the level of the benchmark. As a wholly owned subsidiary of Principal Financial Group, all Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Craig Dawson 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Craig Dawson (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Short-Term Bond Account Martin Schafer Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 3 $358,514,735 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 2 $294,344,244 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 3 $121,680,635 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for fixed income portfolio managers is 80% weighted to investment performance and 20% weighted to Principal Global Investors annual performance score. The target incentive for fixed income portfolio managers ranges from 60% to 150% of actual base earnings, depending on job level. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers and a benchmark is measured for a period up to five years (shorter if the portfolio manager has managed the respective portfolio for a period less than five years). o Versus the peer group, 100% of target incentive is achieved if the portfolio performance is 35th percentile. No payout is realized if performance is below 50th percentile. 200% payout is achieved at 15th percentile or better for the respective period. o Versus the benchmark, 100% of target incentive is achieved at certain levels of outperformance, which vary by portfolio. No payout is realized for performance at or below the level of the benchmark. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Martin Schafer 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Martin Schafer (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - SmallCap Account Thomas Morabito Principal Global Investors, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 1 $54,043,838 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 6 $302,748,055 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 1 $39,282,741 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Global Investors offers all employees a competitive salary and incentive compensation plan that is evaluated annually. Percentages of base salary versus performance bonus vary by position but are based on nationally competitive market data and are consistent with industry standards. Total cash compensation is targeted at the median of the market and benefits are targeted slightly above median. The investment staff is compensated under a base salary plus variable annual bonus (incentive compensation). The incentive compensation plan for equity portfolio managers is 90% weighted to investment performance and 10% weighted to Principal Global Investors annual performance score. o Investment performance is based on gross performance versus a benchmark, peer group or both, depending on the client mandate o Performance versus peers is measured for a period up to three years (shorter if the portfolio manager has managed the respective portfolio for a period less than three years). o Versus the peer group, incentive payout starts at 55th percentile and reaches 100% at the 25th percentile for the 1, 2, and 3-year periods. As a wholly owned subsidiary of Principal Financial Group, some Principal Global employees are eligible to participate in our Employee Stock Purchase Plan that allows them to purchase company stock at a 15% discount each quarter. In addition, through our 401(k) plan, employees are able to contribute to an Employee Stock Ownership Plan (ESOP) through which they can buy additional company stock. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Thomas Morabito ------------------------------------ 4/18/06 (Signature of person authorized to sign on behalf of the Sub-Advisor) (Date) Thomas Morabito (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Bond Account Larry A. Post Post Advisory Group, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 5 508,757,000 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 10 1,400,412,000 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 55 6,172,031,000 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 9 1,242,130,000 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 16 1,213,351,000 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. The compensation for the senior investment professionals is comprised of base salary (50%), bonus pool (35%) and certain other performance incentives (15%). Incentives, in the form of an annual bonus, are determined based on the overall performance of the firm. One hundred percent of the performance incentives for the portfolio managers and research analysts are based on their respective contribution to performance of the investment products rather than growth of assets. We have established a pool of 30% of the net revenue to compensate employees for contributions to the success of the organization. The management team makes the final determination of the relative amount allocated to each individual. We feel this environment fosters a strong sense of teamwork, which enables us to continue to attract exceptional and passionate investment professionals. One hundred percent of the performance incentives for the portfolio managers and research analysts are based on their respective contribution to performance of the investment products rather than growth of assets. Post believes our compensation structure is competitive with other top-tier investment firms, which is demonstrated by our talented team of professionals and the absence of investment professional turnover. There has been no turnover of key investment professionals since the beginning of Post Advisory Group and its predecessor in 1992. The reliance on ownership and profit sharing in the compensation package aligns the interests of clients and senior management and, we believe, will virtually eliminate voluntary turnover. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Larry A. Post 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Larry A. Post (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Bond Account Allan Schweitzer Post Advisory Group, LLC. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 5 508,757,000 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 10 1,400,412,000 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 55 6,172,031,000 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 9 1,242,130,000 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 16 1,213,351,000 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. The compensation for the senior investment professionals is comprised of base salary (50%), bonus pool (35%) and certain other performance incentives (15%). Incentives, in the form of an annual bonus, are determined based on the overall performance of the firm. One hundred percent of the performance incentives for the portfolio managers and research analysts are based on their respective contribution to performance of the investment products rather than growth of assets. We have established a pool of 30% of the net revenue to compensate employees for contributions to the success of the organization. The management team makes the final determination of the relative amount allocated to each individual. We feel this environment fosters a strong sense of teamwork, which enables us to continue to attract exceptional and passionate investment professionals. One hundred percent of the performance incentives for the portfolio managers and research analysts are based on their respective contribution to performance of the investment products rather than growth of assets. Post believes our compensation structure is competitive with other top-tier investment firms, which is demonstrated by our talented team of professionals and the absence of investment professional turnover. There has been no turnover of key investment professionals since the beginning of Post Advisory Group and its predecessor in 1992. The reliance on ownership and profit sharing in the compensation package aligns the interests of clients and senior management and, we believe, will virtually eliminate voluntary turnover. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Allan Schweitzer 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Allan Schweitzer (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Bond Account L. Phillip Jacoby Spectrum Asset Management, Inc. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 10 8,115,708,905 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 16 2,515,026,464 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 38 2,574,884,668 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Spectrum professionals are paid a base salary as well as quarterly and year-end performance bonuses. The performance bonuses are based on overall firm revenues (25% weighting), assets under management (25%), and individual performance and contributions to the investment team (50%). The performance bonuses may comprise up to 90% of an individual's total compensation. Salaries of our senior executive and investment staff are benchmarked against national compensation levels of asset management firms and the bonus is driven by investment performance and factors described earlier, such that top quartile fund performance generates top quartile compensation. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/L. Phillip Jacoby 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) L. Phillip Jacoby (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contract Fund, Inc. - Bond Account Bernard M. Sussman Spectrum Asset Management, Inc. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 10 8,115,708,905 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 16 2,515,026,464 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 42 2,578,870,334 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Spectrum professionals are paid a base salary as well as quarterly and year-end performance bonuses. The performance bonuses are based on overall firm revenues (25% weighting), assets under management (25%), and individual performance and contributions to the investment team (50%). The performance bonuses may comprise up to 90% of an individual's total compensation. Salaries of our senior executive and investment staff are benchmarked against national compensation levels of asset management firms and the bonus is driven by investment performance and factors described earlier, such that top quartile fund performance generates top quartile compensation. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Bernard M. Sussman 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Bernard M. Sussman (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Equity Income Account Kelly D. Rush Principal Real Estate Investors, LLC For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 2 $1,023,742,250 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 9 $86,807,637 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 9 $137,678,605 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 1 $29,665,853 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Real Estate Investors is a member of Principal Global Investors ("Principal Global"), whose compensation policies and practices apply to Principal's Portfolio Manager. Principal Global offers a nationally competitive salary and incentive compensation plan that is evaluated annually relative to other top-tier asset management firms. Percentages of base salary verses performance bonus vary by position but are based on national market data and are consistent with industry standards. Total cash compensation is targeted to be consistent with the national averages. Incentive compensation for portfolio managers is directly aligned with client objectives. On average, two thirds of incentive compensation for portfolio managers is determined directly on the basis of relative performance versus appropriate client benchmarks and peer groups. Results are measured over rolling one year, three year and five year periods consistent with appropriate risk management standards. The remaining one third of incentive compensation is based on a combination of individual results and overall firm results. Overall firm results are driven primarily by aggregate investment performance across products relative to benchmarks and peers, in addition to financial results and new business development. A portion of annual incentive compensation for real estate portfolios may be payable in the form of restricted stock grants. In addition to traditional cash incentive compensation, portfolio managers are eligible for long-term equity incentives including stock options and stock grants. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Kelly D. Rush 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Kelly D. Rush (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Equity Income Account Fernando Diaz Spectrum Asset Management, Inc. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 1 9,317 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Spectrum professionals are paid a base salary as well as quarterly and year-end performance bonuses. The performance bonuses are based on overall firm revenues (25% weighting), assets under management (25%), and individual performance and contributions to the investment team (50%). The performance bonuses may comprise up to 90% of an individual's total compensation. Salaries of our senior executive and investment staff are benchmarked against national compensation levels of asset management firms and the bonus is driven by investment performance and factors described earlier, such that top quartile fund performance generates top quartile compensation. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Fernando Diaz 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Fernando Diaz (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Equity Income Account Joseph J. Urciuoli Spectrum Asset Management, Inc. For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 3 399,755 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 $0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Spectrum professionals are paid a base salary as well as quarterly and year-end performance bonuses. The performance bonuses are based on overall firm revenues (25% weighting), assets under management (25%), and individual performance and contributions to the investment team (50%). The performance bonuses may comprise up to 90% of an individual's total compensation. Salaries of our senior executive and investment staff are benchmarked against national compensation levels of asset management firms and the bonus is driven by investment performance and factors described earlier, such that top quartile fund performance generates top quartile compensation. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Joseph J. Urciuoli 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Joseph J. Urciuoli (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Principal LifeTime 2010 Account Principal Variable Contracts Fund, Inc. - Principal LifeTime 2020 Account Principal Variable Contracts Fund, Inc. - Principal LifeTime 2030 Account Principal Variable Contracts Fund, Inc. - Principal LifeTime 2040 Account Principal Variable Contracts Fund, Inc. - Principal LifeTime 2050 Account Principal Variable Contracts Fund, Inc. - Principal LifeTime Strategic Income Account Name of Fund Douglas A. Loeffler, CFA Name of Portfolio Manager (Please use one form per Portfolio Manager per Fund/Account) Principal Management Corporation Firm Name For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. n/a n/a ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... ----------------------- ------------------------ or each of the categories, the number of accounts and the total assets in the accounts with respect to which advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. n/a n/a ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manager. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Compensation is predominantly composed of salary. Salary is reviewed annually. Annual Bonus is driven by company and business unit performance. No part of salary, bonus, or retirement plan compensation is tied to fund performance or aset levels. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. The portfolio manager does not have any Variable Annuity investments, but has invested between $10,001 - $50,000 in the Principal Investors LifeTime 2020 fund. This portfolio is managed in an identical style to the Principal Variable Contracts Fund, Inc.-Principal LifeTime 2020 Account. /s/ Douglas A. Loeffler 3/28/2006 ---------------------------------------- --------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Douglas A. Loeffler (Printed Name of person signing) (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Real Estate Securities Account Kelly D. Rush Principal Real Estate Investors, LLC For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 2 $1,023,742,250 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 9 $86,807,637 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 9 $137,678,605 ----------------------- ------------------------ For each of the categories, the number of accounts and the total assets in the accounts with respect to which the advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 $0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 1 $29,665,853 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. None For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manger. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Principal Real Estate Investors is a member of Principal Global Investors ("Principal Global"), whose compensation policies and practices apply to Principal's Portfolio Manager. Principal Global offers a nationally competitive salary and incentive compensation plan that is evaluated annually relative to other top-tier asset management firms. Percentages of base salary verses performance bonus vary by position but are based on national market data and are consistent with industry standards. Total cash compensation is targeted to be consistent with the national averages. Incentive compensation for portfolio managers is directly aligned with client objectives. On average, two thirds of incentive compensation for portfolio managers is determined directly on the basis of relative performance versus appropriate client benchmarks and peer groups. Results are measured over rolling one year, three year and five year periods consistent with appropriate risk management standards. The remaining one third of incentive compensation is based on a combination of individual results and overall firm results. Overall firm results are driven primarily by aggregate investment performance across products relative to benchmarks and peers, in addition to financial results and new business development. A portion of annual incentive compensation for real estate portfolios may be payable in the form of restricted stock grants. In addition to traditional cash incentive compensation, portfolio managers are eligible for long-term equity incentives including stock options and stock grants. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Kelly D. Rush 2/28/06 ---------------------------------------- ------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Kelly D. Rush (Printed Name of person signing) Portfolio Manager (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - Equity Growth Series Name of Fund Robert W. Sharps Name of Portfolio Manager (Please use one form per Portfolio Manager per Fund/Account) T. Rowe Price Associates, Inc. Firm Name For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 4 $1,626,211,131 (excludes PVC-Equity Growth Series) ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 5 $556,623,203 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 10 $2,416,853,735 ----------------------- ------------------------ or each of the categories, the number of accounts and the total assets in the accounts with respect to which advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. Portfolio managers at T. Rowe Price typically manage multiple accounts. These accounts may include, among others, mutual funds, separate accounts (assets managed on behalf of institutions such as pension funds, colleges and universities, foundations), and commingled trust accounts. Portfolio managers make investment decisions for each portfolio based on the investment objectives, policies, practices and other relevant investment considerations that the managers believe are applicable to that portfolio. Consequently, portfolio managers may purchase (or sell) securities for one portfolio and not another portfolio. T. Rowe Price has adopted brokerage and trade allocation policies and procedures which it believes are reasonably designed to address any potential conflicts associated with managing multiple accounts for multiple clients. Also, as disclosed under the "Portfolio Manager's Compensation" section, our portfolio managers' compensation is determined in the same manner with respect to all portfolios managed by the portfolio manager. Please see the attached excerpts from T. Rowe Price's Form ADV for more information on our brokerage and trade allocation policies. For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manager. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Portfolio manager compensation consists primarily of a base salary, a cash bonus, and an equity incentive that usually comes in the form of a stock option grant. Occasionally, portfolio managers will also have the opportunity to participate in venture capital partnerships. Compensation is variable and is determined based on the following factors. Investment performance over one-, three-, five-, and 10-year periods is the most important input. We evaluate performance in absolute, relative, and risk-adjusted terms. Relative performance and risk-adjusted performance are determined with reference to the broad based index (ex. S&P500) and an applicable Lipper index (ex. Large-Cap Growth), though other benchmarks may be used as well. Investment results are also compared to comparably managed funds of competitive investment management firms. Performance is primarily measured on a pre-tax basis though tax-efficiency is considered and is especially important for tax efficient funds. It is important to note that compensation is viewed with a long term time horizon. The more consistent a manager's performance over time, the higher the compensation opportunity. The increase or decrease in a fund's assets due to the purchase or sale of fund shares is not considered a material factor. Contribution to our overall investment process is an important consideration as well. Sharing ideas with other portfolio managers, working effectively with and mentoring our younger analysts, and being good corporate citizens are important components of our long term success and are highly valued. All employees of T. Rowe Price, including portfolio managers, participate in a 401(k) plan sponsored by T. Rowe Price Group. In addition, all employees are eligible to purchase T. Rowe Price common stock through an employee stock purchase plan that features a limited corporate matching contribution. Eligibility for and participation in these plans is on the same basis as for all employees. Finally, all vice presidents of T. Rowe Price Group, including all portfolio managers, receive supplemental medical/hospital reimbursement benefits. This compensation structure is used for all portfolios managed by the portfolio manager. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None. /s/Darrell N. Braman 3/23/2006 ---------------------------------------- --------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Darrell N. Braman (Printed Name of person signing) Vice President (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - LargeCap Blend Series Name of Fund William J. Stromberg Name of Portfolio Manager (Please use one form per Portfolio Manager per Fund/Account) T. Rowe Price Associates, Inc. Firm Name For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 4 $1,312,564,567 (excludes PVC- LargeCap Blend Series) ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 3 $983,546,426 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 21 $3,973,275,412 ----------------------- ------------------------ or each of the categories, the number of accounts and the total assets in the accounts with respect to which advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. Portfolio managers at T. Rowe Price typically manage multiple accounts. These accounts may include, among others, mutual funds, separate accounts (assets managed on behalf of institutions such as pension funds, colleges and universities, foundations), and commingled trust accounts. Portfolio managers make investment decisions for each portfolio based on the investment objectives, policies, practices and other relevant investment considerations that the managers believe are applicable to that portfolio. Consequently, portfolio managers may purchase (or sell) securities for one portfolio and not another portfolio. T. Rowe Price has adopted brokerage and trade allocation policies and procedures which it believes are reasonably designed to address any potential conflicts associated with managing multiple accounts for multiple clients. Also, as disclosed under the "Portfolio Manager's Compensation" section, our portfolio managers' compensation is determined in the same manner with respect to all portfolios managed by the portfolio manager. Please see the attached excerpts from T. Rowe Price's Form ADV for more information on our brokerage and trade allocation policies. For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manager. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Portfolio manager compensation consists primarily of a base salary, a cash bonus, and an equity incentive that usually comes in the form of a stock option grant. Occasionally, portfolio managers will also have the opportunity to participate in venture capital partnerships. Compensation is variable and is determined based on the following factors. Investment performance over one-, three-, five-, and 10-year periods is the most important input. We evaluate performance in absolute, relative, and risk-adjusted terms. Relative performance and risk-adjusted performance are determined with reference to the broad based index (ex. S&P500) and an applicable Lipper index (ex. Large-Cap Blend), though other benchmarks may be used as well. Investment results are also compared to comparably managed funds of competitive investment management firms. Performance is primarily measured on a pre-tax basis though tax-efficiency is considered and is especially important for tax efficient funds. It is important to note that compensation is viewed with a long term time horizon. The more consistent a manager's performance over time, the higher the compensation opportunity. The increase or decrease in a fund's assets due to the purchase or sale of fund shares is not considered a material factor. Contribution to our overall investment process is an important consideration as well. Sharing ideas with other portfolio managers, working effectively with and mentoring our younger analysts, and being good corporate citizens are important components of our long term success and are highly valued. All employees of T. Rowe Price, including portfolio managers, participate in a 401(k) plan sponsored by T. Rowe Price Group. In addition, all employees are eligible to purchase T. Rowe Price common stock through an employee stock purchase plan that features a limited corporate matching contribution. Eligibility for and participation in these plans is on the same basis as for all employees. Finally, all vice presidents of T. Rowe Price Group, including all portfolio managers, receive supplemental medical/hospital reimbursement benefits. This compensation structure is used for all portfolios managed by the portfolio manager. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Darrell N. Braman 3/23/2006 ---------------------------------------- --------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Darrell N. Braman (Printed Name of person signing) Vice President (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. - LargeCap Blend Series Name of Fund Richard T. Whitney Name of Portfolio Manager (Please use one form per Portfolio Manager per Fund/Account) T. Rowe Price Associates, Inc. Firm Name For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 2 $1.461.337.942 (excludes PVC-LargeCap Blend Series) ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:.............................. 0 0 ----------------------- ------------------------ or each of the categories, the number of accounts and the total assets in the accounts with respect to which advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 0 0 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 0 0 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. Portfolio managers at T. Rowe Price typically manage multiple accounts. These accounts may include, among others, mutual funds, separate accounts (assets managed on behalf of institutions such as pension funds, colleges and universities, foundations), and commingled trust accounts. Portfolio managers make investment decisions for each portfolio based on the investment objectives, policies, practices and other relevant investment considerations that the managers believe are applicable to that portfolio. Consequently, portfolio managers may purchase (or sell) securities for one portfolio and not another portfolio. T. Rowe Price has adopted brokerage and trade allocation policies and procedures which it believes are reasonably designed to address any potential conflicts associated with managing multiple accounts for multiple clients. Also, as disclosed under the "Portfolio Manager's Compensation" section, our portfolio managers' compensation is determined in the same manner with respect to all portfolios managed by the portfolio manager. Please see the attached excerpts from T. Rowe Price's Form ADV for more information on our brokerage and trade allocation policies. For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manager. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. Portfolio manager compensation consists primarily of a base salary, a cash bonus, and an equity incentive that usually comes in the form of a stock option grant. Occasionally, portfolio managers will also have the opportunity to participate in venture capital partnerships. Compensation is variable and is determined based on the following factors. Investment performance over one-, three-, five-, and 10-year periods is the most important input. We evaluate performance in absolute, relative, and risk-adjusted terms. Relative performance and risk-adjusted performance are determined with reference to the broad based index (ex. S&P500) and an applicable Lipper index (ex. Large-Cap Blend), though other benchmarks may be used as well. Investment results are also compared to comparably managed funds of competitive investment management firms. Performance is primarily measured on a pre-tax basis though tax-efficiency is considered and is especially important for tax efficient funds. It is important to note that compensation is viewed with a long term time horizon. The more consistent a manager's performance over time, the higher the compensation opportunity. The increase or decrease in a fund's assets due to the purchase or sale of fund shares is not considered a material factor. Contribution to our overall investment process is an important consideration as well. Sharing ideas with other portfolio managers, working effectively with and mentoring our younger analysts, and being good corporate citizens are important components of our long term success and are highly valued. All employees of T. Rowe Price, including portfolio managers, participate in a 401(k) plan sponsored by T. Rowe Price Group. In addition, all employees are eligible to purchase T. Rowe Price common stock through an employee stock purchase plan that features a limited corporate matching contribution. Eligibility for and participation in these plans is on the same basis as for all employees. Finally, all vice presidents of T. Rowe Price Group, including all portfolio managers, receive supplemental medical/hospital reimbursement benefits. This compensation structure is used for all portfolios managed by the portfolio manager. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. None /s/Darrell N. Braman 3/23/2006 ---------------------------------------- --------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) Darrell N. Braman (Printed Name of person signing) Vice President (Title of person signing) FISCAL YEAR-END PORTFOLIO MANAGER QUESTIONNAIRE Principal Variable Contracts Fund, Inc. Small Cap Growth Account Name of Fund Paul Graham / David Wabnik Name of Portfolio Manager (Please use one form per Portfolio Manager per Fund/Account) UBS Global Asset Management (Americas) Inc. Firm Name For purposes of this request, Portfolio Manager is a member of the management team who is jointly and primarily responsible for the day-to-day management (with decision-making authority) of the Fund's portfolio. If the Fund has more than one Portfolio Manager, please describe the role of each Portfolio Manager including any limitation of the person's role and the relationship between the person's role and the roles of other persons who have responsibility for the day-to-day management of the Fund's portfolio. For example, if a portfolio management team for a balanced fund has one team member who is responsible only for the overall allocation of the fund's assets among equities, bonds, and money market instruments, and other team members who are responsible only for selection of securities within a particular segment of the fund, the disclosure should describe these limitations in describing each member's role. Please provide the following information as of December 31, 2005 (the Fund's most recently completed fiscal year). 1. If the Portfolio Manager is primarily responsible for the day-to-day management of the portfolio of any other account, please provide: o the number of other accounts managed within each of the following categories and the total assets in the accounts managed within each category:
NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. 5 $876,744,294 ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. 2 $380,951,732 ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 31 $239,846,489 ----------------------- ------------------------ or each of the categories, the number of accounts and the total assets in the accounts with respect to which advisory fee is based on the performance of the account NUMBER OF TOTAL ACCOUNTS ASSETS >> registered investment companies: ............. ----------------------- ------------------------ ----------------------- ------------------------ >> other pooled investment vehicles:............. ----------------------- ------------------------ ----------------------- ------------------------ >> other accounts:............................... 1 $55,631,943 ----------------------- ------------------------
A description of any material conflicts of interest that may arise in connection with the Portfolio Manager's management of the Fund's investments, on the one hand, and the investments of the other account included in response to this question, on the other. The management of a portfolio and other accounts by a portfolio manager could result in potential conflicts of interest if the portfolio and other accounts have different objectives, benchmarks and fees because the portfolio manager and his team must allocate time and investment expertise across multiple accounts, including the portfolio. The portfolio manager and his team manage the portfolio and other accounts utilizing a model portfolio approach that groups similar accounts within a model portfolio. UBS Global Asset Management (Americas) Inc. manages accounts according to the appropriate model portfolio, including where possible, those accounts that have specific investment restrictions. Accordingly, portfolio holdings, position sizes, and industry and sector exposures tend to be similar across accounts, which may minimize the potential for conflicts of interest. If a portfolio manager identifies a limited investment opportunity that may be suitable for more than one account or model portfolio, the portfolio may not be able to take full advantage of that opportunity due to an allocation or filled purchase or sale orders across all eligible model portfolios and accounts. To deal with these situations, UBS Global Asset Management (Americas) Inc. has adopted procedures for allocating portfolio trades among multiple accounts to provide fair treatment to all accounts. The management of personal accounts by a portfolio manager may also give rise to potential conflicts of interest. UBS Global Asset Management (Americas) Inc. has adopted Codes of Ethics that govern such personal trading, but there is no assurance that the Codes will adequately address all such conflicts. For example: Material conflicts between the investment strategy of the Fund and the investment strategy of other accounts managed by the Portfolio Manager and material conflicts in allocation of investment opportunities between the Fund and other accounts managed by the Portfolio Manager. 2. Describe the structure of, and the method used to determine, the compensation of each Portfolio Manager. For each type of compensation (e.g., salary, bonus, deferred compensation, retirement plans and arrangements), describe with specificity the criteria on which that type of compensation is based, for example, whether compensation is fixed, whether (and, if so, how) compensation is based on Fund pre- or after-tax performance over a certain time period, and whether (and, if so, how) compensation is based on the value of assets held in the Fund's portfolio. For example, if compensation is based solely or in part on performance, identify any benchmark used to measure performance and state the length of the period over which performance is measured. If the Portfolio Manager's compensation is based on performance with respect to some accounts but not the Fund, this must be disclosed. The compensation received by portfolio managers at UBS Global Asset Management includes a base salary and incentive compensation based on the portfolio manager's personal performance. UBS Global Asset Management's compensation and benefits programs are designed to provide its investment professionals with incentives to excel, and to promote an entrepreneurial, performance-oriented culture. They also align the interests of our investment professionals with the interests of UBS Global Asset Management's clients. Overall compensation can be grouped into four categories: - Competitive salary, benchmarked to maintain competitive compensation opportunities. - Annual bonus, tied to individual contributions and investment performance. - UBS equity awards, promoting company-wide success and employee retention. - Partnership Incentive Program (PIP), a phantom-equity-like program for key senior staff. Base salary is fixed compensation used to recognize the experience, skills and knowledge that the investment professionals bring to their roles. Salary levels are monitored and adjusted periodically in order to remain competitive within the investment management industry. Annual bonuses are strictly and rigorously correlated with performance. As such, annual incentives can be highly variable, and are based on three components: 1) the firm's overall business success; 2) the performance of the respective asset class and/or investment mandate; and 3) an individual's specific contribution to the firm's results. UBS Global Asset Management strongly believes that tying bonuses to both long-term (3-year) and shorter-term (1-year) portfolio pre-tax performance closely aligns our investment professionals' interests with those of UBS Global Asset Management's clients. A portion of each portfolio manager's bonus is based on the performance of each portfolio the portfolio manages as compared to the portfolio's broad-based index over a three-year rolling period. UBS AG equity. Senior investment professionals, including each portfolio manager of the portfolio, may receive a portion of their annual performance-based incentive in the form of deferred or restricted UBS AG shares or employee stock options. UBS Global Asset Management believes that this reinforces the critical importance of creating long-term business value, and also serves as an effective retention tool as the equity shares typically vest over a number of years. Broader equity share ownership is encouraged for all employees through "Equity Plus". This long-term incentive program gives employees the opportunity to purchase UBS stock with after-tax funds from their bonus or salary. Two UBS AG stock options are given for each share acquired and held for two years. UBS Global Asset Management feels that this engages its employees as partners in the firm's success, and helps to maximize its integrated business strategy. 3. For each Portfolio Manager, state the dollar range of equity securities in the Fund beneficially owned (as defined by Securities Exchange Act of 1934 Rule 16a-1(a)(2)) by the Portfolio Manager using the following ranges: none, $1 - $10,000; $10,001 - $50,000; $50,001 - $ 100,000; $100,001 - $500,000; $500,001 - $1,000,000; or over $1,000,000. If the Portfolio Manager has reasons for not holding shares of the Fund, e.g., that its investment objectives do not match the Portfolio Manager's, you may provide an explanation of those reasons. The portfolio managers do not own any shares of the Principal Variable Contracts Fund, Inc. Small Cap Growth Account. /s/Rachel M Wood/Mary T. Capasso 4/12/06 ---------------------------------------- --------- (Signature of person authorized to sign (Date) on behalf of the Sub-Advisor) RAchel M Wood/Mary T. Capasso (Printed Name of person signing) Assoc. Director/Director (Title of person signing)