485BPOS 1 usaa_n6.txt POST-EFFECTIVE AMENDMENT NO. 8 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM N-6 Registration Nos. 333-45343 811-08625 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM N-6 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [ ] Pre-Effective Amendment No. [ ] Post-Effective Amendment No. 8 [X] and/or REGISTRATION STATEMENT UNDER THE INVESTMENT ACT OF 1940 [ ] Amendment No. 3 [X] LIFE INSURANCE SEPARATE ACCOUNT OF USAA LIFE INSURANCE COMPANY ------------------------------------------------------ (Exact Name of Registrant) USAA LIFE INSURANCE COMPANY ------------------------------------------------------ (Name of Depositor) 9800 Fredericksburg Road, A-1-E San Antonio, Texas 78288-4501 (Address of Depositor's Principal Executive Offices)(Zip Code) Depositor's Telephone Number:(210) 498-8000 Name and Address of Agent Please send copies of all for Service: communications to: Cynthia A. Toles, Esq. Diane E. Ambler, Esq. USAA Life Insurance Company Kirkpatrick & Lockhart LLP 9800 Fredericksburg Road, A-1-E 1800 Massachusetts Ave, NW San Antonio, Texas 78288-4501 Washington. D.C. 20036 It is proposed that this filing will become effective (check appropriate box) [X] immediately upon filing pursuant to paragraph (b) of Rule 485 [ ] on May 1, 2003 pursuant to paragraph (b) of Rule 485 [ ] 60 days after filing pursuant to paragraph (a)(1) of Rule 485 [ ] on May 1, 2003 pursuant to paragraph (a)(1) of Rule 485 If appropriate, check the following box: [ ] This post-effective amendment designates a new effective date for a previously filed post-effective amendment. Title and Amount of Securities Being Registered: An Indefinite Amount of Interests in Life Insurance Separate Account of USAA Life Insurance Company Under Variable Universal Life Insurance Policies. VARIABLE UNIVERSAL LIFE INSURANCE POLICY PROSPECTUS MAY 1, 2003 Offered by: USAA LIFE INSURANCE COMPANY Telephone: Toll-Free 1-800-531-2923 This prospectus describes a Variable Universal Life Insurance Policy ("Policy") that we are offering, through our Life Insurance Separate Account, to individual members of the United Services Automobile Association ("USAA"), the parent company of the USAA Group of Companies, as well as to the general public. The Policy offers: o Life insurance protection guaranteed by USAA Life Insurance Company ("USAA Life") (See "Payment of Policy Benefits") o Flexible premium payments (See "Premium Payments") o 18 investment options (See "Investment Options" and the Fund prospectuses for a description of the Funds)
USAA LIFE INVESTMENT TRUST FIDELITY(R)VARIABLE INSURANCE PRODUCTS -------------------------- -------------------------------------- USAA Life Growth and Income Fund Fidelity VIP Contrafund(R)Portfolio, Initial Class USAA Life Aggressive Growth Fund Fidelity VIP Equity-Income Portfolio, Initial Class USAA Life World Growth Fund Fidelity VIPs Dynamic Capital Appreciation Portfolio, USAA Life Diversified Assets Fund Initial Class USAA Life Income Fund VANGUARD(R) VARIABLE INSURANCE FUND SCUDDER VARIABLE SERIES I ----------------------------------- ------------------------- Vanguard Diversified Value Portfolio Scudder VS I Capital Growth Portfolio, Class A Shares Vanguard Equity Index Portfolio Vanguard Mid-Cap Index Portfolio THE ALGER AMERICAN FUND ----------------------- Vanguard Small Company Growth Portfolio Alger American Growth Portfolio, Class O Shares Vanguard International Portfolio Vanguard REIT Index Portfolio Vanguard High Yield Bond Portfolio Vanguard Money Market Portfolio
PLEASE READ THIS PROSPECTUS CAREFULLY AND KEEP IT FOR FUTURE REFERENCE. YOUR PROSPECTUS AND POLICY MAY REFLECT VARIATIONS REQUIRED BY THE LAWS OF YOUR STATE. DEFINED TERMS USED IN THIS PROSPECTUS APPEAR AT THE END OF THIS BOOKLET. FOR MORE INFORMATION, REQUEST A COPY OF THE STATEMENT OF ADDITIONAL INFORMATION ("SAI"), DATED MAY 1, 2003. THE TABLE OF CONTENTS OF THE SAI APPEARS ON PAGE 38 OF THIS PROSPECTUS. FREE COPIES OF THE PROSPECTUS, ANNUAL REPORT OR SEMI-ANNUAL REPORT FOR EACH OF THE FUNDS ARE AVAILABLE BY CALLING 1-800-531-2923. IMPORTANT NOTICES: o THE SECURITIES AND EXCHANGE COMMISSION ("SEC") HAS NOT APPROVED OR DISAPPROVED THE SECURITIES DESCRIBED IN THIS PROSPECTUS OR PASSED UPON THE ADEQUACY OF THIS PROSPECTUS. ANYONE WHO TELLS YOU OTHERWISE IS COMMITTING A FEDERAL CRIME. o YOU MAY CANCEL THE POLICY WITHIN 10 DAYS AFTER RECEIVING IT, OR SUCH LONGER PERIOD AS THE LAWS OF YOUR STATE MAY REQUIRE. NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE VUL Policy 1 TABLE OF CONTENTS POLICY SUMMARY...............................................................4 POLICY BENEFITS...........................................................4 TYPE OF LIFE INSURANCE..................................................4 PURCHASING A POLICY.....................................................4 INSURANCE PROTECTION OFFERED BY THE POLICY.............................4 PERSONALIZED ILLUSTRATIONS..............................................4 FREE LOOK/RIGHT TO EXAMINE..............................................4 FLEXIBLE PREMIUM PAYMENTS...............................................5 INVESTMENT OPTIONS......................................................5 SEPARATE ACCOUNT.....................................................5 INVESTMENT CHOICES...................................................5 TRANSFERS AMONG INVESTMENT OPTIONS...................................5 ALLOCATING CASH VALUE...................................................5 TRACKING CASH VALUE.....................................................5 ACCESSING YOUR CASH VALUE...............................................6 FULL SURRENDER.......................................................6 PARTIAL SURRENDER....................................................6 LOAN.................................................................6 POLICY RISKS..............................................................6 CASH VALUE AND INVESTMENT EXPERIENCE....................................6 TRANSACTION RISKS.......................................................6 RISKS OF INVESTMENT OPTIONS.............................................6 LAPSE RISK..............................................................6 TAX RISKS...............................................................7 FEE TABLES................................................................7 TRANSACTION FEES........................................................7 PERIODIC CHARGES OTHER THAN FUND OPERATING EXPENSES.....................7 OPTIONAL RIDER CHARGES..................................................8 TOTAL ANNUAL FUND OPERATING EXPENSES....................................9 POLICY INFORMATION..........................................................10 WHO MAY PURCHASE A POLICY AND HOW TO PURCHASE A POLICY.................10 EFFECTIVE DATE.........................................................11 PREMIUM PAYMENTS.......................................................11 METHODS OF PAYMENT..................................................11 AMOUNT AND FREQUENCY OF PAYMENTS....................................11 PREMIUM ALLOCATION..................................................11 PLANNED PERIODIC PREMIUM PAYMENTS...................................11 ANNUAL TARGET PREMIUM PAYMENT.......................................12 INVESTMENT OPTIONS.....................................................12 ADDITIONS OR CHANGES TO INVESTMENT OPTIONS..........................12 VOTING PRIVILEGES...................................................12 POLICY LAPSE AND REINSTATEMENT.........................................19 LAPSE...............................................................19 GRACE PERIOD........................................................19 GUARANTEED DEATH BENEFIT............................................20 REINSTATEMENT.......................................................20 CHARGES AND DEDUCTIONS.................................................20 PREMIUM CHARGE......................................................20 MONTHLY DEDUCTIONS FROM CASH VALUE..................................21 SEPARATE ACCOUNT CHARGES............................................21 TRANSFER CHARGES....................................................22 SURRENDER CHARGES...................................................22 OTHER CHARGES.......................................................22 DEDUCTION OF CHARGES................................................22 VUL Policy 2 DEATH BENEFIT..........................................................22 CHANGING DEATH BENEFIT OPTION.......................................23 CHANGING POLICY'S SPECIFIED AMOUNT..................................23 OPTIONAL INSURANCE BENEFITS............................................24 PAYMENT OF POLICY BENEFITS.............................................25 BENEFITS AT MATURITY................................................25 PAYMENT AT DEATH....................................................25 DEATH BENEFIT PAYMENT OPTIONS.......................................25 CASH VALUE.............................................................26 CALCULATING YOUR VALUE IN THE VARIABLE FUND ACCOUNTS................26 TRANSFER OF VALUE...................................................27 LOANS..................................................................27 LOAN COLLATERAL.....................................................27 LOAN INTEREST.......................................................27 REPAYMENT OF INDEBTEDNESS...........................................28 EFFECT OF POLICY LOANS..............................................28 SURRENDERS.............................................................28 FULL SURRENDERS.....................................................28 PARTIAL SURRENDERS..................................................28 TELEPHONE TRANSACTIONS.................................................29 DOLLAR COST AVERAGING PROGRAM..........................................29 POSTPONEMENT OF PAYMENTS...............................................29 MORE POLICY INFORMATION.....................................................30 OWNERS AND BENEFICIARIES...............................................30 OWNERS..............................................................30 BENEFICIARIES.......................................................30 CALCULATING YOUR COST OF INSURANCE.....................................30 NET AMOUNT AT RISK..................................................31 NET AMOUNT AT RISK - MORE THAN ONE RATE CLASS.......................31 COST OF INSURANCE RATES.............................................31 MINIMUM AMOUNT INSURED.................................................31 OTHER INFORMATION...........................................................32 USAA LIFE..............................................................32 SEPARATE ACCOUNT.......................................................32 TAX MATTERS............................................................32 TAXATION OF POLICY PROCEEDS.........................................33 TAXATION OF USAA LIFE...............................................36 LEGAL PROCEEDINGS......................................................36 FINANCIAL STATEMENTS...................................................36 DEFINITIONS.................................................................36 STATEMENT OF ADDITIONAL INFORMATION.........................................40 VUL Policy 3 POLICY SUMMARY -------------- This summary describes the Policy's benefits and risks. Please read the remainder of this Prospectus for further details. The glossary at the end of the Prospectus defines certain terms used in this Prospectus. POLICY BENEFITS --------------- TYPE OF LIFE INSURANCE ---------------------- The Policy is a FLEXIBLE PREMIUM VARIABLE LIFE INSURANCE POLICY. "Flexible Premium" gives you the flexibility to vary the amount and frequency of your premium payments, within certain limits. The Policy is called "Variable" life insurance because your Cash Value, your cost of insurance charges, and your life insurance (death) benefits can vary according to your investment in one or more Variable Fund Accounts. Your investment experience in the Variable Fund Accounts may be positive or negative. THE POLICY HAS NO MINIMUM GUARANTEED CASH VALUE, WHICH MEANS YOU BEAR THE ENTIRE INVESTMENT RISK THAT YOUR CASH VALUE COULD DECLINE TO ZERO. PURCHASING A POLICY ------------------- Call us at 1-800-531-2923. USAA Life Insurance Company's licensed insurance representatives can help you complete an application and guide you through the "underwriting" process, which normally involves a medical exam. o We will issue you a Policy, provided you meet requirements for insurability. o The minimum amount of insurance available is $100,000 ($25,000 if the Insured is less than 18 years of age). o We will not issue a Policy that insures a person older than age 80. o We reserve the right to reject an application for any reason. o Insurance coverage under your Policy begins on its Effective Date. INSURANCE PROTECTION OFFERED BY THE POLICY ------------------------------------------ The Policy offers insurance protection as either a level death benefit option or an increasing death benefit option as shown below. OPTION A (LEVEL DEATH BENEFIT) OPTION B (INCREASING DEATH BENEFIT) ------------------------------ ----------------------------------- Death Benefit Greater of: Death Benefit Greater of: o Your Policy's Specified o Your Policy's Specified Amount Amount, or PLUS the Cash Value, or o The Minimum Amount Insured o The Minimum Amount Insured See "Death Benefit" for more detailed information. As long as the Policy remains in effect, under either option, the death benefit will never be less than the Policy's Specified Amount, less any Indebtedness and any due and unpaid Monthly Deductions. In addition, you can add optional insurance death benefits to a Policy by rider (see "Other Policy Benefits - Optional Insurance Benefits"). PERSONALIZED ILLUSTRATIONS -------------------------- Upon request and at no charge, we will provide a personalized illustration showing Insured's age, sex and rate class. If applicable and requested, an illustration for a Policy not affected by sex of the Insured will be provided. To receive a personalized illustration, please contact us at 1-800-531-4265. "FREE LOOK"/RIGHT TO EXAMINE ---------------------------- You may cancel the Policy within 10 days after receiving it, or later, as required by law. Initial Net Premium Payments allocated to any of the Variable Fund Accounts will be invested in the Vanguard Money Market Portfolio Variable Fund Account during the 10-day "Free Look" period plus 5 calendar days. Should you elect to cancel the Policy, return it to us with your written request for cancellation and we will refund the greater of: o your premium payments, or o the value of the Variable Fund Accounts VUL Policy 4 as of the date of receipt of your request plus any premium charge, monthly deduction, and mortality and expense charge that we deducted. FLEXIBLE PREMIUM PAYMENTS ------------------------- Within certain limits, you have the flexibility to determine the amount and timing of your premium payments to reflect your changing financial conditions or objectives. We generally require a minimum initial premium to issue a Policy, but we do not impose a minimum on your subsequent premium payments. You must maintain sufficient Cash Value to keep your Policy in effect, which may require you to make additional unscheduled premium payments. You can request a periodic premium schedule to suit your needs when applying for a Policy and we will bill you for these amounts, if you wish; however, you are not required to follow this schedule. INVESTMENT OPTIONS ------------------ SEPARATE ACCOUNT The Separate Account is a segregated asset account of USAA Life that supports the Policy's variable life insurance benefits. The Separate Account consists of 18 Variable Fund Accounts, each of which invests in a corresponding Fund. INVESTMENT CHOICES Through the Separate Account, you may invest in up to 18 Variable Fund Accounts, each of which invests exclusively in a corresponding Fund of o the USAA Life Investment Trust ("Trust"), o the Vanguard(R)Variable Insurance Fund ("Vanguard Fund"), o the Fidelity(R)Variable Insurance Products ("Fidelity Funds"), o the Scudder Variable Series I ("Scudder Series"), or o the Alger American Fund ("Alger Fund"). TRANSFERS AMONG INVESTMENT OPTIONS ---------------------------------- You may transfer value among the Variable Fund Accounts up to 18 times per Policy Year without charge. Transfers under the Dollar Cost Averaging Program are free and do not count against the limit. o Additional transfers in a Policy Year are subject to a $25 transfer charge. o You may authorize transfers by telephone or by written notice. o Transfers must be at least $250, or the remaining value in the Variable Fund Account, if less. o We reserve the right at any time, without prior notice, to terminate, suspend or modify these transfer privileges. ALLOCATING CASH VALUE --------------------- o Specify on your Policy application how much of your Net Premium Payment to apply to each Variable Fund Account. o After the Free Look Period, we will allocate your Net Premium Payments in accordance with these instructions until you direct otherwise. o Change future allocations at any time by telephone or by written notice. o Allocations can be as small as 1/10th of one percent. TRACKING CASH VALUE ------------------- We will mail you periodic reports regarding your Policy and the Separate Account. In addition, log on to USAA.COM or call the USAA TOUCHLINE(R) at 1-800-531-5433 to find information about: o Policy details o Variable Fund Account summaries o Financial activity You will need a USAA Member Number and USAA PIN to access USAA.COM or USAA TOUCHLINE(R) information. You can also use your Social Security Number to access USAA TOUCHLINE(R) information. VUL Policy 5 ACCESSING YOUR CASH VALUE ------------------------- Access your Cash Value through full or partial surrenders or Policy loans. FULL SURRENDER At any time while your Policy is in force, you may request to surrender the Policy and receive the Policy's Cash Surrender Value. Cash Surrender Value is the Policy Cash Value less the Surrender Charge, if any, payable on full surrender of your Policy. A full surrender may have tax consequences. (See "Tax Matters) A full surrender terminates the Policy. PARTIAL SURRENDER At any time while your policy is in force, you may request to withdraw part of the Policy's Cash Value. An administrative charge equal to the lesser of $25 or 2% of the amount withdrawn will apply. Your Policy's remaining Cash Value, after a partial surrender, may not be less than an amount equal to the then current surrender charge for a full surrender. A partial surrender will reduce your death benefit. A partial surrender may have tax consequences. (See "Tax Matters) LOAN You may borrow from your Policy at any time after the first Policy Year. The Policy is used as security for the loan. The maximum loan amount is 85% of the Cash Value which would be available for a full surrender. We charge you interest, in advance, at a maximum annual interest rate of 6% (4.5% for preferred loans). Lower rates may be available. If loans are not repaid, they will reduce the Policy's death benefit. A loan may have tax consequences. (See "Tax Matters) POLICY RISKS ------------ The Policy is a long-term investment designed to provide significant life insurance benefits. You should consider the Policy in conjunction with other insurance you own. It may be to your advantage to replace existing insurance with the Policy. The Policy should be purchased only if you have the financial ability to keep it in force for a substantial period of time. You should not purchase the Policy if you intend to surrender all or part of the Policy Cash Value in the near future. THE POLICY IS DESIGNED TO MEET LONG-TERM FINANCIAL GOALS. IT IS NOT SUITABLE AS A SHORT-TERM INVESTMENT. CASH VALUE AND INVESTMENT EXPERIENCE ------------------------------------ o Your Policy's Cash Value may change daily to reflect the investment experience of the Variable Fund Accounts. o Your Policy's Cash Value also will reflect the amount and frequency of premium payments, partial surrenders of Cash Value, Policy loans and the charges and deductions connected with the Policy. o Your Policy has no minimum guaranteed Cash Value, which means you bear the entire investment risk that your Cash Value could decline to zero (see "Cash Value"). TRANSACTION RISKS ----------------- There are risks associated with surrenders, withdrawals, and loans. These risks arise from the charges associated with those transactions, as well as their effect on the Policy. You should consider the following carefully: o A surrender charge applies for 10 Policy Years after the Policy Date. It is possible you will receive no net cash surrender value if you surrender your Policy in the first few Policy years. o You should not purchase the Policy if you intend to surrender all or part of the policy account value in the near future. o You should purchase the Policy only if you have the financial ability to keep it in force for a substantial period of time. RISKS OF INVESTMENT OPTIONS --------------------------- A COMPREHENSIVE DISCUSSION OF THE RISKS OF EACH FUND MAY BE FOUND IN EACH FUND'S PROSPECTUS. PLEASE REFER TO THE FUNDS' PROSPECTUSES FOR MORE INFORMATION. LAPSE RISK ---------- If the Cash Value can no longer cover the Policy's Monthly Deduction and any loan interest due, the Policy will lapse and a grace period will begin, unless you have paid enough premiums to qualify for the Guaranteed Death VUL Policy 6 Benefit (see "Guaranteed Death Benefit"). During the grace period, you must pay the necessary premium. If you do not pay the necessary premium before the grace period ends, the Policy will terminate without value, ending all insurance coverage, including any benefits provided by rider. If partial surrenders, loans, and charges reduce the Cash Value to too low an amount and/or if the investment experience in your selected Variable Fund Accounts is unfavorable, there is a risk that the Policy could lapse. After termination, you may reinstate the Policy within five years, subject to certain conditions. TAX RISKS --------- WE DO NOT INTEND THIS DISCUSSION TO BE TAX ADVICE. YOU SHOULD CONSULT WITH YOUR OWN TAX ADVISOR BEFORE PURCHASING A POLICY (SEE "TAX MATTERS"). This Policy is intended to meet the definition of a "life insurance contract" under federal tax law. The Policy's death benefit should be fully excludable from the Beneficiary's gross income if paid due to the death of the Insured. Any earnings on your investment in a Variable Fund Account should not be taxable to you while the Policy is in effect unless you receive a full or partial surrender of the Policy's Cash Value. Federal tax law limits premium payments relative to your Policy's Specified Amount in order for the Policy to meet the definition of life insurance. If the premiums you pay exceed these limits, the Policy will be treated as a modified endowment contract ("MEC") and federal tax law may impose penalties on amounts you take out of your Policy, whether as withdrawals, surrenders, or loans. We monitor your premium payments to help assure that you do not exceed permitted amounts or inadvertently incur any tax penalties due to excess premium payments. FEE TABLES ---------- The following tables describe the fees and charges that you will pay when buying, owning, and surrendering the Policy. The first table describes the fees and charges that you will pay at the time you buy the Policy, surrender the Policy, or transfer Cash Value between investment options.
------------------------------------------------------------------------------------------------- TRANSACTION FEES ------------------------------------------------------------------------------------------------- CHARGE WHEN CHARGE IS DEDUCTED AMOUNT DEDUCTED ------------------------------------------------------------------------------------------------- Maximum Charge Imposed on Each premium payment until 3% of premium paid Premiums the amount paid totals 10 Annual Target Premium Payments(1) ------------------------------------------------------------------------------------------------- Maximum Deferred Sales Charge On surrender of Policy Maximum of 50% of Annual Target Premium Payment(2) ------------------------------------------------------------------------------------------------- Partial Surrender On partial surrender of Lesser of $25 or 2% of amount Policy withdrawn ------------------------------------------------------------------------------------------------- Transfer Fees Applied, after the 18th $25 per transfer(3) transfer in each Policy Year, to each transfer. -------------------------------------------------------------------------------------------------
1 An increase or decrease in the Policy's Specified Amount will result in a new Annual Target Premium Payment. 2 Declines by 5% each Policy Year to 0% after the 10th Policy Year. 3 We reserve the right at any time, and without prior notice, to terminate, suspend or modify transfer privileges under the Policy. The next table describes the fees and charges that you will pay periodically during the time that you own the Policy, not including Fund operating expenses.
------------------------------------------------------------------------------------------------- PERIODIC CHARGES OTHER THAN FUND OPERATING EXPENSES ------------------------------------------------------------------------------------------------- CHARGE WHEN CHARGE IS DEDUCTED AMOUNT DEDUCTED ------------------------------------------------------------------------------------------------- Cost of Insurance(4) Policy's Effective Date, and each (per $1,000 of net amount at risk) Monthly Anniversary thereafter ------------------------------------------------------------------------------------------------- o Minimum and Maximum Charge $0.03 - $83.33 per $1,000 of Net Amount at Risk -------------------------------------------------------------------------------------------------
VUL Policy 7
------------------------------------------------------------------------------------------------- o Charge for 34 year old male $.062 per $1,000 of in preferred rate class in Net Amount at Risk the first policy year -------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------- Maintenance Charge Policy's Effective Date, and each $5 Monthly Anniversary thereafter ------------------------------------------------------------------------------------------------- Annualized rate of Mortality and Expense Charge(5) Daily .75% of average net assets of each Variable Fund Account ------------------------------------------------------------------------------------------------- Policy's Effective Date, and each Administrative Charge Monthly Anniversary thereafter $10 during the first Policy Year ------------------------------------------------------------------------------------------------- Federal Income Tax Charge None(6) ------------------------------------------------------------------------------------------------- At the commencement of the loan Loan Interest and at the beginning of each Policy Year thereafter so long as the loan is outstanding ------------------------------------------------------------------------------------------------- Maximum Loan Interest Rate Policy Years 1 - 10 and each year after that until the Insured is 6.0% annually age 55 ------------------------------------------------------------------------------------------------- Maximum Loan Interest Rate Policy Year 11 and thereafter if 4.5% annually (Insured is age 55 or older) the Insured is age 55 or older ------------------------------------------------------------------------------------------------- OPTIONAL RIDER CHARGES(7) ------------------------------------------------------------------------------------------------- Accidental Death Benefit Rider Later of the Policy's Effective Annualized rate of Date or the rider's effective date, and each Monthly Anniversary $.84 per $1,000 thereafter coverage ------------------------------------------------------------------------------------------------- Later of the Policy's Effective Date or the rider's effective date, Annualized rate of Children Term Life Insurance Rider and each Monthly Anniversary $6.00 per $1,000 thereafter coverage ------------------------------------------------------------------------------------------------- Extended Maturity Date Rider Not applicable None ------------------------------------------------------------------------------------------------- Terminal Illness Rider Not applicable None ------------------------------------------------------------------------------------------------- Later of the Policy's Effective Date or the rider's effective date, Waiver of Monthly Deduction Rider(8) and each Monthly Anniversary thereafter ------------------------------------------------------------------------------------------------- $0.05 - $0.277 per o Minimum and Maximum Charge $1 of Monthly Deduction ------------------------------------------------------------------------------------------------- o Charge for 34 year old $0.062 per $1 of male in preferred rate class in the first policy year Monthly Deduction -------------------------------------------------------------------------------------------------
4 The cost of insurance charge for an Insured depends on the age, sex, and rate class of the Insured. (See "Calculating Your Cost of Insurance.") The cost of insurance charge shown in the table may not be representative of the charge that a particular Policy Owner will pay. The actual charge will be determined by an underwriting review of the Insured's health and circumstances. On request, we will provide a personalized illustration which will include the cost of insurance charge for the Insured. 5 We deduct the Mortality and Expense Charge on a daily basis at an annual rate of .75% of the average net assets of each Variable Fund Account. 6 Currently, we make no charge for federal income taxes that may be attributable to the Separate Account. We may, however, make such a charge in the future, should it be necessary. We also may make charges for other taxes, if any, attributable to the Separate Account. 7 Riders offer additional benefits to go with your Policy. Not all riders are available in all states. 8 The Waiver of Monthly Deduction charge for an Insured depends on the age of the Insured. The charge shown in the table may not be representative of the charge that a particular Policy Owner will pay. On request, we will provide a personalized illustration which will include the Waiver of Monthly Deduction rider. The next table shows the minimum and maximum total operating expenses charged by the Funds that you will pay periodically during the time that you own the Policy. More detail concerning each Fund's fees and expenses is contained in the prospectus for each Fund. VUL Policy 8 -------------------------------------------------------------------------------- TOTAL ANNUAL FUND OPERATING EXPENSES MINIMUM MAXIMUM -------------------------------------------------------------------------------- Expenses that are deducted from Fund assets, .18% 2.64% including management fees and other expenses(9) -------------------------------------------------------------------------------- 9 The maximum actual total Fund operating expense was 1.50% as the result of a voluntary expense reimbursement arrangement that had the effect of reducing expenses actually paid by the Fund. The expense reimbursement arrangements, including whether they are voluntary or contractual, appear in footnotes to the next following table of expenses. The next table shows the operating expenses (before and after contractual waiver or reimbursement) charged by each Fund for the fiscal year ended December 31, 2002. FUND OPERATING EXPENSES -----------------------
--------------------------------------------------------- --------------------------------- OTHER TOTAL FUND TOTAL FUND EXPENSES OPERATING VARIABLE FUND MANAGEMENT OTHER OPERATING AFTER EXPENSES AFTER ACCOUNT FEES EXPENSES EXPENSES REIMBURSEMENT REIMBURSEMENT --------------------------------------------------------- --------------------------------- USAA LIFE INVESTMENT TRUST(10, 11) --------------------------------------------------------- --------------------------------- Growth and Income .20 .26 .46 .26 .46 --------------------------------------------------------- --------------------------------- Aggressive Growth .50 .68 1.18 .45 .95 --------------------------------------------------------- --------------------------------- World Growth .35 1.30 1.65 .60 .95 --------------------------------------------------------- --------------------------------- Diversified Assets .20 .38 .58 .38 .58 --------------------------------------------------------- --------------------------------- Income .20 .51 .71 .45 .65 --------------------------------------------------------- --------------------------------- VANGUARD(R) VARIABLE INSURANCE FUND --------------------------------------------------------- --------------------------------- .46 .04 .50 N/A .50 Diversified Value Portfolio --------------------------------------------------------- --------------------------------- Equity Index .16 .02 .18 N/A .18 Portfolio --------------------------------------------------------- --------------------------------- Mid-Cap Index .24 .06 .30 N/A .30 Portfolio --------------------------------------------------------- --------------------------------- Small Company .54 .03 .57 N/A .57 Growth Portfolio --------------------------------------------------------- --------------------------------- International .42 .11 .53 N/A .53 Portfolio --------------------------------------------------------- --------------------------------- REIT Index .34 .05 .39 N/A .39 Portfolio --------------------------------------------------------- --------------------------------- High Yield Bond .30 .03 .33 N/A .33 Portfolio --------------------------------------------------------- --------------------------------- Money Market .18 .03 .21 N/A .21 Portfolio --------------------------------------------------------- ---------------------------------
VUL Policy 9 FUND OPERATING EXPENSES -----------------------
--------------------------------------------------------- --------------------------------- OTHER TOTAL FUND TOTAL FUND EXPENSES OPERATING VARIABLE FUND MANAGEMENT OTHER OPERATING AFTER EXPENSES AFTER ACCOUNT FEES EXPENSES EXPENSES REIMBURSEMENT REIMBURSEMENT --------------------------------------------------------- --------------------------------- FIDELITY(R) VARIABLE INSURANCE PRODUCTS --------------------------------------------------------- --------------------------------- Contrafund(R) .58 .10 .68 N/A N/A Portfolio, Initial Class --------------------------------------------------------- --------------------------------- .48 .069 .57 N/A N/A Equity-Income Portfolio, Initial Class --------------------------------------------------------- --------------------------------- .58 2.06 2.64 N/A(12) N/A(12) Dynamic Capital Appreciation Portfolio, Initial Class --------------------------------------------------------- --------------------------------- SCUDDER VARIABLE .47 .04 .51 .04 .51 SERIES I Capital Growth Portfolio, Class A Shares --------------------------------------------------------- --------------------------------- ALGER AMERICAN .75 .10 .85 .10 .85 FUND Growth Portfolio, Class O Shares --------------------------------------------------------- ---------------------------------
(10) Pursuant to a contractual expense reimbursement arrangement, USAA Life, out of its general account, limits Fund expenses of the USAA Life Investment Trust Funds, excluding fee offset arrangements, and reimburse the Funds for all expenses in excess of, on an annual basis, .95% of the average net assets of the Aggressive Growth and World Growth Funds, .75% of the average net assets of the Diversified Assets Fund, .65% of the average net assets of the Income Fund, and .60% of the average net assets of the Growth & Income Fund. The arrangement may not be terminated before May 1, 2004. (11) A portion of the brokerage commissions that the Funds pay may be reimbursed and used to reduce the Funds' expenses. In addition, through fee offset arrangements with the Funds' custodian, credits, if any, realized as a result of uninvested cash balances are used to reduce custodian expenses. Total fund operating expenses reflect total expenses excluding any custodian fee offset arrangement, which reduced the total expenses of the Aggressive Growth Fund, the World Growth Fund, and the Income Fund by .01%, and had no impact on the total expenses of the Growth and Income Fund and Diversified Assets Fund. (12) The Fund's manager has voluntarily agreed to reimburse the Fund to the extent that total operating expenses (excluding interest, taxes, certain securities lending costs, brokerage commissions, and extraordinary expenses) exceed 1.50%. As a result, for the fiscal year ended December 31, 2002, Other Expenses After Reimbursement were .92%, and Total Fund Operating Expenses After Reimbursement were 1.50%. This arrangement can be discontinued by the Fund's manager at any time. POLICY INFORMATION ------------------ WHO MAY PURCHASE A POLICY AND HOW TO PURCHASE A POLICY ------------------------------------------------------ o Complete an application and submit it, with your initial premium payment (if required), to our Home Office. o You are required to provide us with satisfactory evidence of your insurability as part of the "underwriting" process. o During the underwriting process, you will be asked to complete a medical examination in order to assign you to an underwriting class used to determine your cost of insurance charges. o After completion of the underwriting process, we will notify you of our decision regarding your application. o We will not issue a Policy to insure a person older than age 80. VUL Policy 10 EFFECTIVE DATE -------------- o If the first premium is submitted with the application, the Effective Date will ordinarily be the date the application is approved and the Policy is issued. o Insurance coverage begins on the Policy's Effective Date which is shown on the Policy Information Page. o You must pay the first premium before the Policy becomes effective. PREMIUM PAYMENTS ---------------- METHODS OF PAYMENT o We accept premium payments by check or money order drawn on a U.S. bank in U.S. dollars and made payable to "USAA Life Insurance Company" or "USAA Life". o We accept premium payments made by bank draft, wire, or exchange from another insurance company. o Premium payments must be sent directly to our Home Office. o You may use our Automatic Payment Plan to have monthly premium payments automatically deducted from your bank account. AMOUNT AND FREQUENCY OF PAYMENTS o As long as you maintain sufficient Cash Value, you have flexibility to determine amount and frequency of premium payments. o INITIAL PREMIUM PAYMENT - To issue a Policy, you are required to provide us with an initial premium payment equal to at least one full Planned Periodic Premium Payment specified in your Policy. (If you select the Automatic Payment Plan, your initial premium payment would equal 2 monthly payments under the Plan.) o MINIMUM AND MAXIMUM PREMIUM PAYMENTS - Except for the initial premium payment, we do not require any minimum premium. However, you must maintain enough Cash Value to cover policy charges or the Policy will lapse. In addition, for the Policy to qualify as a life insurance contract for federal tax purposes, the total amount of your premium payments may not exceed the maximum amount allowed by federal tax law, unless necessary to prevent lapse. If a premium payment would cause you to exceed that maximum amount, we will refund the excess premium payment to you. (See "Tax Matters.") PREMIUM ALLOCATION On your application, you must specify the allocation of Net Premium Payments to each selected Variable Fund Account. You can specify allocations in increments as small as 1/10th of one percent. The total amount of your allocations must equal 100%. During the application process, we will hold your initial premium payment in our general account (without interest). If a policy is not issued, we will return your premium. Once your application is in good order, we will credit your initial net premium to the Policy as of the date the Policy is issued. There is a "Free Look" period during which we will allocate your initial Net Premium Payment and any subsequent Net Premium received during the "Free Look" period to the Vanguard Money Market Portfolio Variable Fund Account. The Net Premium will remain in the Vanguard Money Market Portfolio Variable Fund Account for the "Free Look" period plus five days. On the Valuation Date immediately following the end of that period, we will allocate the initial Net Premium Payment, together with any subsequent Net Premium Payments that have been made, plus any earnings, among the Variable Fund Accounts in the percentages directed on the application. We will allocate these amounts at the Accumulation Unit Value next computed on that date. (See "Calculating Your Value in the Variable Fund Accounts.") You may change your fund allocations at any time by telephone or by written notice. There are no charges or fees for changing your allocation instructions. The allocation change will become effective with the first premium payment we receive on or following the Date of Receipt of your request. (See "Transfer of Value") PLANNED PERIODIC PREMIUM PAYMENTS You may choose to make planned periodic premium payments. For convenience, we will also set up a schedule of premium payments and will send you premium notices at quarterly, semiannual or annual intervals. To facilitate planned periodic premium payments, we also will accept monthly premium payments through our Automatic Payment Plan. You are not obligated to follow the schedule of planned periodic premium payments, and failing to do so will not itself cause your Policy to lapse. Conversely, following the schedule will not guarantee that your Policy will remain in effect, unless you have made enough premium payments to qualify for the Guaranteed Death Benefit (see "Guaranteed Death Benefit"). VUL Policy 11 ANNUAL TARGET PREMIUM PAYMENT We will use the Annual Target Premium Payment specified in your Policy to determine whether we will deduct a premium charge from your premium payments or a surrender charge if you fully surrender. (SEE "Premium Charge" and "Surrender Charge" under "Charges and Deductions.") We also will use the Annual Target Premium Payment to determine whether the Guaranteed Death Benefit applies. (SEE "Guaranteed Death Benefit" under "Lapse and Reinstatement.") We determine the Annual Target Premium Payment actuarially based on the age, sex and rate class of the Insured, and the insurance benefits contained in the Policy. INVESTMENT OPTIONS ------------------ Currently, you may invest in up to 18 Funds through the Separate Account. You can invest in a Fund by allocating Net Premium Payments to the corresponding Variable Fund Account. The Funds are managed by professional money managers as shown in the chart below that provides a brief description of each Fund. For more information, including a discussion of potential investment and other risks, please refer to the prospectuses for the Funds. ADDITIONS OR CHANGES TO INVESTMENT OPTIONS In the future, additional Funds may be made available as investment options through corresponding Variable Fund Accounts. For example, we may add Funds if we believe investment or marketing conditions warrant. We reserve the right, subject to compliance with applicable law, to change the Funds available as investment options. For example, we may eliminate or merge one or more Funds or substitute the shares of a Fund for those of another fund. We may do so, in our sole discretion, if we determine further investment in any Fund would be inconsistent with the purposes of the Policies. We will give you written notice of the addition, elimination, merger, or substitution of any Fund to the extent required by law. In the event of a substitution or other change, we may, by appropriate endorsement, make any changes in your Policy and any future policies as may be necessary or appropriate to reflect the substitution or change, operate the Separate Account as a management company, deregister it with the SEC in the event such registration is no longer required, or combine it with other USAA Life separate accounts. VOTING PRIVILEGES Based on our present view of the law, we will vote the shares of the Funds we hold directly or indirectly through the Separate Account in accordance with instructions received from Owners entitled to give such instructions. We will determine the persons entitled to give voting instructions and the number of shares a person has a right to instruct based on Variable Fund Account Values as of the record date of the meeting. We will vote shares attributable to Policies for which we have not received instructions, as well as shares attributable to us, in the same proportion as we vote shares for which we have received instructions, unless we determine, based on SEC rules or other authority, that we may vote such shares ourselves in our own discretion.
------------------------------------------------------------------------------------------------- INVESTMENT OBJECTIVE PRINCIPAL INVESTMENT & INVESTMENT ADVISER STRATEGIES INVESTOR PROFILE ------------------------------------------------------------------------------------------------- LARGE-CAP VALUE FUNDS ------------------------------------------------------------------------------------------------- FIDELITY VIP EQUITY-INCOME o Normally invests at May be appropriate for PORTFOLIO INITIAL CLASS least 80% of total assets investors who are willing to in income-producing equity ride out stock market OBJECTIVE: securities, which tends to fluctuations in pursuit of Reasonable income. The Fund lead to investments in potentially above-average will also consider the large cap "value" stocks. long-term returns. Designed potential for capital o Potentially invests for those who want some appreciation. The Fund's goal in other types of equity income from equity and bond is to achieve a yield which securities and debt securities, but also want to exceeds the composite yield on securities, including be invested in the stock the securities comprising the lower-quality debt market for its long-term S&P 500(R)Index securities. growth potential o Invests in domestic ADVISER: and foreign issuers. Fidelity Management & Research o Uses fundamental Company analysis of each issuer's 82 Devonshire Street financial condition and Boston, Massachusetts 02109 industry position and market and economic conditions to select investments. -------------------------------------------------------------------------------------------------
VUL Policy 12
------------------------------------------------------------------------------------------------- INVESTMENT OBJECTIVE PRINCIPAL INVESTMENT & INVESTMENT ADVISER STRATEGIES INVESTOR PROFILE ------------------------------------------------------------------------------------------------- LARGE-CAP VALUE FUNDS ------------------------------------------------------------------------------------------------- USAA LIFE GROWTH & INCOME FUND o Invests primarily in Designed for the investor equity securities that seeking to benefit from OBJECTIVE: show the best potential long-term growth of capital Primary: Capital growth for total return through a and return. Because the Fund Secondary: Current income combination of capital emphasizes investments in appreciation and income. common stocks, its value will ADVISER: o Investments in convertible fluctuate based on market USAA Investment Management securities is limited to conditions. Consequently, Company 5% of assets. May invest the Fund should not be relied 9800 Fredericksburg Road in nonconvertible debt upon for short-term financial San Antonio, Texas 78288 securities and preferred needs or short-term stock. investment in the stock SUBADVISER: o While most of the Fund's market. Wellington Management Co., LLP assets will be invested 75 State Street in U.S. securities, we Boston, MA 02109 may also invest up to 20% of the Fund's total assets in foreign securities purchased in either foreign or U.S. markets. These foreign holdings may include securities issued in emerging markets as well as securities issued in established markets. ------------------------------------------------------------------------------------------------- LARGE-CAP GROWTH FUNDS ------------------------------------------------------------------------------------------------- VANGUARD DIVERSIFIED VALUE o Invests primarily in May be suitable investment PORTFOLIO common stocks of large and for you if: (1) you wish to medium-size companies add a stock fund to your OBJECTIVE: whose stocks are existing holdings, which Long-term growth of capital and considered by the adviser could include other stock a moderate level of dividend to be undervalued and out investments as well as bond income of favor with investors. and money market investments; Such "value" stocks (2) you want a stock fund ADVISER: typically have employing a value approach in Barrow, Hanley, Mewhinney & above-average dividend seeking long-term growth in Strauss, Inc. yields and/or capital as well as moderate One McKinney Plaza below-average prices in level of dividend income. 3232 McKinney Ave, 15th Floor relation to such financial Dallas, Texas 75204 measures as earnings, book value, and cash flow. ------------------------------------------------------------------------------------------------- ALGER AMERICAN GROWTH o Invests primarily in May be appropriate for PORTFOLIO, CLASS O SHARES* equity securities, such investors seeking long-term as common or preferred capital appreciation. OBJECTIVE: stocks, which are listed Long-term capital appreciation on U.S. exchanges or in the over-the-counter ADVISER: market. Fred Alger Management, Inc. o The Portfolio invests primarily in "growth" 111 Fifth Avenue stocks. New York, NY 10003 o Under normal circumstances, the *The Alger American Portfolio invests Fund offers both primarily in the Class O and Class S equity securities of shares. The classes large companies with a differ only in that market capitalization of Class S shares are $1 billion or greater. subject to distribution and shareholder servicing fees, while Class O shares are not. Only Class O shares are available under the Policy. -------------------------------------------------------------------------------------------------
VUL Policy 13
------------------------------------------------------------------------------------------------- INVESTMENT OBJECTIVE PRINCIPAL INVESTMENT & INVESTMENT ADVISER STRATEGIES INVESTOR PROFILE ------------------------------------------------------------------------------------------------- LARGE-CAP GROWTH FUNDS ------------------------------------------------------------------------------------------------- FIDELITY VIP CONTRAFUND(R) o Normally invests May be appropriate for PORTFOLIO, INITIAL CLASS primarily in common stocks investors who are willing to OBJECTIVE: o Invests in securities ride out stock market Long-term capital appreciation of companies whose value fluctuations in pursuit of it believes is not fully potentially above-average ADVISER: recognized by the public. long-term returns. Fidelity Management & Research o Invests in domestic Company and foreign issuers. 82 Devonshire Street o Invests in either Boston, Massachusetts 02109 "growth" stocks or "value" stocks or both. o Uses fundamental analysis of each issuer's financial condition and industry position and market and economic conditions to select investments. ------------------------------------------------------------------------------------------------- LARGE-CAP BLEND FUNDS ------------------------------------------------------------------------------------------------- SCUDDER VS I CAPITAL GROWTH o Invests at least 65% May be appropriate for PORTFOLIO, CLASS A SHARES of total assets in common investors seeking long-term OBJECTIVE: stocks of U.S. companies. growth. Maximize long-term capital o Although the Portfolio growth through a broad and can invest in companies flexible investment program. of any size, it generally focuses on ADVISER: established companies that Deutsche Investment Management are similar in size to the Americas, Inc. companies in the S&P 500 345 Park Avenue Index. The Portfolio New York, New York intends to invest primarily in companies whose market capitalizations fall within the normal range of the Index. ------------------------------------------------------------------------------------------------- VANGUARD EQUITY INDEX PORTFOLIO o Employs a "passively" May be a suitable investment OBJECTIVE: managed- or for you if: (1) you wish to Long-term growth of capital and index-approach, by holding add a low-cost, income by attempting to match all of the stocks in the large-capitalization stock the performance of a Standard & Poor's 500 index fund to your existing broad-based market index of Composite Stock Price holdings, which could include stocks of large U.S. companies. Index in roughly the same other stock investments as proportion to their well as bond and money market ADVISER: weighting in the index. investments; (2) you want the The Vanguard Group o Stocks represented in potential for long-term P.O. Box 2600 the Index, and thus the capital appreciation, with a Valley Forge, Pennsylvania Portfolio's holding, are moderate level of dividend 19482 weighted according to each income. stock's market capitalization (shares outstanding x share price). For example, if a specific stock represented 2% of the S&P 500 Index, the Portfolio would invest 2% of its assets in that company. -------------------------------------------------------------------------------------------------
VUL Policy 14
------------------------------------------------------------------------------------------------- INVESTMENT OBJECTIVE PRINCIPAL INVESTMENT & INVESTMENT ADVISER STRATEGIES INVESTOR PROFILE ------------------------------------------------------------------------------------------------- LARGE-CAP BLEND FUNDS ------------------------------------------------------------------------------------------------- VANGUARD MID-CAP INDEX PORTFOLIO o Employs a "passively" May be a suitable investment OBJECTIVE: managed- or index-approach for you if: (1) you wish to Long-term growth of capital by by holding the stocks in add a low-cost, attempting to match the the Standard & Poor's mid-capitalization stock performance of a broad-based MidCap 400 Index in index fund to your existing market index of stocks of roughly the same holdings, which could include medium-size U.S. companies. proportion to their other stock investments as weighting in the Index. well as bond and money market ADVISER: o Stocks represented in investments; (2) you want the The Vanguard Group the Index, and thus the potential for long-term P.O. Box 2600 Portfolio's holdings, are capital appreciation. Valley Forge, Pennsylvania weighted according to 19482 each stock's market capitalization. For example, if a specific stock represented 5% of the S&P MidCap 400 Index, the Portfolio would invest 5% of its assets in that company. ------------------------------------------------------------------------------------------------- MID-CAP GROWTH FUNDS ------------------------------------------------------------------------------------------------- FIDELITY VIP DYNAMIC CAPITAL o Normally invests May be appropriate for APPRECIATION PORTFOLIO, INITIAL primarily in common stocks. investors seeking broad CLASS o Invests in domestic exposure to the domestic OBJECTIVE: and foreign issuers. equity market without Capital appreciation o Invests in either investment style restrictions. "growth" stocks or "value" ADVISER: stocks or both Fidelity Management & Research o Uses fundamental Company analysis of each issuer's 82 Devonshire Street financial condition and Boston, Massachusetts 02109 industry position and market and economic conditions to select investments. ------------------------------------------------------------------------------------------------- USAA LIFE AGGRESSIVE GROWTH FUND o Invests primarily in Designed for the investor OBJECTIVE: equity securities of large seeking to benefit from Appreciation of capital companies that are long-term growth of capital. selected for their Generally, this Fund is ADVISER: attractive growth expected to have a greater USAA Investment Management potential. These potential for long-term Company investments will tend to capital appreciation than 9800 Fredericksburg Road consist primarily of a growth and income funds, but San Antonio, Texas 78288 diversified portfolio of is also significantly more stocks of large companies volatile. SUBADVISER: selected for their growth Marsico Capital Management, LLC potential. The term 1200 17th Street, Suite 1300 "equity securities" is Denver, CO 80202 used to include common stocks, convertible securities, and securities that carry the right to buy common stock. o While most of the Fund's assets will be invested in U.S. securities, we may also invest up to 20% of the Fund's total assets in foreign securities purchased in either foreign or U.S. markets. -------------------------------------------------------------------------------------------------
VUL Policy 15
------------------------------------------------------------------------------------------------- INVESTMENT OBJECTIVE PRINCIPAL INVESTMENT & INVESTMENT ADVISER STRATEGIES INVESTOR PROFILE ------------------------------------------------------------------------------------------------- MID-CAP GROWTH FUNDS ------------------------------------------------------------------------------------------------- VANGUARD SMALL COMPANY GROWTH o Invest mainly in the May be suitable investment PORTFOLIO stocks of smaller for you if: (1) you wish to OBJECTIVE: companies (which, at the add a small-capitalization Long-term growth of capital time of purchase, growth stock fund to your typically have a market existing holdings, which ADVISERS: value of less than $1-$2 could include other stock Granahan Investment Management, billion). These companies investments as well as bond Inc. are considered by the and money market investments; 275 Wyman Street Portfolio's advisers to (2) you are seeking growth of Waltham, Massachusetts 02154 have above-average capital over the long-term at prospects for growth, but least five years; (3) you are Grantham, Mayo, Van Otterloo & often provide little or no not looking for dividend Co. LLC dividend income. income; (4) you are willing 40 Rowes Wharf to assume the above-average Boston, Massachusetts 02110 risk associated with investing in small cap growth stocks. ------------------------------------------------------------------------------------------------- DOMESTIC HYBRID FUND ------------------------------------------------------------------------------------------------- USAA LIFE DIVERSIFIED ASSETS o Invests in a Designed for the investor FUND diversified program within seeking the benefits of both OBJECTIVE: one mutual fund by long-term capital Long-term capital growth, allocating the Fund's appreciation and current consistent with preservation of assets, under normal return. Generally, the Fund capital and balanced by current market conditions, in is expected to have less income. approximately 60% equity exposure to equity securities securities (selected for than growth funds. ADVISER: their potential return) USAA Investment Management and approximately 40% in Company debt securities of varying 9800 Fredericksburg Road maturities. San Antonio, Texas 78288 o The equity securities will consist significantly of domestic common stocks and, to a much lesser extent, may include shares of real estate investments trust (REITs). o The fixed income component will be made up of the same types of debt securities in which the USAA Life Income Fund may invest. The Fund may also invest in municipal lease obligations. o While most of the Fund's assets will be invested in U.S. securities, we may also invest up to 20% of the Fund's total assets in foreign or U.S. markets. These foreign holdings may include securities issued in emerging markets as well as securities issued in established markets. -------------------------------------------------------------------------------------------------
VUL Policy 16
------------------------------------------------------------------------------------------------- INVESTMENT OBJECTIVE PRINCIPAL INVESTMENT & INVESTMENT ADVISER STRATEGIES INVESTOR PROFILE ------------------------------------------------------------------------------------------------- WORLD STOCK FUND ------------------------------------------------------------------------------------------------- USAA LIFE WORLD GROWTH FUND o Invests primarily in Designed for the investor OBJECTIVE: equity securities of both seeking to diversify by Long-term capital appreciation foreign and domestic investing in securities of issuers. both domestic and foreign ADVISER: o May not invest more issuers and who is prepared USAA Investment Management than 25% of assets in one to bear the risks of such Company industry. investments. Because of the 9800 Fredericksburg Road o Under normal market Fund's emphasis on equity San Antonio, Texas 78288 conditions, the Fund's securities and securities of investments will be foreign issuers, the Fund SUBADVISER: diversified in at least should not be relied upon as MFS Investment Management three countries, one of a balanced investment program. 500 Boylston Street which is the United States. Boston, MA 02116 ------------------------------------------------------------------------------------------------- FOREIGN STOCK FUND ------------------------------------------------------------------------------------------------- VANGUARD INTERNATIONAL PORTFOLIO o Invests in the stocks May be suitable investment OBJECTIVE: of seasoned companies for you if: (1) you wish to Long-term growth of capital located outside of the add an international stock United States. fund to your existing ADVISER 1: o In selecting stocks, holdings, which could include Schroder Investment Management Schroder evaluates foreign other stock investments as North America, Inc. markets around the world. well as bond and money market 875 3rd Avenue, New York, NY Within markets regarded as investments; (2) you are 10022 having favorable seeking growth of capital investment climates, this over the long-term at least Sub-Adviser: advisor selects companies five years; (3) you are not Schroder Investment Management with above-average growth looking for income; (4) you North America, Limited potential whose stocks are willing to assume the 31 Gresham Street sell at reasonable prices. additional risks (including London EC2V 7QA, England o Baillie Gifford uses currency and country risk) a fundamental approach to associated with international Adviser 2: identify quality growth stocks. Baillie Gifford Overseas Ltd companies and considers 1 Rutland Court, Edinburgh, EH3 sustainable earnings and 8EY, Scotland free cash flow growth to be critical factors in evaluating a company's prospects. Companies are screened first for quality and then for value. Baillie Gifford looks for companies with attractive industry backgrounds, strong competitive positions within those industries, high quality earnings and a positive approach towards shareholders. The main fundamental factors considered when analyzing companies in this bottom-up analysis are: earnings growth, cash flow growth, profitability, debt and interest coverage, and valuation. -------------------------------------------------------------------------------------------------
VUL Policy 17
------------------------------------------------------------------------------------------------- INVESTMENT OBJECTIVE PRINCIPAL INVESTMENT & INVESTMENT ADVISER STRATEGIES INVESTOR PROFILE ------------------------------------------------------------------------------------------------- LONG-TERM BOND FUND ------------------------------------------------------------------------------------------------- USAA LIFE INCOME FUND o Invests primarily in Designed primarily for the OBJECTIVE: U.S. dollar-denominated investor seeking to benefit Maximum current income without debt and income-producing from returns higher than undue risk to principal. securities that have been those available in a money selected for their high market fund. An investor in ADVISER: yields relative to the this Fund should also be USAA Investment Management risk involved. willing to accept principal Company o Debt securities must fluctuations. The Fund 9800 Fredericksburg Road be investment-grade at the should not be relied upon as San Antonio, Texas 78288 time of purchase. a balanced investment program. ------------------------------------------------------------------------------------------------- HIGH YIELD BOND FUND ------------------------------------------------------------------------------------------------- VANGUARD HIGH YIELD BOND o Invests primarily in May be a suitable investment PORTFOLIO a diversified group of for you if: (1) you are OBJECTIVE: high -yielding, seeking a high level of High level of income higher-risk corporate income and are willing to bonds with medium- and take substantial risks in ADVISER: lower-range credit-quality pursuit of higher returns; Wellington Management Company, ratings, commonly known as (2) you have a long-term LLP "junk bonds". investment horizon - more 75 State Street o The Portfolio emphasizes than five years. Boston, Massachusetts 02109 higher grades of credit quality within the high- yield bond universe. The Portfolio invests at least 80% of its assets in corporate bonds that are rated below Baa by Moody's Investors Service, Inc. or below BBB by Standard & Poor's Corporation. o The Portfolio may not invest more than 20% of its assets in any of the following taken as a whole: securities with credit ratings lower than B or that are unrated, convertible securities, and preferred stocks. o The adviser may consider a security's potential for capital appreciation only when it is consistent with the objective of high and sustainable current income. -------------------------------------------------------------------------------------------------
VUL Policy 18
------------------------------------------------------------------------------------------------- INVESTMENT OBJECTIVE PRINCIPAL INVESTMENT & INVESTMENT ADVISER STRATEGIES INVESTOR PROFILE ------------------------------------------------------------------------------------------------- SPECIALTY-REAL ESTATE FUND ------------------------------------------------------------------------------------------------- VANGUARD REIT INDEX PORTFOLIO o Invests in the stocks May be a suitable investment OBJECTIVE: of real estate investment for you if: (1) You are High level of income and rusts (REITs), which own looking for a simple way to moderate long-term growth of office buildings, hotels, gain indirect exposure to the capital shopping centers, and real estate market to further other properties. diversify your existing ADVISER: o The Portfolio employs holdings, which could include The Vanguard Group a "passively" managed-or other stock, bond, and money P.O. Box 2600 index-approach, by holding market investments. (2) You Valley Forge, Pennsylvania a mix of securities that want a stock fund that offers 19482 seeks to match the the potential for performance of the Morgan above-average dividend Stanley REIT Index, a income. (Historically, the benchmark of U.S. REITs. securities that make up the Holdings of the Index, and Index have provided higher thus of the Portfolio, are dividend income than those in weighted according to each the S&P 500 Index.) (3) You stock's market are seeking modest growth of capitalization. capital over the long term - o The Portfolio holds at least five years. each stock found in the Index in approximately the same proportion as represented in the Index itself. For example, if a specific stock represented 2% of the Morgan Stanley REIT Index, the Portfolio would invest 2% in that stock ------------------------------------------------------------------------------------------------- MONEY MARKET FUND ------------------------------------------------------------------------------------------------- VANGUARD MONEY MARKET PORTFOLIO o Invests more than 25% May be a suitable investment OBJECTIVE: of its assets in for you if: (1) you wish to Income while maintaining high-quality, short-term add a money market fund to liquidity and a stable share money market instruments your existing holdings, which price of $1 issued by companies in the might also include stock and financial services bond investments; (2) you are ADVISER: industry. The Fund also seeking income and stability The Vanguard Group invests in high-quality of principal. P.O. Box 2600 money market instruments Valley Forge, Pennsylvania issued by non-financial 19482 corporations, such as securities backed by the full faith and credit of the U.S. government, securities issued by U.S. agencies, or obligations issued by corporations and financial institutions. -------------------------------------------------------------------------------------------------
POLICY LAPSE AND REINSTATEMENT ------------------------------ LAPSE Your Policy will lapse if your Policy Cash Value is insufficient to pay the Monthly Deduction and any loan interest due, unless you have paid enough premiums to qualify for the Guaranteed Death Benefit. (See "Guaranteed Death Benefit") GRACE PERIOD You have a 61-day grace period to provide sufficient payment to keep your Policy in force. The grace period will begin on any Monthly Anniversary when your Policy Cash Value is insufficient to cover the Monthly Deduction for the following month and any loan interest due. We will notify you and any assignee of record of the date the grace period expires and of the premium payment necessary to continue the Policy in effect. During the grace period, you must submit enough premium to cover 3 Monthly Deductions and any loan interest due. If you do not pay the necessary premium within the grace period, the Policy will lapse, terminating all insurance, including benefits provided by rider. If the Insured dies during the grace period, we will pay your Beneficiary the death benefit, less VUL Policy 19 any due and unpaid Monthly Deductions and any loan interest due through the month of death. During the grace period, or at lapse, we will not refund any Cash Value remaining in the Policy at the beginning of the grace period. GUARANTEED DEATH BENEFIT During the first 5 Policy years, your Policy will qualify for the Guaranteed Death Benefit if specified minimum premium payments have been paid. Guaranteed Death Benefit means that we guarantee that your Policy will not lapse, even if the Cash Value is insufficient to pay for the monthly deduction and any loan interest then due. The determination will be made at each Monthly Anniversary, at which time premium payments must total the Annual Target Premium payment specified in your Policy, adjusted to reflect the number of Monthly Anniversaries since the Policy's Effective Date. For example, if o Annual Target Premium is $2,000. o The policy has been in force for 3.5 years. o There are no partial surrenders and no loans. o The Cash Value at 3.5 years is insufficient to pay the Monthly Deduction. To qualify for the Guaranteed Death Benefit, premium payments must equal the Annual Target Premium. Here, $2,000 x 3.5 years = $7,000 premium. If $7,000 total premiums have been paid, then the policy will not lapse because the Guaranteed Death Benefit applies. The Guaranteed Death Benefit is only available during the first five policy years. We will declare a new Annual Target Premium payment if the Specified Amount is increased or decreased within the first five policy years. We will use the new Annual Target Premium Payment in the Guaranteed Death Benefit calculation. REINSTATEMENT You may reinstate a lapsed Policy within 5 years from the date of lapse and before the Policy's Maturity Date if you meet all of the following requirements: o Provide a completed written application for reinstatement. o Give proof of insurability satisfactory to USAA Life. o Make payment of premium sufficient to pay the estimated Monthly Deductions for at least the 3 Policy months beginning with the effective date of reinstatement. o Make payment of, or agreement to reinstate, any Policy Indebtedness. The Effective Date of the reinstatement will be the Monthly Anniversary on or before we approve your request. Upon reinstatement, the death benefit will be the Specified Amount in effect at lapse, less any reinstated Indebtedness. Your Policy's initial reinstated Cash Value will be calculated as follows: o Net reinstated premium, o MINUS the monthly deduction for the month following the Effective Date of reinstatement, o PLUS (if applicable) any reinstated indebtedness, o PLUS any interest earnings credited to the loan collateral held in the general account. An advantage of reinstating a lapsed Policy is that we will not deduct the first-year Administrative Charge again if it has already been paid. A possible disadvantage of reinstatement is that you must pay or reinstate any Policy Indebtedness. A Policy cannot be reinstated once it has been fully surrendered. CHARGES AND DEDUCTIONS ---------------------- PREMIUM CHARGE o We deduct a 3% premium charge from each premium as compensation for selling expenses and taxes. o We deduct the premium charge from all of your premium payments until the gross amount of premium payments exceeds the sum of the Annual Target Premium payments payable over 10 years. (See "Annual Target Premium Payment") o If you increase or decrease the Specified Amount, we will declare a new Annual Target Premium Payment for you and use it to determine whether the premium charge applies. VUL Policy 20 The amount remaining after we deduct the premium charge is the Net Premium payment and is the amount we allocate to the Variable Fund Accounts you select. EXAMPLE: Annual Target Premium payment is $2,000. $2,000 x 10 years = $20,000. We would no longer deduct the premium charge once you have paid in premiums of $20,000. MONTHLY DEDUCTIONS FROM CASH VALUE On your Policy's Effective Date, and each Monthly Anniversary thereafter, we will deduct certain monthly charges from your Policy's Cash Value (See "Deduction of Charges"). The Monthly Deduction includes the following items, each as described below. o Cost of insurance charge. o Charge for optional insurance benefits provided by rider. o Administrative charge. o Maintenance charge. COST OF INSURANCE CHARGES. (See "Calculating Your Cost of Insurance" for a more detailed discussion of the factors that affect the net amount at risk and how the cost of insurance charge is calculated.) Monthly cost of insurance charges depend on a number of variables, including: o Specified Amount of insurance coverage; o Death benefit option you select; o Cost of insurance RATE; and o Investment experience of your value in the Variable Fund Accounts. CHARGES FOR OPTIONAL INSURANCE BENEFITS. Monthly Deductions include charges for any optional insurance benefits added to the Policy by rider. (See "Optional Insurance Benefits") ADMINISTRATIVE CHARGES (FIRST POLICY YEAR ONLY). During the first 12 Policy months only, we deduct a monthly Administrative Charge of $10 for start-up administrative expenses we incur in issuing your Policy. These expenses include the cost of processing your application, conducting a medical examination, determining insurability and rate class, and establishing Policy records. The investment advisers or other affiliates of certain Funds may reimburse USAA Life for the cost of administrative services provided to the Funds as investment options under the Policies. Compensation is paid out of fee earnings, based on a percentage of a Fund's average net assets attributable to a Policy. MAINTENANCE CHARGE. The Monthly Deduction includes a recurring Maintenance Charge of $5. This charge compensates us for the recurring administrative expenses related to the maintenance of your Policy and of the Separate Account. These expenses include premium notices and collection, record keeping, processing death benefit claims, Policy changes, reporting, and overhead costs. USAA Life guarantees that this charge will not increase during the life of the Policy. SEPARATE ACCOUNT CHARGES We deduct certain charges on a daily basis as a percentage of the value of each Variable Fund Account of the Separate Account. These charges reduce your Policy's Cash Value. MORTALITY AND EXPENSE CHARGE. We assess a daily charge of .00204% (equal to .75% annual rate) against the values of each Variable Fund Account for mortality and expense risks that USAA Life assumes under the Policies. We guarantee that this charge will not increase during the life of your Policy. The mortality risk that USAA Life assumes is that Insureds may live for a shorter period of time than we estimate and thus a greater amount of death benefits than expected will be payable. The expense risk we assume is that expenses incurred in issuing and administering the Policies will be greater than we estimate. FEDERAL INCOME TAX CHARGE. Currently, we make no charge against a Variable Fund Account for federal income tax that may be attributable to that Account. We may, however, make such a charge in the future, should it be necessary. We also may make charges for other taxes, if any, attributable to any Variable Fund Account. VUL Policy 21 TRANSFER CHARGES For each transfer between Variable Fund Accounts in excess of 18 per Policy Year, we assess a $25 charge. We reserve the right, at any time, and without prior notice, to terminate, suspend, or modify these transfer privileges. SURRENDER CHARGES PARTIAL SURRENDER CHARGE. For each partial surrender, we assess a charge equal to the lesser of $25 or 2% of the amount withdrawn. This charge is an administrative processing fee. FULL SURRENDER CHARGE. For full surrenders prior to the end of the 10th Policy Year, we assess the surrender charge described below. The surrender charge compensates USAA Life for the expenses it incurs in distributing the Policies. The amount of the surrender charge will equal a percentage of the Annual Target Premium Payment specified in your Policy, regardless of the amount of premiums you actually pay. The surrender charge depends on when you surrender. As shown in the table below, the surrender charge declines each Policy Year to 0% after the 10th Policy Year. -------------------------------------------------------------------------------- SURRENDER CHARGE AS A % OF ANNUAL TARGET PREMIUM PAYMENT POLICY YEAR 1 2 3 4 5 6 7 8 9 10 11+ APPLICABLE % 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0 -------------------------------------------------------------------------------- Example: o Annual Target Premium payment is $2,000, o Full surrender during the first Policy Year Surrender charge = 50% x $2,000 or $1,000 surrender charge If you increase or decrease your Policy's Specified Amount within the first 10 Policy Years, we will set a new Annual Target Premium Payment for you. We will use the new Annual Target Premium Payment to determine the surrender charge. (See "Changing Your Policy's Specified Amount") We will not impose a surrender charge at the time you decrease your Policy's Specified Amount. OTHER CHARGES The Variable Fund Accounts purchase shares of the Funds at the Net Asset Value ("NAV") of the shares. The NAV reflects the investment management fees and other expenses already deducted from each Fund's assets. These fees and other expenses appear in the "Fee Tables." Please refer to the prospectuses for the Funds for more information on these fees and expenses. DEDUCTION OF CHARGES We will deduct the Monthly Deduction, any partial surrender charge, and any transfer charge from your value in each Variable Fund Account in the same proportion as each Variable Fund Account's value has to the total Policy Cash Value. Alternatively, you may specify in advance the Variable Fund Account(s) from which you want the partial surrender charge and transfer charge deducted. DEATH BENEFIT ------------- The Policy offers two death benefit options, Option A and Option B, which you select on your Policy application. Under either option, we will reduce the amount of death benefit we pay by the amount of any outstanding Indebtedness and any due and unpaid Monthly Deductions. (See "Payment of Policy Benefits") Partial surrenders and related surrender charges also will reduce the amount of your death benefit. (See "Changing Your Policy's Specified Amount") The death benefit increases by any applicable optional insurance benefits provided by rider. (See "Optional Insurance Benefits") VUL Policy 22
---------------------------------------------------------------------------------------------------- OPTION A (LEVEL DEATH BENEFIT) OPTION B (INCREASING DEATH BENEFIT) ---------------------------------------------------------------------------------------------------- DEATH BENEFIT Greater of: Greater of: o Your Policy's Specified o Your Policy's Specified Amount Amount, or PLUS your Cash Value, or o The Minimum Amount Insured o The Minimum Amount Insured ---------------------------------------------------------------------------------------------------- PURPOSE Emphasizes Cash Value Growth Emphasizes Death Benefit Growth ---------------------------------------------------------------------------------------------------- IMPACT Cost of Insurance will generally be Death Benefit generally greater than for lower than for same Specified Amount same Specified Amount in Option A in Option B ----------------------------------------------------------------------------------------------------
EXAMPLE OF OPTION A AND OPTION B: -------------------------------- o Insured less than 40 years old o Policy's Specified Amount is $100,000 o No loans or outstanding Monthly Deductions o Policy Cash Value is $25,000
---------------------------------------------------------------------------------------------------- OPTION A OPTION B ---------------------------------------------------------------------------------------------------- Death Benefit greater of $100,000 or Minimum Death Benefit greater of $125,000 ($100,000 Amount Insured* Specified Amount plus $25,000 Cash Value) or the Minimum Amount Insured* ----------------------------------------------------------------------------------------------------
* The Minimum Amount Insured is calculated by multiplying Cash Value by a specific percentage based on the Insured's age (see "Calculating Your Cost of Insurance"). CHANGING DEATH BENEFIT OPTION After the death benefit option you selected on your application has been in effect for one Policy Year, you may change it by sending written notice to USAA Life. The new death benefit option also must remain in effect for one Policy Year before we allow another change. There is no charge or fee for changing the death benefit option. The change will become effective on the Monthly Anniversary on or following the date we approve the change. A change in death benefit option will affect your cost of insurance. (See "Calculating Your Cost of Insurance") We will recalculate the maximum premium limitation following a change in death benefit option. (See "Minimum Amount Insured" under "Calculating Your Cost of Insurance") OPTION A TO OPTION B -------------------- o Option B Specified Amount equals prior Option A Specified Amount MINUS Policy's Cash Value as of the date we receive written notice of the requested change. (The result of this is that the death benefit before and after the change will remain the same.) o We will not allow the change if it would result in a Specified Amount that is less than the minimum Specified Amount of $50,000 ($25,000 for Insureds less than 18 years of age). o If you want the Option B Specified Amount to be the same as the prior Option A Specified Amount, you must provide proof of insurability. OPTION B TO OPTION A -------------------- o Option A Specified Amount equals prior Option B Specified Amount PLUS Policy's Cash Value next determined on the Date of Receipt of written notice. (The result of this is that the death benefit before and after the change will remain the same.) o This change does not require proof of insurability, unless you also want to make changes in your Policy's Specified Amount or add optional benefits by rider. CHANGING POLICY'S SPECIFIED AMOUNT You may increase or decrease your Policy's Specified Amount, within certain limits. A change in Specified Amount: o May increase or decrease your cost of insurance charges (see "Calculating Your Cost of Insurance"). o May have tax consequences (see "Tax Matters"). o Does not necessarily require changes in planned periodic premiums (see "Planned Periodic Premium Payments"). o Will require us to set a new Annual Target Premium payment for the new Specified Amount (see "Annual Target Premium Payment"). VUL Policy 23 Whether the premium charge applies is determined using the new Annual Target Premium Payment. (See "Premium Charge") We will recalculate the maximum premium limitation following an increase or decrease in Specified Amount. (See "Premium Payments" and "Tax Matters") Any increase to your Policy's specified Amount must be at least $25,000, unless such increase is in conjunction with a change in death benefit option or to satisfy federal tax law requirements. For any increase, you must apply in writing and we will require satisfactory proof of insurability. An increase will become effective on the Monthly Anniversary on or following the date we approve the increase. Your rights to cancel your Policy do not apply to increases in Specified Amounts. You may not reduce your Policy's Specified Amount to less than $50,000. There are exceptions for reductions resulting from a surrender of Cash Value under Option A and if the Insured is less than 18 years of age. We will not allow a reduction that would cause your Policy not to qualify as a life insurance contract for federal tax law purposes. You must request a reduction in writing. To determine the cost of insurance charge, we will apply any decrease in Specified Amount against the most recent increase in Specified Amount. The decrease will become effective on the Monthly anniversary on or following the Date of Receipt of your written notice to USAA Life. OPTIONAL INSURANCE BENEFITS --------------------------- You may add one or more of the following optional insurance benefits to your Policy by rider, subject to certain underwriting or issue requirements. Each rider's description in this Prospectus is subject to the specific terms and conditions of the rider. We will deduct the cost of any optional insurance benefits as part of the Monthly Deduction. (See "Monthly Deductions") NOT ALL RIDERS ARE AVAILABLE IN ALL STATES. ACCELERATED BENEFITS FOR TERMINAL ILLNESS RIDER. This rider provides for an early benefit payment to you upon receipt of proof that the Insured is terminally ill (as defined in the rider). The maximum amount you may receive under the rider prior to the Insured's death is the lesser of (1) 50% of the then current death benefit payable under the Policy (excluding additional benefits payable under other riders), or (2) $250,000. We will deduct the amount of any Indebtedness from the amount of the early payment. We treat the early payment as a "lien" against Policy values. We reduce the death benefit by the amount of the lien and any Policy loans, plus accrued interest. We will continue to take Monthly Deductions after the early payment. The Owner's access to the Cash Value of the Policy through Policy loans, partial surrenders, or full surrender is limited to any excess of the Cash Value over the amount of the lien. We charge interest on the amount of the early payment and any unpaid Monthly Deductions. We require premium payments to be made for cost of insurance that are still required to be made after the early payment. If such payment is not paid when due, we will pay the premium on behalf of the Owner and add that amount to the early payment amount to be deducted from the death benefit. If the amount of the early payment plus accrued interest and required unpaid cost of insurance premiums ever exceed the amount of the death benefit, we will terminate the Policy and no additional insurance benefits will be payable. There is no charge for this rider. ACCIDENTAL DEATH BENEFIT RIDER. This rider provides an additional life insurance benefit if the Insured's death results from accidental bodily injury (as defined in the rider). You can select an additional life insurance benefit up to a maximum of $200,000, or the Specified Amount, whichever is less. The premium for this rider is $.84 per $1,000 of coverage per year. CHILDREN TERM LIFE INSURANCE RIDER. This rider provides level term life insurance on the lives of the Insured's children (as defined in the rider). The cost for this rider is $6 per $1,000 of coverage per year. EXTENDED MATURITY DATE RIDER. This rider permits you to extend your Policy's Maturity Date up to 10 years beyond what it otherwise would be (i.e., the Monthly Anniversary following the Insured's 100th birthday). The death benefit during the extended maturity period will be your Policy's Cash Value less any Indebtedness. Also during this period, the Policy's Cash Value will continue to accrue in the same manner as described in the Policy, and any Policy loans in effect will continue to accrue interest. We will not deduct cost of insurance charges or accept additional premium payments during this period. We will assess the Maintenance Charge during this period. Extension of the Maturity Date is subject to all of the terms and conditions of the Policy, except where they are inconsistent with the rider. Extending the maturity date of your Policy beyond the Insured's age 100 may result in the current taxation of any increases in your Policy's Cash Value that result from investment experience in the Variable Fund Accounts. You should consult a qualified tax advisor before making such an extension. VUL Policy 24 WAIVER OF MONTHLY DEDUCTION RIDER. This rider waives your Monthly Deduction during periods of total and permanent disability of the Insured, but only if the Insured has been totally and permanently disabled (as defined in the rider) for at least 6 consecutive months. We will not deduct the amount of any Monthly Deduction waived under this rider from the Cash Value proceeds payable upon maturity of your Policy, or the death benefit proceeds payable if the Insured dies before the Policy matures. If Option A is in effect when we approve a claim under the rider, we will change your death benefit option from Option A to Option B as of the Monthly Anniversary after the disability began. While we are paying benefits under the rider, you may not increase your Policy's Specified Amount. Please note that the rider does not apply to interest under your Policy loans. As a result, it is possible that your Policy could lapse for nonpayment of loan interest. The premium for this rider varies based upon the age of the Insured. If you would like further information about the optional insurance benefits available under your Policy, please contact us at 1-800-531-2923. Please note that adding or deleting riders, or increasing or decreasing coverage under the riders, can have tax consequences. (See "Tax Matters") You should consult a qualified tax advisor. PAYMENT OF POLICY BENEFITS -------------------------- BENEFITS AT MATURITY All Policies will mature on the Monthly Anniversary following the Insured's 100th birthday, unless extended by rider. If the Insured is living at maturity, we will pay the Cash Value of your Policy (less any Indebtedness and any due and unpaid Monthly Deductions). We may postpone payments in certain circumstances. (See "Postponement of Payments") PAYMENT AT DEATH As long as your Policy has not terminated due to lapse, maturity, or full surrender, we will pay your Policy's death benefit to your Beneficiary. We will usually pay the death benefit within 7 days after we receive due proof of death at our Home Office and all other requirements necessary to make payment. We will determine the Cash Value portion of the death benefit as of the Valuation Date immediately following the date of death. We will pay the death benefit in cash or under one or more of the payment options you have selected in advance. If you have not selected a payment option, your Beneficiary may select the payment option. We may postpone payment of the death benefit in certain circumstances. (See "Postponement of Payments") We will reduce the death benefit by any Indebtedness and any due and unpaid Monthly Deductions. These proceeds will be increased by any applicable additional optional insurance death benefits provided by rider. DEATH BENEFIT PAYMENT OPTIONS We will pay the death benefit in a lump sum or under one of the payment options below. During the Insured's lifetime, you may select a payment option. If the Insured dies and you have not chosen a payment option, your Beneficiary can choose a payment option. If you have selected a payment option before the Insured's death, your Beneficiary may not change that option after the Insured's death. Proceeds applied under a payment option will no longer vary by the investment experience of the Variable Fund Accounts. The nature and timing of your choice of payment option may have tax consequences to you or your Beneficiary. You should consult your tax advisor. INTEREST ONLY OPTION. The Policy's principal amount may be left on deposit with USAA Life for a mutually determined period, not to exceed 30 years. We will make interest payments at mutually determined regular intervals. The principal amount will earn interest at a minimum rate of 3% compounded annually. At the end of the fixed period, we will pay the principal amount. INSTALLMENTS FOR A FIXED PERIOD OPTION. Under this option, we will pay the principal amount plus interest in installments for a specified number of years (not more than 30), as mutually agreed upon. The amount of the installments will not be less than that shown in the Table of Guaranteed Payments contained in your Policy. INSTALLMENTS OF A FIXED AMOUNT OPTION. Under this option, we will pay the principal amount plus interest in installments, as mutually agreed upon, until the amount applied, together with interest on the unpaid balance, is paid in full. VUL Policy 25 OTHER OPTIONS. We will apply the principal amount under any other option mutually agreed upon. Any arrangements involving more than one payment option, or involving a Beneficiary that is not a natural person (e.g., a corporation) or who is a fiduciary (e.g., a trustee) are subject to our approval. In addition, the details of the arrangements are subject to our rules in effect at the time the arrangements take effect. The Beneficiary may designate a successor payee as to any amount that we would otherwise pay to the Beneficiary's estate. Amounts applied under these payment options will not be subject to the claims of creditors or to legal process, to the extent permitted by law. CASH VALUE ---------- Your Policy's Cash Value will vary: o on a daily basis with the investment experience of the Variable Fund Accounts to which you have allocated your Net Premium Payments; o to reflect the effect of various Policy transactions, such as additional premium payments, partial surrenders, and Policy loans; and o to reflect applicable charges and deductions. YOUR POLICY DOES NOT PROVIDE A MINIMUM GUARANTEED CASH VALUE, WHICH MEANS YOU BEAR THE ENTIRE INVESTMENT RISK THAT YOUR CASH VALUE COULD FALL TO ZERO. On your Policy's Effective Date, your Cash Value will equal your Net Premium Payments, less the Monthly Deduction for the following Policy month. Thereafter, your Cash Value on any Valuation Date will equal the sum of: o your Policy's value in each Variable Fund Account; o plus, if applicable, any value held in our general account to secure any Policy loan; o plus any interest earnings credited on the value held in the general account; o less the amount of any outstanding Indebtedness; o less any Monthly Deductions, transfer charges, and partial surrender charges applied through that date. On each Monthly Anniversary, the Monthly Deduction will reduce your Policy's Cash Value. CALCULATING YOUR VALUE IN THE VARIABLE FUND ACCOUNTS When you invest in a Variable Fund Account, you are purchasing units of interest or "Accumulation Units" ("units") of that Account. You purchase units at their price next determined on any given Valuation Date following the receipt of your payment. Therefore, on any given Valuation Date, you can calculate the value of your investment in a Variable Fund Account by multiplying (1) the number of units of each Variable Fund Account credited to your Policy by (2) the price of the units on that Date. We determine the number of units to credit to you by dividing (1) the Net Premium Payment you allocate to a Variable Fund Account by (2) that Variable Fund Account's price per unit or "unit value" next computed on the Date of Receipt of the premium payment. Certain transactions will affect the number of units in a Variable Fund Account credited to you. Net Premium Payments will increase the number of full or fractional units. Loans, partial or full surrenders, partial surrender charges, transfer charges, and Monthly Deductions involve redemption of full or fractional units and will decrease the number of units. In addition, Transfer of Value among Variable Fund Accounts will decrease the number of units in the Variable Fund Accounts from which value is transferred and increase the number of units in the Variable Fund Accounts to which value is transferred. Each Variable Fund Account's units are valued separately. We calculate the value of an Accumulation Unit ("Accumulation Unit Value (AUV)") for each Variable Fund Account on any Valuation Date by adjusting the unit value from the previous Valuation Date for: o the investment performance of the corresponding Fund; o any dividends or distributions paid by that Fund; and o the Separate Account charges that we assess. (SEE "Separate Account Charges.") VUL Policy 26 Log on to USAA.COM to access information about your Policy details, Variable Fund Account summaries, and financial activity information. You may also find out information about your Cash Value, including the value and number of units of each Variable Fund Account credited to your Policy, by calling us at 1-800-531-4265. TRANSFER OF VALUE Except during the first 30 days after your Policy becomes effective, you may transfer all or part of the value in any Variable Fund Account to any other Variable Fund Account of the Separate Account, up to 18 times per Policy Year, without charge. Each transfer thereafter is subject to a $25 charge. Excessive transfer activity can disrupt portfolio management strategy and increase Variable Fund Account expenses, which are borne by all Policy owners participating in the Variable Fund Accounts regardless of their transfer activity. You should note that the product is not designed for professional "market timing" organizations, or other organizations or individuals engaged in market timing strategy, making programmed transfers, or frequent transfers that are large in relation to the total assets of the underlying Funds in which the Variable Fund Account options invest. Market timing strategies are disruptive to the underlying Funds in which the Variable Fund Account options invest. If we determine that your transfer patterns among the Variable Fund Account options reflect a market timing strategy, we reserve the right to take action including but not limited to: restricting the availability of transfers through telephone requests, facsimile transmissions, automated telephone services, internet services, or any electronic transfer services. We will inform you in writing of any such transfer restrictions on your Policy. The minimum amount you can transfer from any Variable Fund Account is $250 (or the remaining Account value if less). A transfer will result in the redemption or purchase (or both) of units of the Variable Fund Accounts involved. You may request a transfer by telephone or by Notice to Us. A request for transfer must clearly state the amount to be transferred, the Variable Fund Account from which it is to be withdrawn, and the Variable Fund Account to which it is to be credited. We will effect the transfer using the Variable Fund Account unit values next computed on the Date of Receipt of your request, unless a postponement of payments is in effect. (SEE "Postponement of Payments.") We reserve the right at any time, and without prior notice, to terminate, suspend, or modify these transfer privileges. LOANS ----- After your first Policy Year, you may borrow money from USAA Life by using your Policy as the sole security for the loan. The amount that you may borrow is the "loan value." The maximum loan value is 85% of your cash surrender value. You may request a loan by telephone or by Notice to Us, but you must obtain the written consent of all assignees and irrevocable Beneficiaries, if any, before we can make the loan. We will usually pay you the loan proceeds within 7 days after the Date of Receipt of your loan request, unless a postponement of payments is in effect. (SEE "Postponement of Payments.") LOAN COLLATERAL When you take a loan, we will transfer an amount equal to the loan from your value in the Variable Fund Accounts to our general account. We make this transfer of "loan collateral" to secure your loan. You may specify the Variable Fund Accounts from which you want us to withdraw the loan collateral. If you do not so specify, we will withdraw the loan collateral from the Variable Fund Accounts in the same proportion as each Account's value has to the total Policy Cash Value. While a loan is outstanding, we will credit the loan collateral with interest on a daily basis at an effective annual rate of 4%. LOAN INTEREST You are charged interest on the loan at a maximum annual rate of 6% payable in advance. We have the option of charging less. For Policies that have been in effect more than 10 Policy Years and if the Insured is age 55 or older, we charge a preferred loan interest rate of 4.5%. We have the option of charging less for a preferred loan. The entire amount of interest on your loan balance for each Policy Year is payable in advance at the commencement of the loan and at the beginning of each Policy Year thereafter. We will automatically deduct the interest from your Variable Fund Account(s) in the same proportion as each Account's value has to the total Policy Cash Value on the date the loan starts. Similarly, we will deduct interest from your Variable Fund Account(s) at the beginning of each Policy Year in the same proportion as each Account's value has to the total Policy Cash Value as of that date. VUL Policy 27 If there is insufficient value in your Variable Fund Account(s) to pay the interest in advance, your policy will enter its grace period. Because interest is paid in advance, loan repayments during a Policy Year may result in an overpayment of interest. We will credit any overpayment of interest to you on the date of any loan repayment. REPAYMENT OF INDEBTEDNESS You may repay your Indebtedness (I.E., loans and any unpaid interest) in full or in part at any time before the Insured's death and while the Policy is in effect. If not repaid, we will deduct the Indebtedness from any death benefit, maturity benefit, or full surrender proceeds. You may not repay loans and unpaid loan interest in existence at the end of the grace period until the Policy is reinstated. You must designate any loan repayment as such. Otherwise, we will treat it as a premium payment. You may direct how you want your loan repayment to be allocated among the Variable Fund Accounts. If you do not specify an allocation, we will allocate your loan repayment to the Variable Fund Accounts in the same proportion as Net Premium Payments are being allocated. EFFECT OF POLICY LOANS A loan will reduce the value of the Variable Fund Accounts from which it is deducted. Thus, the amount loaned will not share in the investment experience of the Variable Fund Accounts. A loan, whether repaid or not, will have a permanent effect on the Cash Value of the Policy. We will determine loan values as of the Date of Receipt of the loan request. A Policy loan may increase the chance that your Policy may lapse and result in adverse tax consequences. For situations where a Policy loan may be treated as a taxable distribution, SEE "Tax Matters." SURRENDERS ---------- You may fully or partially surrender your Policy for all or part of its Cash Value to the extent described below. We will usually pay full or partial surrenders of Cash Value within 7 days after we receive your written request at our Home Office. We will determine the Cash Value of the surrendered amount as of the Date of Receipt of your request for surrender. There may be tax consequences in connection with a full or partial surrender. (SEE "Tax Matters.") You must obtain the written consent of all assignees or irrevocable Beneficiaries, if any, before we will process any request for surrender. We will effect any surrenders using the Variable Fund Account unit values next computed on the Date of Receipt of your Notice to Us or, in the case of partial surrenders, your Notice to Us or telephone request. In certain circumstances, we may postpone the payment of surrenders. (SEE "Postponement of Payments.") FULL SURRENDERS At any time before the Insured's death and while the Policy is still in effect, you may surrender your Policy for its entire cash surrender value by sending Notice to Us. We may require the return of the Policy. We also may assess a surrender charge. (SEE "Surrender Charges.") We sometimes refer to the net amount you would receive as the Policy's "cash surrender value." We will terminate your Policy and all insurance on the Date of Receipt of your Notice to Us. PARTIAL SURRENDERS After your first Policy Year and while your Policy is still in effect, but before the Insured's death, you may surrender a portion of your Policy for cash. We will assess an administrative processing fee equal to the lesser of $25 or 2% of the amount withdrawn. You may direct how you would like us to withdraw a partial surrender and the administrative processing fee from your current value in the Variable Fund Accounts. If you do not specify a withdrawal allocation, we will withdraw the partial surrender and the administrative processing fee from the Variable Fund Accounts in the same proportion as each Account's value has to the total Policy Cash Value. (SEE "Surrender Charges" and "Deduction of Charges.") You may request a partial surrender by telephone or by Notice to Us. Your Policy's remaining Cash Value after a partial surrender may not be less than an amount equal to the then current surrender charge for a full surrender. VUL Policy 28 Partial surrenders and related surrender charges reduce your Policy's death benefit on a dollar for dollar basis. If the death benefit is the Minimum Amount Insured, your death benefit will be reduced by a multiple of the amount surrendered. Under death benefit Option A, we will reduce the Specified Amount and the Cash Value by the amount of the partial surrender. Under death benefit Option B, we will reduce only the Cash Value portion of the death benefit by the amount of the partial surrender. TELEPHONE TRANSACTIONS ---------------------- You may submit requests by telephone to change your premium payment allocation, request partial surrenders, request loans, and request Transfer of Value among Variable Fund Accounts. We will employ reasonable procedures to confirm that instructions communicated by telephone are genuine, and only if we do not will we be liable for any losses because of unauthorized or fraudulent instructions. We will obtain information prior to any discussion regarding your Policy including, but not limited to: o your USAA number or Policy number, o your name, and o your Social Security number. In addition, we will record all telephone communications with you and will send confirmations of all transactions to your address. Your Policy automatically authorizes you to make telephone transactions, subject to our right to modify, suspend, or discontinue this telephone transaction privilege at any time without prior notice. When filling out your Policy application, you may decline the option of utilizing the telephone transaction privilege. DOLLAR COST AVERAGING PROGRAM ----------------------------- The Dollar Cost Averaging Program enables you to make regular, equal investments over time into one or more of the Variable Fund Accounts, by transferring a fixed dollar amount at regular intervals from one or more other Variable Fund Accounts under the Policy. To begin the Dollar Cost Averaging Program, you must have at least $5,000 in the Variable Fund Account from which you intend to transfer value. The minimum amount you may transfer is $100, or the remaining value of the Account, if less. The transfers must be scheduled to occur over a period of at least 12 months at monthly, quarterly, or semiannual intervals, as you elect. You may select this Program by submitting a written request to our Home Office or by making a request by telephone. You may cancel your participation in this Program in the same manner. We will process transfers under the Dollar Cost Averaging Program to be effective at the Accumulation Unit Values (AUV) at the end of the Valuation Period that includes the date of the transfer. No charges apply to transfers made under the Dollar Cost Averaging Program. Also, transfers under this Program do not count against your limit on free transfers. We reserve the right to suspend, terminate, or modify the Dollar Cost Averaging Program upon providing you written notice 30 days in advance. Should we suspend or terminate the Program, the suspension or cancellation will not affect any Policy for which the Dollar Cost Averaging Program is already in effect. POSTPONEMENT OF PAYMENTS ------------------------ We may postpone payments of partial surrenders, full surrenders, Policy loans, maturity benefits, death benefits, and Variable Fund Account transfers beyond 7 days whenever: o the New York Stock Exchange is closed, o the SEC, by order, permits postponement for the protection of Policy Owners, or o the SEC requires trading to be restricted or declares an emergency. We reserve the right to defer payment of any partial surrenders, full surrenders, Policy loans or refunds that would be derived from a premium payment made by a check until the check has cleared the banking system. -------------------------------------------------------------------------------- Log on to USAA.COM for policy details, fund account summaries and financial activity information. -------------------------------------------------------------------------------- ----------------------- MORE POLICY INFORMATION ----------------------- VUL Policy 29 OWNERS AND BENEFICIARIES ------------------------ OWNERS If you are the Owner of the Policy, the rights and privileges of the Policy during the lifetime of the Insured belong to you. Generally, the Owner is also the Insured, unless a different Owner is designated in the application or at a later date. SUCCESSOR OWNER. As Owner, you may designate a successor Owner. If you die without designating a successor Owner, ownership of the Policy will pass to your estate. CHANGE OF OWNERSHIP. As Owner, you may change ownership of your Policy, at any time, during the Insured's lifetime, by submitting Notice to Us. The change will take effect on the Date of Receipt of the request. A change of ownership is subject to the rights of an assignee of record and those of any irrevocable Beneficiary. We are not responsible for any payments made or actions taken before we receive your Notice to Us. COLLATERAL ASSIGNMENT. As Owner, you may assign the Policy as collateral security by submitting a Notice to Us. You will need to obtain the written consent of any irrevocable Beneficiaries and assignees of record before we recognize any assignment; however, a collateral assignment takes precedence over the interest of a revocable Beneficiary. The assignment will take effect as of the date we receive your Notice to Us. We are not responsible for the validity or effect of any collateral assignment, nor are we responsible for any payment or other action taken before we receive the Notice to Us. We are not bound by an assignment until we receive it at our Home Office. We will pay any death benefit payable to an assignee in one lump sum. We will pay any remaining proceeds to the designated Beneficiary or Beneficiaries. A collateral assignee is not an Owner. A collateral assignment is not a transfer of ownership, unless it is an absolute assignment. All collateral assignees of record must consent to any full surrender, partial surrender, loan or payment from a Policy under an Accelerated Benefits for Terminal Illness Rider. There may be unfavorable tax consequences, including recognition of taxable income and the loss of income tax-free treatment for any death benefit payable to the Beneficiary. Therefore, you should consult a qualified tax advisor prior to making an assignment. BENEFICIARIES You may name one or more Beneficiaries in your Policy application. You may classify Beneficiaries as primary, contingent, revocable, or irrevocable. If no primary Beneficiary survives the Insured, we will pay the Policy proceeds to the contingent Beneficiaries. Beneficiaries in the same class will receive equal payments unless you direct otherwise. A Beneficiary must survive the Insured in order to receive his or her share of the death benefit proceeds. If a Beneficiary dies before the Insured dies, his or her unpaid share is divided among the remaining Beneficiaries of the same class who survive the Insured. If no Beneficiary survives the Insured, we will pay the proceeds to you, if you are alive, or, if not, to your estate. CHANGE OF BENEFICIARY. You may change the Beneficiary while the Insured is living, by submitting a Notice to Us. You must obtain the written consent of any irrevocable Beneficiaries before we will accept any change in Beneficiary. A change in Beneficiary will take effect on the Date of Receipt of the request. We will not be responsible for any payment or other action taken before receipt of your Notice to Us. If we make a payment of death benefits in good faith before receiving the Notice to Us, we will receive credit for the payment against our liability under the Policy. A change of Beneficiary is subject to the rights of an assignee of record. CALCULATING YOUR COST OF INSURANCE ---------------------------------- For each Monthly Anniversary, we determine your monthly cost of insurance by multiplying (1) the net amount at risk under your Policy by (2) your cost of insurance rate, and (3) dividing the resulting amount by 1000. NET AMOUNT AT RISK We determine the net amount at risk by (1) subtracting your Policy's Cash Value on any Monthly Anniversary (prior to the application of the Monthly Deduction, including the Cost of Insurance charge) from (2) your Policy's current death benefit (divided by a factor that discounts the death benefit to the beginning of the month). Your Policy's death benefit may be the death benefit required to VUL Policy 30 qualify the Policy as life insurance. (SEE "Minimum Amount Insured.") The net amount at risk may be greater if you have selected death benefit Option B rather than death benefit Option A. SEE "Death Benefits." Since the death benefit payable under Option B is the Specified Amount plus the Cash Value, the difference between the death benefit and the Cash Value will be greater under Option B than under Option A (unless the Minimum Amount Insured applies). As the net amount at risk will be greater, so the cost of insurance also will be greater. The net amount at risk also may be affected by changes in your Policy's Cash Value or in the Specified Amount. (SEE "Cash Value" and "Death Benefits.") The net amount at risk for each Policy continues to be determined generally by subtracting the Policy's Cash Value from the Policy's death benefit (divided by a factor that discounts the death benefit to the beginning of the month), regardless of whether the death benefit is the Policy's current Specified Amount or the Minimum Amount Insured. The cost of insurance rate applied against the net amount at risk will continue to increase as the Insured's age increases. NET AMOUNT AT RISK - MORE THAN ONE RATE CLASS If you increase the Specified Amount and the rate class applicable to the increase is different from that of the initial Specified Amount, then, in determining the cost of insurance charge, we will calculate the net amount at risk separately for each rate class. The method of determining the net amount at risk for each rate class will differ between Option A and Option B. If Option A is in effect, we will apportion the Cash Value among the initial Specified Amount and any increases in Specified Amount. The Cash Value will first be considered a part of the initial Specified Amount. If the Cash Value is greater than the initial Specified Amount, the balance of the Cash Value will then be considered a part of each increase in Specified Amount, beginning with the first increase. If Option B is in effect, we will determine the net amount at risk by the proportional relationship of the initial Specified Amount and the Specified Amount increases for each new rate class to the total Specified Amount. Because the method of calculating the net amount at risk is different between Option A and Option B when more than one rate class is in effect, a change in the death benefit option may result in a different net amount at risk for each rate class than would have occurred had the death benefit option not been changed. Thus, the total cost of insurance will be increased or decreased. COST OF INSURANCE RATES Your cost of insurance rates are based on the Insured's age, sex, and rate class. Generally, we set cost of insurance rates based on our expectations as to future mortality experience. We apply any changes to cost of insurance rates to all persons of the same age, sex, and rate class. We will give you 30 days' notice before any increase in your current cost of insurance rates becomes effective. We guarantee that your cost of insurance rates will never be greater than the maximum cost of insurance rates shown in your Policy. These guaranteed rates are based on the 1980 Commissioners Standard Ordinary Mortality Table and age on the Insured's last birthday. The rate class of the Insured will affect your cost of insurance rate. USAA Life currently places Insureds into one of three preferred rate classes or into one of two standard rate classes involving higher mortality risks. In an otherwise identical Policy, Insureds in the preferred rate class will have a lower cost of insurance rate than those in a standard rate class. We make all final determinations of an Insured's rate class. MINIMUM AMOUNT INSURED ---------------------- The Minimum Amount Insured is the amount of insurance proceeds that the Internal Revenue Code requires for your Policy to qualify as life insurance and to exclude the death benefit from your Beneficiary's taxable income. If higher than the death benefit under Option A or Option B, we will pay you the Minimum Amount Insured. You can determine the Minimum Amount Insured by multiplying your Policy's Cash Value (ignoring the amount of any outstanding loan and any unpaid loan interest) by a specified percentage based on the Insured's age. The specified percentages, which generally decline as the Insured gets older, are: -------------------------------------------------------------------------------- MINIMUM AMOUNT INSURED AS A PERCENTAGE OF CASH VALUE -------------------------------------------------------------------------------- VUL Policy 31 -------------------------------------------------------------------------------- INSURED'S 40 or 95 and AGE* Under 45 50 55 60 65 70 75 to 90 older PERCENTAGE 250% 215% 185% 150% 130% 120% 115% 105% 100% -------------------------------------------------------------------------------- * Last birthday at the beginning of the Policy Year. A more complete table appears in your Policy. If, prior to the Insured's death, unexpected increases in your Policy's Cash Value would cause your Policy not to satisfy Internal Revenue Code requirements, we will increase the death benefit to the Minimum Amount Insured so that the death benefit will be excluded from the Beneficiary's taxable income. ----------------- OTHER INFORMATION ----------------- USAA LIFE --------- USAA Life is a stock insurance company incorporated in the State of Texas on June 24, 1963. USAA Life is principally engaged in writing life insurance policies, health insurance policies, and annuity contracts. USAA Life is authorized to transact insurance business in all states of the United States (except New York) and the District of Columbia. On a consolidated basis prepared in conformity with accounting principles generally accepted in the United States of America, USAA Life had total assets of $10,376,573,000 on December 31, 2002. USAA Life is a wholly-owned stock subsidiary of USAA, a diversified financial services organization. The commitments under the Policies are USAA Life's, and USAA has no legal obligation to back those commitments. USAA Life is obligated to pay all amounts promised to Policy owners under the Policies. USAA Life is the depositor administering the Separate Account. USAA Life's obligations as depositor of the Separate Account may not be transferred without notice to and consent of the Owners. USAA Life also issues variable annuity contracts through another separate account, which is also a registered investment company. In addition, USAA Life serves as transfer agent of the USAA Life Investment Trust. SEPARATE ACCOUNT ---------------- By a resolution of the Board of Directors of USAA Life, we established the Separate Account as a separate account on January 20, 1998. The Separate Account is organized as a unit investment trust and registered with the SEC under the Investment Company Act of 1940. Registration does not involve supervision of the management of the Separate Account by the SEC. The assets of the Separate Account are the property of USAA Life and are held for the benefit of the Owners and other persons entitled to payments under Policies issued through the Separate Account. The assets of the Separate Account equal to the reserves and other liabilities of the Separate Account are not chargeable with liabilities that arise from any other business which USAA Life may conduct. The Separate Account is divided into Variable Fund Accounts, each representing a different investment objective. Net Premium Payments are allocated to the Variable Fund Accounts in accordance with your instructions. (SEE "Investment Options.") Each Variable Fund Account invests exclusively in the shares at the Net Asset Value (NAV) of a Fund. Income and gains and losses from assets in each Variable Fund Account are credited to, or charged against, that Variable Fund Account without regard to income, gains, or losses in the other Variable Fund Accounts. TAX MATTERS ----------- The following is a discussion of certain federal income tax matters affecting your ownership of a Policy. The discussion is general in nature, does not purport to be complete or to cover all situations, and should not be considered tax advice, for which you should consult a qualified tax advisor. The particular situation of each Owner or Beneficiary will determine how ownership or receipt of Policy proceeds will be treated for purposes of the federal estate tax, state inheritance tax and other taxes. TAXATION OF POLICY PROCEEDS The following discussion is based on current federal tax law and interpretations. It assumes that the Owner is a natural person who is a U.S. citizen and resident. The tax effects on non-U.S. residents or non-U.S. citizens may be different. VUL Policy 32 GENERAL. A Policy will be treated as a "life insurance contract" for federal tax purposes (a) if it meets the definition thereof under Section 7702 of the Internal Revenue Code (the "Code") and (b) for as long as the investments made by the underlying Funds in which Premium Payments under the Policy are invested satisfy certain investment diversification requirements under Section 817(h) of the Code. We believe that the Policies will meet these requirements and that: o the death benefit received by the Beneficiary under your Policy will not be subject to federal income tax; and o increases in your Policy's Cash Value as a result of investment experience will not be subject to federal income tax unless and until there is a distribution from your Policy, such as a surrender or a partial surrender. The federal tax consequences of a distribution from or loan under your Policy can be affected by whether your Policy is determined to be a "modified endowment contract ("MEC")" (which is discussed below). In all cases, however, the character of all income that is described below as taxable to the payee will be ordinary income (as opposed to capital gain). TESTING FOR MODIFIED ENDOWMENT CONTRACT (MEC) STATUS. Your Policy will be a MEC if, at any time during the first seven Policy Years, you have paid a cumulative amount of premiums that exceeds the premiums that would have been paid by that time under a similar fixed-benefit insurance policy that was designed (based on certain assumptions mandated under the Code) to provide for paid-up future benefits after the payment of seven level annual premiums. This is called the "seven-pay" test. Whenever there is a "material change" under a Policy, the Policy will generally be (1) treated as a new contract for purposes of determining whether the Policy is a MEC and (2) subject to a new seven-pay period and a new seven-pay limit. The new seven-pay limit would be determined taking into account, under a prescribed formula, the accumulation value of the Policy at the time of such change. A materially changed Policy would be considered a MEC if it failed to satisfy the new seven-pay limit. A material change for these purposes could occur as a result of a change in death benefit option, the selection of additional rider benefits, an increase in your Policy's Specified Amount of coverage, and certain other changes. If your Policy's benefits are reduced during the first seven Policy Years (or within seven years after a material change), the calculated seven-pay premium limit will be redetermined based on the reduced level of benefits and applied retroactively for purposes of the seven-pay test. (Such a reduction in benefits could include, for example, a decrease in the Specified Amount you request or, in some cases, a partial surrender or termination of additional benefits under a rider.) If the premiums previously paid are greater than the recalculated seven-pay premium level limit, the Policy will become a MEC. A life insurance policy that is received in exchange for a MEC will also be considered a MEC. OTHER EFFECTS OF POLICY CHANGES. Changes made to your Policy (for example, a decrease in benefits or a lapse or reinstatement of your Policy) may have other effects on the Policy. Such effects may include impacting the maximum amount of premiums that can be paid under your Policy, as well as the maximum amount of accumulation value that may be maintained under your Policy. TAXATION OF PRE-DEATH DISTRIBUTIONS IF YOUR POLICY IS NOT A MODIFIED ENDOWMENT CONTRACT (MEC). As long as your Policy remains in force during the Insured's lifetime as a non-MEC, a Policy loan will be treated as Indebtedness and not a distribution, and no part of the loan proceeds will be subject to current federal income tax. Interest on the loan generally will not be tax deductible. After the first 15 Policy Years, the proceeds from a partial surrender will be subject to federal income tax only to the extent they exceed your "basis" in your Policy. (Your basis generally will equal the premiums you have paid, less the amount of any previous distributions from your Policy that were not taxable.) During the first 15 Policy Years, the proceeds from a partial surrender or a reduction in insurance coverage could be subject to federal income tax, under a complex formula, to the extent that your Cash Value exceeds your basis in your Policy. On the Maturity Date or upon full surrender, any excess of the proceeds we pay (including amounts we use to discharge any Policy loan) over your basis in the Policy will be subject to federal income tax. In addition, if a Policy terminates after a grace period while there is a Policy loan, the cancellation of such loan and accrued loan interest will be treated as a distribution and could be subject to tax under the above rules. Finally, if you make an VUL Policy 33 assignment of rights or benefits under your Policy, you may be deemed to have received a distribution from the Policy, all or part of which may be taxable. TAXATION OF PRE-DEATH DISTRIBUTIONS IF YOUR POLICY IS A MODIFIED ENDOWMENT CONTRACT (MEC). If your Policy is a MEC, any distribution from your Policy during the Insured's lifetime will be taxed on an "income-first" basis. Distributions for this purpose include (1) loan proceeds (including any increase in the loan amount to pay interest on an existing loan or an assignment or a pledge to secure a loan) or (2) partial surrender. Any such distributions will be considered taxable income to you to the extent your Cash Value exceeds your basis in the Policy. (For MECs, your basis is similar to the basis described above for other Policies, except that it also would be increased by the amount of any prior loan under your Policy that was considered taxable income to you.) For purposes of determining the taxable portion of any distribution, all MECs issued by the same insurer (or its affiliate) to the same owner (excluding certain qualified plans) during any calendar year are aggregated. The U.S. Treasury Department has authority to prescribe additional rules to prevent avoidance of "income-first" taxation on distributions from MECs. A 10% penalty will apply to the taxable portion of most distributions from a Policy that is a MEC. The penalty will not, however, apply to distributions (1) to taxpayers 59 1/2 years of age or older, (2) in the case of a "disability" (as defined in the Code), or (3) received as part of a series of substantially equal periodic annuity payments for the life (or life expectancy) of the taxpayer or the joint lives (or joint life expectancies) of the taxpayer and his or her Beneficiary. If your Policy terminates after a grace period while there is a Policy loan, the cancellation of such loan will be treated as a distribution to the extent not previously treated as such and could be subject to federal income tax, including the 10% penalty, as described above. In addition, on the Maturity Date and upon a full surrender, any excess of the proceeds we pay (including any amounts we use to discharge any loan) over your basis in the Policy will be subject to federal income tax and, unless an exception applies, the 10% penalty. Distributions that occur during a Policy Year in which your Policy becomes a MEC, and during any subsequent Policy Years, will be taxed as described in the two preceding paragraphs. In addition, distributions from a Policy within two years before it becomes a MEC also will be subject to tax in this manner. This means that a distribution made from a Policy that is not a MEC could later become taxable as a distribution from a MEC. The Treasury Department has been authorized to prescribe rules that would treat similarly other distributions made in anticipation of a Policy becoming a MEC. POLICY LAPSES AND REINSTATEMENTS. A Policy that has lapsed may have the tax consequences described above, even though you may be able to reinstate that Policy. For tax purposes, some reinstatements may be treated as the purchase of a new life insurance contract. TERMINAL ILLNESS RIDER. Amounts received under an insurance policy on the life of an individual who is "terminally ill," as defined by the Code, are generally excludable from the payee's gross income. We believe that the benefits provided under our terminal illness rider meet the Code's definition of terminally ill and can qualify for this income tax exclusion. This exclusion does not apply, however, to amounts paid to someone other than the Insured, if the payee has an insurable interest in the Insured's life because the Insured is a director, officer or employee of the payee or by reason of the Insured's being financially interested in any trade or business carried on by the payee. DIVERSIFICATION. Under Section 817(h) of the Code, the Treasury Department has issued regulations that implement investment diversification requirements for insurance company separate accounts - for these purposes, each Variable Fund Account is treated as a separate account. Failure to comply with these regulations would disqualify your Policy as a life insurance contract for federal tax purposes. If this occurred, you would be subject to federal income tax on the income under the Policy for the period of the disqualification and all subsequent periods. Each Variable Fund Account, through the underlying Fund in which it invests, intends to continue to comply with these requirements. In connection with the issuance of the diversification regulations in 1986, the Treasury Department stated that guidance would be provided concerning the circumstances in which an insurance policy owner's control of a separate account's investments may cause that owner, rather than the insurance company, to be treated as owning the assets in the account. If you (rather than USAA Life) were considered the owner of the Separate Account's assets attributable to your Policy, income and gains from the account would be included in your gross income currently for federal income tax purposes. USAA Life reserves the right to amend the Policies in any way necessary to avoid any such result. As of the date of this Prospectus, no such guidance has been issued, although the Treasury Department VUL Policy 34 has informally indicated that any such guidance could limit the number of investment funds or the frequency of transfers among such funds. These guidelines may apply only prospectively, although retroactive application is possible if such standards are considered not to embody a new position. FEDERAL ESTATE AND GENERATION-SKIPPING TAXES. If the Insured is the Policy Owner, the death benefit under the Policy will be includable in the Owner's estate for federal estate tax purposes. If the Owner is not the Insured, under certain conditions only an amount approximately equal to the cash surrender value of the Policy would be so includable. In general, taxable estates of less than $1,000,000 for decedents dying during 2003 (increasing incrementally to $3,500,000 in 2009) ("exclusion amount") will not incur a federal estate tax liability. In addition, an unlimited marital deduction is available for federal estate tax purposes. As a general rule, if a "transfer" of property is made to a person two or more generations younger than the donor, a federal tax is payable at rates similar to the maximum federal estate tax rate in effect at the time. The generation-skipping tax provisions generally apply to "transfers" that would be subject to the federal estate tax rules. Individuals are generally allowed an aggregate generation-skipping tax exemption of $1,100,000 for 2003, and thereafter an exemption equal to the exclusion amount. Because these rules are complex, you should consult with a qualified tax advisor for specific information, especially where benefits are passing to younger generations. If the Owner of the Policy is not the Insured, and the Owner dies before the Insured, the value of the Policy, as determined for federal estate tax purposes, is includable in the federal gross estate of the Owner for those purposes. PENSION AND PROFIT-SHARING PLANS. If Policies are purchased by a trust that forms part of a pension or profit-sharing plan qualified under Section 401(a) of the Code (a "plan") for the benefit of participants covered under the plan, the federal income tax treatment of such Policies will be somewhat different from that described above. If insurance is purchased for a participant as part of a plan, the reasonable net annual premium cost for such insurance is treated as ordinary income to the participant. The amount so treated is the lower of the IRS "P.S. 58" table cost or the life insurance company's actual rates for standard risks. If the plan participant dies while covered by the plan and the Policy proceeds are paid to the participant's Beneficiary, then the excess of the death benefit over the Policy's Cash Value will not be subject to federal income tax. However, the Policy's Cash Value will generally be taxable to the extent it exceeds the participant's cost basis in the Policy, which will generally include the costs of insurance previously taxable as income to the participant. Special rules may apply if the participant had borrowed from the Policy or was an owner-employee under the plan. There are limits on the amounts of life insurance that may be purchased on behalf of a participant in a plan. Complex rules, in addition to those discussed above, apply whenever life insurance is purchased by a plan. You should consult a qualified tax advisor. OTHER EMPLOYEE BENEFIT PROGRAMS. Complex rules may also apply when a Policy is held by an employer or a trust, or acquired by an employee, in connection with the provision of other employee benefits. These Policy Owners must consider whether the Policy was applied for by or issued to a person having an insurable interest under applicable state law and with the Insured person's consent. The lack of an insurable interest or consent may, among other things, affect the qualification of the Policy as life insurance for federal tax purposes and the right of the Beneficiary to receive a death benefit. ERISA. Employers and employer-created trusts may be subject to reporting, disclosure and fiduciary obligations under the Employee Retirement Income Security Act of 1974. You should consult a qualified legal advisor. WHEN WE WITHHOLD INCOME TAXES. Generally, unless you provide us with an election to the contrary before we make the distribution, we are required to withhold income tax from any proceeds we distribute as part of a taxable transaction under your Policy. In some cases, where generation-skipping taxes may apply, we may also be required to withhold for such taxes unless we are provided satisfactory written notification that no such taxes are due. TAX CHANGES. The U.S. Congress frequently considers legislation that, if enacted, could change the tax treatment of life insurance policies. In addition, the Treasury Department may amend existing regulations, issue regulations on the qualification of life insurance and MECs, or adopt new interpretations of existing law. VUL Policy 35 State and local tax laws or, if you are not a U.S. citizen or resident, foreign tax laws, may also affect the tax consequences to you, the Insured, or your Beneficiary, and are subject to change. Any changes in federal, state, local, or foreign tax law or interpretation could have a retroactive effect. We suggest you consult a qualified tax advisor. TAXATION OF USAA LIFE USAA Life is taxed as a life insurance company under the Code. USAA Life does not initially expect to incur any federal income tax liability on the earnings or the realized capital gains attributable to any Variable Fund Account. If, in the future, USAA Life determines that a Variable Fund Account may incur federal income tax, then we may assess a charge against the Variable Fund Accounts for that tax. Any charge will reduce the Policy's Cash Value. We may have to pay state, local, or other taxes in addition to applicable taxes based on premiums. At present, these taxes are not substantial. If they increase, we may make charges for such taxes when they are attributable to the Separate Account or allocable to the Policies. LEGAL PROCEEDINGS ----------------- USAA LIFE, LIKE OTHER LIFE INSURANCE COMPANIES, IS INVOLVED IN LAWSUITS, INCLUDING CLASS ACTION LAW SUITS. IN SOME CLASS ACTION AND OTHER LAWSUITS INVOLVING INSURERS, SUBSTANTIAL DAMAGES HAVE BEEN SOUGHT AND/OR MATERIAL SETTLEMENT PAYMENTS HAVE BEEN MADE. ALTHOUGH THE OUTCOME OF ANY LITIGATION CANNOT BE PREDICTED WITH CERTAINTY, USAA LIFE BELIEVES THAT, AS OF THE DATE OF THIS PROSPECTUS, THERE ARE NO PENDING OR THREATENED LAWSUITS THAT WILL HAVE A MATERIALLY ADVERSE IMPACT ON USAA LIFE OR THE SEPARATE ACCOUNT. FINANCIAL STATEMENTS -------------------- The financial statements for the Separate Account and USAA Life appear in the SAI. To obtain a copy of the SAI, call us at 1-800-531-2923. You should consider our financial statements only as bearing on our ability to meet our obligations under the Contracts. Our financial statements do not bear on the investment performance of the Separate Account. ----------- DEFINITIONS ----------- IN THIS PROSPECTUS: ------------------- ACCUMULATION UNIT or UNIT means an accounting unit of measure that we use to calculate values in each Variable Fund Account. The value of one unit is known as the Accumulation Unit Value ("AUV"). ADMINISTRATIVE CHARGE means a monthly charge deducted from the Policy's Cash Value during the first Policy Year only. The Administrative Charge compensates us for the start-up expenses we incur in issuing the Policy. The Administrative Charge is shown on the Policy Information Page. ANNIVERSARY means the same date each succeeding year as the Effective Date of the Policy. ANNUAL TARGET PREMIUM PAYMENT means an annual amount of premium payment that we establish when we issue your Policy. It is shown on the Policy Information Page. We use it to determine whether a premium charge will be deducted from premium payments, whether a surrender charge is imposed on a full surrender, and whether the Guaranteed Death Benefit applies. BENEFICIARY means the person or entity designated to receive the death benefit upon the Insured's death. CASH SURRENDER VALUE means your Policy Cash Value less the surrender charge, if any, payable on full surrender of your Policy. CASH VALUE, on the Effective Date, means the Net Premium less the Monthly Deduction for the following month. Thereafter, on any Valuation Date, Cash Value means the sum of: o your Policy's value that you invest in the Variable Fund Accounts; o plus, if applicable, any value that is held in USAA Life's general account to secure any Policy loan; VUL Policy 36 o plus any interest earnings we credit on the value held in the general account; o less the amount of any outstanding loan including any unpaid loan interest; and o less any Monthly Deductions, transfer charges, and partial surrender charges we apply through that date. DATE OF RECEIPT means the date we actually receive the item at our Home Office, subject to two exceptions: o IF WE RECEIVE THE ITEM ON A DATE OTHER THAN A VALUATION DATE, THE DATE OF RECEIPT WILL BE THE FOLLOWING VALUATION DATE; AND o if we receive the item on a Valuation Date after close of regular trading of the New York Stock Exchange, the Date of Receipt will be the following Valuation Date. DEATH BENEFIT means the benefit we pay in accordance with the death benefit option in effect on the Insured's death (1) reduced by any Indebtedness and any due and unpaid Monthly Deductions; and (2) increased by any optional insurance benefits provided by rider. DEATH BENEFIT OPTION means one of the two death benefit options that the Policy provides, namely, Option A and Option B. Option A is the greater of the current Specified Amount or the Minimum Amount Insured. Option B is the greater of the current Specified Amount, plus the Policy's Cash Value, or the Minimum Amount Insured. EFFECTIVE DATE means the date we approve the application and issue your Policy or the date we approve any increase in Specified Amount under your Policy. The Effective Date is shown on the Policy Information Page. FREE LOOK PERIOD means the period of time required by state law during which you may return the Policy for cancellation and receive a refund. The Free Look Period is shown on the Policy Information Page. You may cancel your Policy within 10 days of receipt (or a longer period depending on where you reside). Your initial premium payment allocated to any of the Variable Fund Accounts is invested in the Vanguard Money Market Portfolio Variable Fund Account during the Free Look Period plus 5 calendar days. (SEE "Free Look Right.") FUND means an investment portfolio that has specific investment objectives and policies and is offered by a mutual fund. GUARANTEED DEATH BENEFIT means that if you pay a sufficient amount of premium, we guarantee your Policy will not lapse during the first 5 Policy Years. HOME OFFICE means USAA Life Insurance Company, USAA Building, 9800 Fredericksburg Road, San Antonio, Texas 78288. INDEBTEDNESS means the sum of all unpaid Policy loans and any unpaid accrued interest due on such loans. INSURED means the person whose life is insured. The Insured is identified on the Policy Information Page. The Insured may or may not be the Owner. LAPSE means your Policy has terminated because of insufficient Cash Value from which to deduct the Monthly Deduction and any loan interest then due. No insurance coverage exists when your Policy has lapsed. MAINTENANCE CHARGE means a monthly charge that we deduct from the Policy's Cash Value. The Maintenance Charge compensates us for recurring administrative expenses related to the maintenance of the Policy and the Separate Account. The Maintenance Charge is shown on the Policy Information Page. MATURITY DATE means the date that we will pay your Policy's Cash Value to you, as long as the Policy has not terminated because of lapse, full surrender, or the Insured's death. The Maturity Date is shown on the Policy Information Page. MONTHLY ANNIVERSARY means the same date of each succeeding month as the Effective Date of your Policy. MONTHLY DEDUCTION means a charge we make under your Policy each month against the Policy's Cash Value. The charge is equal to: o the cost of insurance and any riders; plus VUL Policy 37 o the Administrative Charge that is applied during the first 12 months that the Policy is in effect; plus o the Maintenance Charge. MINIMUM AMOUNT INSURED means the minimum amount of life insurance required by the Internal Revenue Code to qualify your Policy as life insurance and to exclude the death benefit from a Beneficiary's taxable income. NET ASSET VALUE ("NAV") means the current value of each Fund's total assets, less all liabilities, divided by the total number of shares outstanding. NET PREMIUM PAYMENT means the amount of a premium payment less the Policy's premium charge. NOTICE TO US means your signed statement that we receive at our Home Office and that is in a form satisfactory to us. OWNER means the person to whom we owe the rights and privileges of the Policy. POLICY INFORMATION PAGE means the page that identifies certain information about the Policy and specifies certain terms of the Policy. POLICY YEAR means a period of 12 calendar months starting with the Effective Date of the Policy, and each 12-month period thereafter. For example, if your Policy was issued on July 15, your first Policy Year would end on the following July 14. Each subsequent Policy Year would start on July 15 and end on July 14. PREMIUM CHARGE means an amount that we deduct from premium payments to compensate us for sales charges and taxes related to the Policy. SEPARATE ACCOUNT means the Life Insurance Separate Account of USAA Life Insurance Company. The Separate Account is an investment account established under Texas law through which we invest the Net Premium Payments we receive for investment in the Variable Fund Accounts under the Policy. The Separate Account is divided into subdivisions called the Variable Fund Accounts. Each Variable Fund Account invests the Net Premium Payments allocated to it in a particular Fund. We own the assets of the Separate Account. To the extent that the assets are equal to the reserves and other contractual liabilities, they are not chargeable with liabilities arising out of any other business of ours. We credit or charge the income, gains, and losses, realized or unrealized, from the assets of the Separate Account to or against the Separate Account without regard to our other income, gains or losses. We registered the Separate Account as an investment company under federal securities law. SPECIFIED AMOUNT means the minimum death benefit payable as long as the Policy is in effect. It is also the amount of life insurance we issue. The specified amount is shown on the Policy Information Page. SURRENDER CHARGE means an amount that we may deduct from your Policy's Cash Value if you surrender your Policy in full. VALUATION DATE means any business day, Monday through Friday, on which the New York Stock Exchange is open for regular trading, except o any day on which the value of the shares of a Fund is not computed, or o any day during which no order for the purchase, surrender or transfer of Accumulation Units is received. VALUATION PERIOD means the period of time from the end of any Valuation Date to the end of the next Valuation Date. VARIABLE FUND ACCOUNT means a subdivision of the Separate Account in which you may invest Net Premium Payments. The Policy provides several Variable Fund Accounts. Each Variable Fund Account corresponds to a particular Fund. Net Premium Payments that you allocate to a Variable Fund Account are invested in a particular Fund. We also refer to the Variable Fund Accounts as Accounts in this Prospectus. WE, OUR, US, OR USAA LIFE means USAA Life Insurance Company. VUL Policy 38 YOU, YOUR OR YOURS refers to the Owner of the Policy. VUL Policy 39 STATEMENT OF ADDITIONAL INFORMATION ----------------------------------- A Statement of Additional Information, with the same date as this prospectus, containing further information about the Life Insurance Separate Account of USAA Life Insurance Company and the Variable Universal Life Insurance Policy is available from us upon request. It has been filed with the SEC and is incorporated by reference into this prospectus. In addition, you may order a personalized illustration of death benefits, cash surrender values, and Cash Values, without charge, from us. To request a Statement of Additional Information, a personalized illustration or any information about your Policy call us at 1-800-531-2923 or write to us at 9800 Fredericksburg Road, San Antonio, TX 78288. Information about the Life Insurance Separate Account of USAA Life Insurance Company (including the Statement of Additional Information) can be reviewed and copied at the Securities and Exchange Commission's Public Reference Room in Washington, DC or at the SEC's website, HTTP://WWW.SEC.GOV. Copies of this information may be obtained, upon payment of a duplicating fee, by writing the Public Reference Section of the Commission, 450 Fifth Street, NW, Washington, DC, 20549-0102. You can also call the SEC at 1-202-942-8090. We have not authorized anyone to give any information or make any representations other than those contained in this Prospectus, the Statement of Additional Information or other material filed with the SEC (or any sales literature we approve) in connection with the offer of the Policies described in this prospectus. You may not rely on any such information or representations, if made. This Prospectus does not constitute an offer in any jurisdiction to any person to whom such offer would be unlawful. The table of contents for the Statement of Additional Information is as follows: Additional Information About Operation of Policies and Separate Account Special Considerations State Regulation of USAA Life Underwriters Performance Data Illustrations Legal Matters Independent Auditors Financial Statements INVESTMENT COMPANY ACT FILE NUMBER 811-08625 VUL Policy 40 Life Insurance Separate Account of USAA Life Insurance Company (Registrant) USAA Life Insurance Company (Depositor) 9800 Fredericksburg Road San Antonio, Texas 78288 1-800-531-2923 STATEMENT OF ADDITIONAL INFORMATION VARIABLE UNIVERSAL LIFE INSURANCE POLICY May 1, 2003 This Statement of Additional Information ("SAI") contains additional information regarding the Variable Universal Life Insurance Policy (the "Policy") offered by USAA Life Insurance Company. This SAI is not a prospectus, and should be read together with the prospectus for the Policy dated May 1, 2003 and the prospectuses for the Funds. You may obtain a copy of these prospectuses by calling us at 1-800-531-2923 or by writing to us at the address above. -------------------------------------------------------------------------------- TABLE OF CONTENTS ADDITIONAL INFORMATION ABOUT OPERATION OF POLICIES AND SEPARATE ACCOUNT......2 THE POLICIES..............................................................2 INCONTESTABILITY..........................................................2 MISSTATEMENT OF AGE OR SEX................................................2 SUICIDE EXCLUSION.........................................................2 NONPARTICIPATING POLICY...................................................3 REPORTS AND RECORDS.......................................................3 SPECIAL CONSIDERATIONS.......................................................3 STATE REGULATION OF USAA LIFE................................................3 UNDERWRITERS.................................................................4 PERFORMANCE DATA.............................................................4 ILLUSTRATIONS................................................................5 LEGAL MATTERS................................................................5 INDEPENDENT AUDITORS.........................................................5 FINANCIAL STATEMENTS.........................................................5 VUL SAI 1 ADDITIONAL INFORMATION ABOUT OPERATION OF POLICIES AND SEPARATE ACCOUNT ----------------------------------------------------------------------- THE POLICIES The Policy is a legal contract between you and us. The consideration for issuing the Policy is: o completion of the application, and o payment of the first full premium. The entire contract consists of: o your Policy, o your Policy application, and o any supplemental applications, riders, endorsements, and amendments. WE WILL CONSIDER STATEMENTS IN THE APPLICATION AS REPRESENTATIONS AND NOT WARRANTIES. WE WILL NOT USE ANY REPRESENTATION TO VOID YOUR POLICY OR DEFEND A CLAIM UNDER YOUR POLICY UNLESS IT IS CONTAINED IN YOUR WRITTEN APPLICATION OR SUPPLEMENTAL APPLICATION. ONLY THE PRESIDENT OR SECRETARY OF USAA LIFE HAS AUTHORITY TO CHANGE OR WAIVE A PROVISION OF YOUR POLICY, AND THEN ONLY IN WRITING. All requests for changes to your Policy must be clear and in writing, and must be received by our Home Office. This Policy is subject to the laws of the state where it is issued. To the extent that the Policy may not comply, it will be interpreted and applied to comply. INCONTESTABILITY We will not contest a Policy, or any increase in Specified Amount, except for lapse or fraud, after the Policy or increase has been in effect during the Insured's lifetime for 2 years. Each increase in the Specified Amount will have its own 2-year contestable period beginning with the Effective Date of the increase. During any 2-year contestable period, we have the right to contest the validity of your Policy based on material misstatements made in the application or any supplemental application. The 2-year contestable period begins on the Effective Date of your Policy, or, in the case of an increase, on the date the increase is approved and made effective. If your Policy is reinstated after lapse, a new 2-year contestable period begins on the date of reinstatement. If the Policy has been in force for 2 years during the lifetime of the Insured, it will be contestable only as to statements made in the reinstatement application. If the Policy has been in force for less than 2 years, it will be contestable as to statements made in any reinstatement applications as well as the initial application. The incontestability provisions do not apply to optional insurance benefits added to your Policy by rider. Each rider contains its own incontestability provision. If we contest and rescind your Policy, you will receive your premiums paid, less any Indebtedness and any previous partial surrenders. MISSTATEMENT OF AGE OR SEX Age means the Insured's age on his or her last birthday. If the Insured's age or sex has been misstated on the application or any supplemental application, we will adjust the Cash Value and death benefit to those based on the correct Monthly Deductions, based on the correct age or sex, since the Policy's Effective Date. SUICIDE EXCLUSION Your Policy does not cover suicide by the Insured, while sane or insane, during an exclusion period after the Policy's Effective Date. This exclusion period is generally 2 years from the Policy's Effective Date but may vary by state. If the Insured commits suicide during this period, our sole liability will be to refund all premiums paid, less any Indebtedness and previous partial surrenders. We will not pay any death benefit in those circumstances. If your Policy lapses and is later reinstated, we will measure the 2-year suicide exclusion period from the Effective Date of reinstatement. If you increase your Policy's Specified Amount, we will measure the 2-year suicide exclusion period for the increase from the increase's Effective Date. If the Insured dies as a result of suicide (whether sane or insane) during the separate 2-year suicide exclusion period, we will only pay the death benefit attributable to the initial Specified Amount (on which the 2-year suicide exclusion period has expired). We will refund the premium payments less any Indebtedness and any partial surrenders attributable to the increase in the Specified Amount. VUL SAI 2 NONPARTICIPATING POLICY YOUR POLICY IS "NONPARTICIPATING," WHICH MEANS YOU WILL NOT SHARE IN ANY OF OUR PROFITS OR SURPLUS EARNINGS. WE WILL NOT PAY DIVIDENDS ON YOUR POLICY. REPORTS AND RECORDS We will maintain all records relating to the Policy and the Separate Account. We will mail to you a Policy annual statement showing: o the amount of death benefit; o the Cash Value; o any Indebtedness; o any loan interest charge; o any loan repayment since the last annual statement; o any partial surrender since the last annual statement; o all premium payments since the last annual statement; o all deductions and charges since the last annual statement; and o other pertinent information required by any applicable law or regulation, or that we deem helpful to you. We will mail the statement within 30 days after the Policy's anniversary, or, at our discretion, within 30 days after the end of each calendar year showing information as of a date not more than 60 days prior to the mailing of the annual statement. We also will send you periodic reports for the Funds that correspond to the Variable Fund Accounts, periodic reports for the Separate Account, and any other information, as required by state and federal law. We will mail confirmation notices (or other appropriate notification) promptly at the time of the following transactions: o Policy issue; o receipt of premium payments; o transfers among Variable Fund Accounts; o change of premium allocation; o change of death benefit option; o increases or decreases in Specified Amount; o partial surrenders; o receipt of loan repayments; and o reinstatement. SPECIAL CONSIDERATIONS ---------------------- The Funds managed by the Vanguard Group, Fidelity Management & Research Company, Deutsche Investment Management Americas, Fred Alger Management, Barrow Hanley Mewhinney & Strauss, Granahan Investment Management, Grantham Mayo Van Otterloo & Co., Schroder Investment Management, Marsico Capital Management, MFS Investment Management, and Wellington Management may offer shares to separate accounts of unaffiliated life insurance companies to fund benefits under variable annuity contracts and variable life insurance policies. The Funds managed by USAA Investment Management Company ("USAA IMCO") offer shares only to our separate accounts to fund benefits under the Policies and the variable annuity contracts that we offer. The boards of directors or trustees of these Funds monitor for possible conflicts among separate accounts buying shares of the Funds. Conflicts could develop for a variety of reasons. For example, differences in treatment under tax and other laws or the failure by a separate account to comply with such laws could cause a conflict. To eliminate a conflict, a Fund's board of directors or trustees may require a separate account to withdraw its participation in a Fund. A Fund's Net Asset Value (NAV) could decrease if it had to sell investment securities to pay redemption proceeds to a separate account withdrawing because of a conflict. STATE REGULATION OF USAA LIFE USAA Life, a stock life insurance company organized under the laws of Texas, is subject to regulation by the Texas Department of Insurance. An annual statement is filed with the Texas Department of Insurance on or before March 1st of each year covering the operations and reporting on the financial condition of USAA Life as of December 31 of the preceding year. Periodically, the Commissioner of Insurance examines the liabilities and reserves of USAA Life and the Separate Account and certifies their adequacy. VUL SAI 3 In addition, USAA Life is subject to the insurance laws and regulations of all other states and jurisdictions where it is licensed. Generally, the Insurance Department of any other state applies the laws of the state of Texas in determining USAA Life's permissible investments. UNDERWRITERS ------------ We intend to sell the Policy in all states in which we are licensed and the District of Columbia. USAA IMCO, located at 9800 Fredericksburg Road, San Antonio, Texas 78288, is the principal underwriter distributing the Policy. USAA IMCO, a Delaware corporation, organized in May 1970, is registered with the SEC under the Securities Exchange Act of 1934 as a broker-dealer and is an active member of the National Association of Securities Dealers, Inc. USAA IMCO is a wholly owned subsidiary of USAA and is an affiliate of USAA Life. The Policy will be sold by licensed life insurance sales representatives who are also registered representatives of USAA IMCO. These licensed insurance sales representatives are salaried employees of USAA Life and receive neither direct nor indirect commissions nor any renewal commissions from the sale of the Policies. The Policies are sold and premium payments are accepted on a continuous basis. USAA IMCO serves as principal underwriter for the Policies pursuant to an amended and restated Distribution and Administration Agreement with USAA Life dated March 30, 1998. Pursuant to this agreement, USAA Life bears the cost of the salaries of the sales representatives who sell the Policies and substantially all other distribution expenses of the Policies. USAA IMCO receives no commission for serving as principal underwriter of the Policies. The agreement terminates upon its assignment or upon at least 60 days notice by either party. USAA IMCO serves as both principal underwriter and investment adviser for the following registered investment companies: USAA Tax Exempt Fund, Inc., USAA Investment Trust, USAA State Tax-Free Trust, USAA Mutual Fund, Inc., and USAA Life Investment Trust. In addition, USAA IMCO serves as principal underwriter for the Separate Account of USAA Life, a registered investment company. PERFORMANCE DATA ---------------- From time to time, we may quote performance information for the Variable Fund Accounts of the Separate Account in advertisements, sales literature, or reports to Owners or prospective investors. We may quote performance information in any manner permitted under applicable law. We may, for example, present such information as a change in a hypothetical Owner's Cash Value or death benefit. We also may present the yield or total return of the Variable Fund Accounts based on a hypothetical investment in a Policy. The performance information shown may cover various periods of time, including periods beginning with the commencement of the operations of the Variable Fund Account or the Fund in which it invests. The performance information shown may reflect the deduction of only some of the applicable charges to the Policy. We may, for example, exclude the deduction of one or more charges, such as the premium charge or surrender charge, and we generally expect to exclude cost of insurance charges because of the individual nature of these charges. The "yield" of a Variable Fund Account refers to the income generated by an investment in the Variable Fund Account over the period specified in the advertisement, excluding realized and unrealized capital gains and losses in the corresponding fund's investments. This income is then "annualized" and shown as a percentage of the investment. We also may advertise the "effective yield" of the Vanguard Money Market Portfolio Variable Fund Account, which is calculated similarly, but, when annualized, the income earned by an investment in the Vanguard Money market Portfolio Variable Fund Account is assumed to be reinvested. The "effective yield" will be slightly higher than the "yield" because of the compounding effect of this assumed reinvestment. The "total return" of a Variable Fund Account is the total change in value of an investment in the Variable Fund Account over a period of time specified in the advertisement. "Average annual total return" is the rate of return that would produce that change in value over the specified period, if compounded annually. "Cumulative total return" is the total return over the entire specified period expressed as a percentage. Neither yield nor total return figures reflect deductions for Policy charges such as the premium charge, surrender charges, administrative and maintenance fees, and cost of insurance charges. Yield and total return figures would be lower if Policy charges were included. We may compare a Variable Fund Account's performance to that of other variable life separate accounts or investment products, as well as to generally accepted indices or analyses, such as those provided by research firms VUL SAI 4 and rating services. In addition, we may use performance ratings that may be reported periodically in financial publications, such as MONEY MAGAZINE, FORBES, BUSINESS WEEK, FORTUNE, FINANCIAL PLANNING, and THE WALL STREET JOURNAL. We also may advertise ratings of USAA Life's financial strength or claims-paying ability as determined by firms that analyze and rate insurance companies and by nationally recognized statistical rating organizations. We may from time to time provide advertisements, sales literature or tools to assist you in choosing your investment options by defining your asset allocation strategy and appropriate risk tolerance. Performance information for any Variable Fund Account reflects the performance of a hypothetical Policy and are not illustrative of how actual investment performance would affect the benefits under your Policy. Therefore, you should not consider such performance information to be an estimate or guarantee of future performance. ILLUSTRATIONS ------------- Illustrations are tools that can help demonstrate how the Policy operates, given the Policy's charges, investment options and any optional features selected, how you plan to accumulate or access Policy value over time, and assumed rates of return. Illustrations may also be able to assist you in comparing the Policy's death benefits, cash surrender values, and Policy values with those of other variable life insurance policies based upon the same or similar assumptions. LEGAL MATTERS ------------- The firm of Kirkpatrick & Lockhart LLP, Washington, D.C., has advised USAA Life on certain federal securities law matters. All matters of Texas law pertaining to the Policy, including the validity of the Policy and USAA Life's right to issue the Policy under Texas insurance law, have been passed upon by Cynthia A. Toles, Vice President and Assistant Secretary of USAA Life. INDEPENDENT AUDITORS -------------------- The audited financial statements and financial highlights of the Separate Account as of December 31, 2002, and for each of the years or periods presented, and the audited consolidated financial statements of USAA Life Insurance Company and its subsidiaries as of December 31, 2002 and 2001, and for each of the years in the three-year period ended December 31, 2002, are included in this SAI or will be included in an amendment to this SAI. The information has been audited by KPMG LLP, independent certified public accountants, through their offices located at 112 E. Pecan, Suite 2400, San Antonio, Texas 78205. FINANCIAL STATEMENTS -------------------- VUL SAI 5 INDEPENDENT AUDITORS' REPORT TO THE BOARD OF DIRECTORS OF USAA LIFE INSURANCE COMPANY AND CONTRACTOWNERS OF THE SEPARATE ACCOUNT OF USAA LIFE INSURANCE COMPANY: We have audited the accompanying statements of assets and liabilities as of December 31, 2002, the related statements of operations, statements of changes in net assets, and financial highlights presented in note 6 for each of the years or periods presented, for the 18 variable fund accounts available within the Separate Account of USAA Life Insurance Company: USAA Life Growth and Income, USAA Life Aggressive Growth, USAA Life World Growth, USAA Life Diversified Assets, USAA Life Income, Vanguard Diversified Value Portfolio, Vanguard Equity Index Portfolio, Vanguard Mid-Cap Index Portfolio, Vanguard Small Company Growth Portfolio, Vanguard International Portfolio, Vanguard REIT Index Portfolio, Vanguard High Yield Bond Portfolio, Vanguard Money Market Portfolio, Fidelity VIP II Contrafund(R) Portfolio, Fidelity VIP Equity-Income Portfolio, Fidelity VIP III Dynamic Cap Appreciation Portfolio, Scudder Capital Growth Portfolio, and Alger American Growth Portfolio. These financial statements and financial highlights are the responsibility of the Separate Account's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Investments owned at December 31, 2002 were verified by confirmation with the investment custodian of the underlying portfolios of the USAA Life Investment Trust or through confirmation with the transfer agents of the other portfolios. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of the aforementioned fund accounts available within the Separate Account of USAA Life Insurance Company as of December 31, 2002, and the results of their operations, the changes in their net assets, and financial highlights for each of the years or periods presented, in conformity with accounting principles generally accepted in the United States of America. KPMG LLP San Antonio, Texas January 31, 2003 LIFE INSURANCE SEPARATE ACCOUNT OF USAA LIFE INSURANCE COMPANY STATEMENTS OF ASSETS AND LIABILITIES DECEMBER 31, 2002 (In Thousands, Except Per Unit Data) FUND ACCOUNTS INVESTING IN: --------------------------------------------------------------------------------
VVIF USAA LIFE USAA LIFE USAA LIFE USAA LIFE DIVERSIFIED VVIF MID- GROWTH AND AGGRESSIVE WORLD GROWTH DIVERSIFIED USAA LIFE VALUE VVIF EQUITY CAP INDEX INCOME FUND GROWTH FUND FUND ASSETS FUND INCOME FUND PORTFOLIO INDEX PORTFOLIO PORTFOLIO ----------- ----------- ------------ ----------- ----------- ----------- --------------- --------- ASSETS: Investments at market value $ 564 $ 796 $ 211 $ 575 $ 302 $ 133 $ 1,162 $ 274 ---------- ---------- ---------- ---------- ---------- --------- --------- --------- Net Assets $ 564 $ 796 $ 211 $ 575 $ 302 $ 133 $ 1,162 $ 274 ========== ========== ========== ========== ========== ========= ========= ========= Net Assets: Net assets attributable to policyowners' reserves $ 564 $ 796 $ 211 $ 575 $ 302 $ 133 $ 1,162 $ 274 ========== ========== ========== ========== ========== ========= ========= ========= Units outstanding (accumulation) 32 67 15 29 18 17 145 33 ========== ========== ========== ========== ========== ========= ========= ========= Unit value (accumulation) $17.449936 $11.836938 $14.273481 $19.611603 $17.110216 $7.947514 $7.995176 $8.397224 ========== ========== ========== ========== ========== ========= ========= ========= VVIF SMALL FVIP FVIP EQUITY- COMPANY VVIF VVIF HIGH VVIF MONEY CONTRAFUND(R) INCOME GROWTH INTERNATIONAL VVIF REIT YIELD BOND MARKET PORTFOLIO, PORTFOLIO, PORTFOLIO PORTFOLIO INDEX PORTFOLIO PORTFOLIO PORTFOLIO INITIAL CLASS INITIAL CLASS ---------- ------------- --------------- ---------- ---------- ------------- ------------- ASSETS: Investments at market value $ 376 $ 224 $ 240 $ 230 $ 1,190 $ 114 $ 175 --------- --------- ---------- --------- --------- --------- --------- Net Assets $ 376 $ 224 $ 240 $ 230 $ 1,190 $ 114 $ 175 ========= ========= ========== ========= ========= ========= ========= Net Assets: Net assets attributable to policyowners' reserves $ 376 $ 224 $ 240 $ 230 $ 1,190 $ 114 $ 175 ========= ========= ========== ========= ========= ========= ========= Units outstanding (accumulation) 47 31 21 23 881 13 23 ========= ========= ========== ========= ========= ========= ========= Unit value (accumulation) $8.065415 $7.120925 $11.252063 $9.946870 $1.350997 $8.561012 $7.771493 ========= ========= ========== ========= ========= ========= ========= FVIP DYNAMIC CAP. SVS I CAPITAL ALGER APPRECIATION GROWTH AMERICAN PORTFOLIO, PORTFOLIO, GROWTH INITIAL CLASS CLASS A SHARES PORTFOLIO TOTAL ------------- -------------- ---------- -------- ASSETS: Investments at market value $ 37 $ 370 $ 816 $7,789 --------- ---------- ---------- ------ Net Assets $ 37 $ 370 $ 816 $7,789 ========= ========== ========== ====== Net Assets: Net assets attributable to policyowners' reserves $ 37 $ 370 $ 816 $7,789 ========= ========== ========== ====== Units outstanding (accumulation) 5 22 47 ========= ========== ========== Unit value (accumulation) $7.809482 $16.508497 $17.520609 ========= ========== ==========
See accompanying Notes to Financial Statements. LIFE INSURANCE SEPARATE ACCOUNT OF USAA LIFE INSURANCE COMPANY STATEMENTS OF OPERATIONS YEAR OR PERIOD ENDED DECEMBER 31, 2002 (In Thousands) FUND ACCOUNTS INVESTING IN: --------------------------------------------------------------------------------
USAA LIFE USAA LIFE USAA LIFE USAA LIFE VVIF GROWTH AND AGGRESSIVE WORLD GROWTH DIVERSIFIED USAA LIFE DIVERSIFIED INCOME FUND GROWTH FUND FUND ASSETS FUND INCOME FUND VALUE PORTFOLIO ----------- ----------- ------------ ------------ ----------- --------------- NET INVESTMENT INCOME (LOSS): Income Dividends from investments $ 7 $ - $ 2 $ 14 $ 13 $ 2 ----- ----- ---- ---- ----- ---- Expenses Mortality and expense risk charge 4 6 2 4 2 1 ----- ----- ---- ---- ----- ---- Net investment income (loss) 3 (6) - 10 11 1 ----- ----- ---- ---- ----- ---- NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS: Net realized gain (loss) on sale of investments (20) (179) (23) (18) (2) (2) Capital gains distributions 14 - - 25 - - ----- ----- ---- ---- ----- ---- Net realized gain (loss) (6) (179) (23) 7 (2) (2) Change in net unrealized appreciation/ depreciation (125) (127) (13) (87) 9 (16) ----- ----- ---- ---- ----- ---- Net realized and unrealized gain (loss) on investments (131) (306) (36) (80) 7 (18) ----- ----- ---- ---- ----- ---- INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $(128) $(312) $(36) $(70) $ 18 $(17) ===== ===== ==== ==== ===== ==== VVIF SMALL COMPANY VVIF VVIF HIGH VVIF EQUITY VVIF MID-CAP GROWTH INTERNATIONAL VVIF REIT YIELD BOND INDEX PORTFOLIO INDEX PORTFOLIO PORTFOLIO PORTFOLIO INDEX PORTFOLIO PORTFOLIO --------------- --------------- ---------- ------------ --------------- ---------- NET INVESTMENT INCOME (LOSS): Income Dividends from investments $ 19 $ 1 $ 3 $ 4 $ 6 $ 7 ------ ---- ----- ---- --- --- Expenses Mortality and expense risk charge 9 1 3 1 2 1 ------ ---- ----- ---- --- --- Net investment income (loss) 10 - - 3 4 6 ------ ---- ----- ---- --- --- NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS: Net realized gain (loss) on sale of investments (38) (9) (2) (4) (3) (1) Capital gains distributions 71 7 12 6 2 - ------ ---- ----- ---- --- --- Net realized gain (loss) 33 (2) 10 2 (1) (1) Change in net unrealized appreciation/ depreciation (338) (32) (111) (44) (8) (1) ------ ---- ----- ---- --- --- Net realized and unrealized gain (loss) on investments (305) (34) (101) (42) (9) (2) ------ ---- ----- ---- --- --- INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $ (295) $(34) $(101) $(39) $(5) $ 4 ====== ==== ===== ==== === === FVIP DYNAMIC SVS I CAPITAL FVIP FVIP EQUITY- CAP GROWTH ALIGER VVIF MONEY CONTRAFUND(R) INCOME APPRECIATION PORTFOLIO, AMERICAN MARKET PORTFOLIO, PORTFOLIO, PORTFOLIO, CLASS A GROWTH PORTFOLIO INITIAL CLASS INITIAL CLASS INITIAL CLASS SHARES PORTFOLIO ---------- ------------- ------------- ------------- ------------ --------- NET INVESTMENT INCOME (LOSS): Income Dividends from investments $ 29 $ - $ 2 $ - $ 1 $ - ----- ----- ---- ---- ----- ----- Expenses Mortality and expense risk charge 13 - 1 - 3 7 ----- ----- ---- ---- ----- ----- Net investment income (loss) 16 - 1 - (2) (7) ----- ----- ---- ---- ----- ----- NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS: Net realized gain (loss) on sale of investments - 1 (6) - (179) (233) Capital gains distributions - - 2 - - - ----- ----- ---- ---- ----- ----- Net realized gain (loss) - 1 (4) - (179) (233) Change in net unrealized appreciation/ depreciation - (9) (24) (2) 25 (149) ----- ----- ---- ---- ----- ----- Net realized and unrealized gain (loss) on investments - (8) (28) (2) (154) (382) ----- ----- ---- ---- ----- ----- INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $ 16 $ (8) $(27) $ (2) $(156) $(389) ===== ===== ==== ==== ===== =====
See accompanying Notes to Financial Statements. LIFE INSURANCE SEPARATE ACCOUNT OF USAA LIFE INSURANCE COMPANY STATEMENTS OF CHANGES IN NET ASSETS YEARS OR PERIODS ENDED DECEMBER 31, 2002 AND 2001 (In Thousands) FUND ACCOUNTS INVESTING IN: --------------------------------------------------------------------------------
USAA LIFE USAA LIFE USAA LIFE GROWTH AGGRESSIVE USAA LIFE WORLD DIVERSIFIED ASSETS AND INCOME FUND GROWTH FUND GROWTH FUND FUND ----------------- ---------------- ----------------- -------------------- 2002 2001 2002 2001 2002 2001 2002 2001 ----------------- ---------------- ----------------- -------------------- FROM OPERATIONS: Net investment income (loss) $ 3 $ 5 $ (6) $ (6) $ - $ 1 $ 10 $ 6 Net realized gain (loss) (6) 15 (179) (23) (23) (10) 7 8 Change in net unrealized appreciation/depreciation (125) (50) (127) (201) (13) (25) (87) 24 ---------------- --------------- --------------- ------------------- Increase (decrease) in net assets resulting from operations (128) (30) (312) (230) (36) (34) (70) 38 ---------------- --------------- --------------- ------------------- FROM POLICY TRANSACTIONS: Purchases and transfers in 215 404 290 461 60 135 248 401 Monthly deduction charges (36) (27) (53) (48) (12) (10) (23) (13) Other redemptions (68) (146) (97) (83) (29) (16) (117) (75) ---------------- --------------- --------------- ------------------- Increase (decrease) in net assets from policy transactions 111 231 140 330 19 109 108 313 ---------------- --------------- --------------- ------------------- Net increase (decrease) in net assets (17) 201 (172) 100 (17) 75 38 351 NET ASSETS: Beginning of period 581 380 968 868 228 153 537 186 ---------------- --------------- --------------- ------------------- End of period $ 564 $ 581 $ 796 $ 968 $ 211 $ 228 $ 575 $ 537 ================ =============== =============== =================== UNITS ISSUED AND REDEEMED Beginning balance 26 16 56 38 13 7 24 9 Units issued 13 19 27 29 5 8 13 19 Units redeemed (7) (9) (16) (11) (3) (2) (8) (4) ---------------- --------------- --------------- ------------------- Ending balance 32 26 67 56 15 13 29 24 ================ =============== =============== =================== USAA LIFE VVIF DIVERSIFIED **VVIF EQUITY- *VVIF MID-CAP INCOME FUND VALUE PORTFOLIO INDEX PORTFOLIO INDEX PORTFOLIO ------------------- ----------------- -------------------- ------------------ 2002 2001 2002 2001 2002 2001 2002 2001 ------------------- ----------------- -------------------- ------------------ FROM OPERATIONS: Net investment income (loss) $ 11 $ 8 $ 1 $ - $ 10 $ (9) $ - $ - Net realized gain (loss) (2) (10) (2) - 33 (158) (2) (6) Change in net unrealized appreciation/depreciation 9 16 (16) - (338) 3 (32) 1 ----------------- --------------- ----------------- ----------------- Increase (decrease) in net assets resulting from operations 18 14 (17) - (295) (164) (34) (5) ----------------- --------------- ----------------- ----------------- FROM POLICY TRANSACTIONS: Purchases and transfers in 224 161 109 60 337 638 257 123 Monthly deduction charges (17) (10) (4) - (56) (45) (11) (2) Other redemptions (200) (111) (15) - (115) (285) (29) (25) ----------------- --------------- ----------------- ----------------- Increase (decrease) in net assets from policy transactions 7 40 90 60 166 308 217 96 ----------------- --------------- ----------------- ----------------- Net increase (decrease) in net assets 25 54 73 60 (129) 144 183 91 NET ASSETS: Beginning of period 277 223 60 - 1,291 1,147 91 - ----------------- --------------- ----------------- ----------------- End of period $ 302 $ 277 $ 133 $ 60 $1,162 $ 1,291 $ 274 $ 91 ================= =============== ================= ================= UNITS ISSUED AND REDEEMED Beginning balance 17 15 6 - 125 97 9 - Units issued 15 10 13 6 46 67 30 13 Units redeemed (14) (8) (2) - (26) (39) (6) (4) ----------------- --------------- ----------------- ----------------- Ending balance 18 17 17 6 145 125 33 9 ================= =============== ================= ================= **VVIF SMALL **VVIF ***USAA LIFE COMPANY GROWTH INTERNATIONAL INTERNATIONAL *VVIF REIT INDEX PORTFOLIO PORTFOLIO FUND PORTFOLIO ------------------ ------------------- ----------------- ---------------- 2002 2001 2002 2001 2002 2001 2002 2001 ------------------ ------------------- ----------------- ---------------- FROM OPERATIONS: Net investment income (loss) $ - $ (2) $ 3 $ (1) $ - $ - $ 4 $ - Net realized gain (loss) 10 (5) 2 (24) - (5) (1) - Change in net unrealized appreciation/depreciation (111) 36 (44) (2) - 2 (8) 4 ----------------- ----------------- ---------------- --------------- Increase (decrease) in net assets resulting from operations (101) 29 (39) (27) - (3) (5) 4 ----------------- ----------------- ---------------- --------------- FROM POLICY TRANSACTIONS: Purchases and transfers in 189 179 85 150 - 10 370 107 Monthly deduction charges (18) (11) (12) (9) - (1) (16) (2) Other redemptions (73) 4 (3) (19) - (53) (218) - ----------------- ----------------- ---------------- --------------- Increase (decrease) in net assets from policy transactions 98 172 70 122 - (44) 136 105 ----------------- ----------------- ---------------- --------------- Net increase (decrease) in net assets (3) 201 31 95 - (47) 131 109 NET ASSETS: Beginning of period 379 178 193 98 - 47 109 - ----------------- ----------------- ---------------- --------------- End of period $ 376 $ 379 $ 224 $ 193 $ - $ - $ 240 $ 109 ================= ================= ================ =============== UNITS ISSUED AND REDEEMED Beginning balance 35 18 22 9 - 4 10 - Units issued 23 19 13 17 - 1 33 10 Units redeemed (11) (2) (4) (4) - (5) (22) - ----------------- ----------------- ---------------- --------------- Ending balance 47 35 31 22 - - 21 10 ================= ================= ================ =============== *FVIP CONTRAFUND *FVIP EQUITY- *VVIF HIGH YIELD **VVIF MONEY (R) PORTFOLIO, INCOME PORTFOLIO, BOND PORTFOLIO MARKET PORTFOLIO INITIAL CLASS INITIAL CLASS ----------------- -------------------- ------------------ ------------------ 2002 2001 2002 2001 2002 2001 2002 2001 ----------------- -------------------- ------------------ ------------------ FROM OPERATIONS: Net investment income (loss) $ 6 $ - $ 16 $ 44 $ - $ - $ 1 $ - Net realized gain (loss) (1) (1) - - 1 - (4) - Change in net unrealized appreciation/depreciation (1) 2 - - (9) 1 (24) 2 --------------- ------------------- ----------------- --------------- Increase (decrease) in net assets resulting from operations 4 1 16 44 (8) 1 (27) 2 --------------- ------------------- ----------------- --------------- FROM POLICY TRANSACTIONS: Purchases and transfers in 130 115 1,376 1,983 94 54 130 95 Monthly deduction charges (6) (1) (56) (30) (9) (1) (7) (1) Other redemptions (1) (12) (1,506) (1,650) (5) (12) (17) - --------------- ------------------- ----------------- --------------- Increase (decrease) in net assets from policy transactions 123 102 (186) 303 80 41 106 94 --------------- ------------------- ----------------- --------------- Net increase (decrease) in net assets 127 103 (170) 347 72 42 79 96 NET ASSETS: Beginning of period 103 - 1,360 1,013 42 - 96 - --------------- ------------------- ----------------- --------------- End of period $ 230 $ 103 $ 1,190 $ 1,360 $ 114 $ 42 $ 175 $ 96 =============== =================== ================= =============== UNITS ISSUED AND REDEEMED Beginning balance 10 - 1,016 782 4 - 10 - Units issued 14 12 1,122 1,735 11 6 16 10 Units redeemed (1) (2) (1,257) (1,501) (2) (2) (3) - --------------- ------------------- ----------------- --------------- Ending balance 23 10 881 1,016 13 4 23 10 =============== =================== ================= =============== FVIP DYNAMIC CAP. APPRECIATION SVS I CAPITAL PORTFOLIO, INITIAL GROWTH PORTFOLIO, ALGER AMERICAN CLASS CLASS A SHARES GROWTH PORTFOLIO ------------------ ------------------ ------------------- 2002 2001 2002 2001 2002 2001 ------------------ ------------------ ------------------- FROM OPERATIONS: Net investment income (loss) $ - $ - $ (2) $ (3) $ (7) $ (6) Net realized gain (loss) - - (179) (30) (233) 54 Change in net unrealized appreciation/depreciation (2) - 25 (128) (149) (206) ----------------- ----------------- ---------------- Increase (decrease) in net assets resulting from operations (2) - (156) (161) (389) (158) ----------------- ----------------- ---------------- FROM POLICY TRANSACTIONS: Purchases and transfers in 35 7 106 313 230 480 Monthly deduction charges (2) - (32) (31) (57) (55) Other redemptions (1) - (184) (134) (161) (81) ----------------- ----------------- ---------------- Increase (decrease) in net assets from policy transactions 32 7 (110) 148 12 344 ----------------- ----------------- ---------------- Net increase (decrease) in net assets 30 7 (266) (13) (377) 186 NET ASSETS: Beginning of period 7 - 636 649 1,193 1,007 ----------------- ----------------- ---------------- End of period $ 37 $ 7 $ 370 $ 636 $ 816 $1,193 ================= ================= ================ UNITS ISSUED AND REDEEMED Beginning balance 1 - 27 22 45 33 Units issued 4 1 7 13 14 19 Units redeemed - - (12) (8) (12) (7) ----------------- ----------------- ---------------- Ending balance 5 1 22 27 47 45 ================= ================= ================
See accompanying Notes to Financial Statements. * Variable fund accounts commenced operations May 1, 2001. ** See accompanying Notes to Financial Statements for information on May 1, 2001 fund substitution. *** USAA Life International Fund reflects operations from 01/01/01 to 04/30/01. LIFE INSURANCE SEPARATE ACCOUNT OF USAA LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2002 1) ORGANIZATION The Life Insurance Separate Account of USAA Life Insurance Company (Life Insurance Separate Account) is registered under the Investment Company Act of 1940, as amended, as a segregated unit investment account of USAA Life Insurance Company (USAA Life), a wholly owned subsidiary of the United Services Automobile Association (USAA). Units of the Life Insurance Separate Account are sold only in connection with the Variable Universal Life Policy. Under applicable insurance law, the assets and liabilities of the Life Insurance Separate Account are clearly identified and distinguished from USAA Life. The Life Insurance Separate Account cannot be charged with liabilities arising out of any other business of USAA Life. The Life Insurance Separate Account is divided into 18 variable fund accounts which are invested in shares of a designated portfolio of the USAA Life Investment Trust, Vanguard(R) Variable Insurance Fund (VVIF), Fidelity(R) Variable Insurance Products (FVIP), Scudder Variable Series I (SVS I), or the Alger American Fund as follows:
Fund Account Mutual Fund Investment -------------------------------------------------------------------------------------------------------------- USAA Life Growth and Income USAA Life Growth and Income Fund USAA Life Aggressive Growth USAA Life Aggressive Growth Fund USAA Life World Growth USAA Life World Growth Fund USAA Life Diversified Assets USAA Life Diversified Assets Fund USAA Life Income USAA Life Income Fund Vanguard Diversified Value Portfolio VVIF Diversified Value Portfolio Vanguard Equity Index Portfolio VVIF Equity Index Portfolio Vanguard Mid-Cap Index Portfolio VVIF Mid-Cap Index Portfolio Vanguard Small Company Growth Portfolio VVIF Small Company Growth Portfolio Vanguard International Portfolio VVIF International Portfolio Vanguard REIT Index Portfolio VVIF REIT Index Portfolio Vanguard High Yield Bond Portfolio VVIF High Yield Bond Portfolio Vanguard Money Market Portfolio VVIF Money Market Portfolio Fidelity VIP Contrafund(R) Portfolio FVIP Contrafund(R) Portfolio, Initial Class Fidelity VIP Equity-Income Portfolio FVIP Equity-Income Portfolio, Initial Class Fidelity VIP Dynamic Cap Appreciation Portfolio FVIP Dynamic Cap Appreciation Portfolio, Initial Class Scudder Capital Growth Portfolio SVS I Capital Growth Portfolio, Class A shares Alger American Growth Portfolio Alger American Growth Portfolio
On May 1, 2001, USAA Life substituted shares of the VVIF Equity Index Portfolio for shares of the Deutsche VIT Equity 500 Index Fund, shares of the VVIF Small Company Growth Portfolio for shares of the Deutsche VIT Small Cap Index Fund, shares of the VVIF International Portfolio for shares of the Deutsche VIT EAFE(R) Equity Index Fund and the USAA Life International Fund, and shares of the VVIF Money Market Fund Portfolio for shares of the USAA Life Money Market Fund. The operations of the predecessor funds prior to May 1, 2001 are included in the accompanying financial statements. Each fund substitution was a non-taxable event for policyholders and did not affect total assets. The policyholders' accumulated value did not change as a result of the substitution. For the Vanguard International Portfolio fund account, which replaced two fund accounts, the accumulation unit value (AUV) of the Deutsche EAFE(R) Equity Index fund account was used as the starting AUV. The AUVs remained the same immediately before and after the substitution for the other fund substitutions. 2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES SECURITY VALUATION Investments in mutual fund securities are carried in the Statements of Assets and Liabilities at net asset value as reported by the fund. Gains or losses on securities transactions are determined on the basis of the first-in first-out (FIFO) cost method. Security transactions are recorded on the trade date. Dividend income, if any, is recorded on ex-dividend date. DISTRIBUTIONS The net investment income (loss) and realized capital gains of the Life Insurance Separate Account are not distributed, but instead are retained and reinvested for the benefit of unit owners. FEDERAL INCOME TAX Operations of the Life Insurance Separate Account are included in the federal income tax return of USAA Life, which is taxed as a "Life Insurance Company" under the Internal Revenue Code. Under current federal income tax law, no income taxes are payable with respect to operation of the Life Insurance Separate Account. USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that may affect the reported amounts in the financial statements. 3) RELATED PARTY TRANSACTIONS During the year ended December 31, 2002, advisory and administrative fees of approximately $722,000 were paid or payable to USAA Investment Management Company (USAA IMCO) by the funds of the USAA Life Investment Trust (the Trust). USAA IMCO is indirectly wholly owned by USAA. The Funds' advisory fees are computed at an annualized rate of .50% of the monthly average net assets of the USAA Life Aggressive Growth Fund, .35% of the monthly average net assets of the USAA Life World Growth Fund, and .20% of the monthly average net assets for each of the other Funds of the Trust for each calendar month. Prior to November 1, 2002, the advisory fee for the USAA Life World Growth Fund was .20% of the Fund's monthly average net assets. The funds are an investment option for both the Variable Universal Life Policy and the Flexible Premium Deferred Combination Fixed and Variable Annuity Contract. Administrative fees are based on USAA IMCO's estimated time incurred to provide such services. 4) EXPENSES A mortality and expense risk charge is deducted by USAA Life from the Life Insurance Separate Account on a daily basis which is equal, on an annual basis, to 0.75% of the daily net assets of each variable fund account. The mortality risk assumed is that insureds may live for a shorter period of time than estimated. Thus, a greater amount of death benefits than expected will be payable. The expense risk assumed by USAA Life is that the costs of administering the policies and the Life Insurance Separate Account may exceed the amount recovered from the policy maintenance and administration expense charges. The mortality and expense risk charge is guaranteed by USAA Life and cannot be increased. The following expenses are charged to reimburse USAA Life for the expenses it incurs in the establishment and maintenance of the Policies and each variable fund account. On the policy's effective date, and each monthly anniversary thereafter, certain monthly charges will be deducted by USAA Life through a redemption of units from the cash value of the policy. The monthly deduction will include cost of insurance charges, which includes charges for any optional insurance benefits provided by rider, an administrative charge of $10 during the first twelve policy months, and a recurring maintenance charge of $5. Total charges deducted during the current year were approximately $430,000. A transfer charge of $25 will be deducted for each value transfer between Variable Fund Accounts in excess of six per Policy Year. For each partial surrender of cash value, a charge equal to the lesser of $25 or 2% of the amount withdrawn will be deducted. This charge is also referred to as an "administrative processing fee." For full surrenders, the amount of the surrender charge will equal a percentage of the Annual Target Premium Payment specified in the policy. The number of years the policy has been in force at the time of surrender determines the applicable percentage. A 3% premium charge is deducted from the policyholder's premium to compensate USAA Life for sales charges and taxes. The charge will be deducted from the policyholder's premium payments until the policyholder's gross amount of premium payments received exceeds the sum of the policyholder's Annual Target Premium payments payable over 10 years. LIFE INSURANCE SEPARATE ACCOUNT OF USAA LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 5) INVESTMENTS The following table shows the number of shares owned, aggregate cost and net asset value per share of each fund at December 31, 2002:
NUMBER OF AGGREGATE NET ASSET SHARES COST VALUE PER (000) (000) SHARE ------------- ------------- ------------- USAA Life Growth and Income Fund 44 $ 733 $ 12.88 USAA Life Aggressive Growth Fund 73 1,308 10.96 USAA Life World Growth Fund 23 275 9.19 USAA Life Diversified Assets Fund 54 651 10.63 USAA Life Income Fund 28 261 10.78 Vanguard Diversified Value Portfolio 15 148 8.98 Vanguard Equity Index Portfolio 54 1,568 21.68 Vanguard Mid-Cap Index Portfolio 26 305 10.60 Vanguard Small Company Growth Portfolio 31 457 11.99 Vanguard International Portfolio 23 283 9.67 Vanguard REIT Index Portfolio 19 243 12.84 Vanguard High Yield Bond 28 230 8.21 Vanguard Money Market Portfolio 1,190 1,190 1.00 Fidelity VIP Contrafund Portfolio 6 121 18.10 Fidelity VIP Equity-Income Portfolio 10 197 18.16 Fidelity VIP Dynamic Capital App. Portfolio 6 39 5.66 Scudder VLIF Capital Growth Portfolio-Class A Shares 32 579 11.55 Alger American Growth Portfolio 33 1,439 24.63
LIFE INSURANCE SEPARATE ACCOUNT OF USAA LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 6) FINANCIAL HIGHLIGHTS A summary of unit values and units outstanding for variable annuity contracts and the expense ratios, excluding expenses of the underlying funds, for each period is as follows:
USAA LIFE GROWTH AND INCOME FUND ACCOUNT ---------------------------------------------------------------------------- Year Ended December 31, 2002 2001 2000 1999 1998(a) ------------ ------------ ------------ ------------ ------------ At end of period: Accumulation units (000) 32 26 16 12 1 Accumulation unit value $ 17.449936 $ 22.397368 $ 23.978970 $ 23.296591 $ 20.468785 Net assets (000) $ 564 $ 581 $ 380 $ 276 $ 3 Ratio of expenses to average net assets(d) 0.75% 0.75% 0.75% 0.75% 0.75%(e) Total return(g) -22.47% -6.96% 2.32% 12.52% NA
USAA LIFE AGGRESSIVE GROWTH FUND ACCOUNT ---------------------------------------------------------------------------- Year Ended December 31, 2002 2001 2000 1999 1998(a) ------------ ------------ ------------ ------------ ----------- At end of period: Accumulation units (000) 67 56 38 17 - Accumulation unit value $ 11.836938 $ 17.214778 $ 22.654870 $ 26.991318 $ 13.993064 Net assets (000) $ 796 $ 968 $ 868 $ 455 $ - Ratio of expenses to average net assets(d) 0.75% 0.75% 0.75% 0.75% 0.75%(e) Total return(g) -31.50% -24.22% -16.30% 91.33% NA
USAA LIFE WORLD GROWTH FUND ACCOUNT ---------------------------------------------------------------------------- Year Ended December 31, 2002 2001 2000 1999 1998(a) ------------ ------------ ------------ ------------ ----------- At end of period: Accumulation units (000) 15 13 7 2 - Accumulation unit value $ 14.273481 $ 16.988356 $ 20.654406 $ 23.209674 $ 17.860722 Net assets (000) $ 211 $ 228 $ 153 $ 51 $ - Ratio of expenses to average net assets(d) 0.75% 0.75% 0.75% 0.75% 0.75%(e) Total return(g) -16.44% -18.11% -11.48% 28.46% NA
USAA LIFE DIVERSIFIED ASSETS FUND ACCOUNT ---------------------------------------------------------------------------- Year Ended December 31, 2002 2001 2000 1999 1998(a) ----------- ----------- ----------- ----------- ----------- At end of period: Accumulation units (000) 29 24 9 7 2 Accumulation unit value $ 19.611603 $ 22.295041 $ 19.815589 $ 19.192009 $ 17.974654 Net assets (000) $ 575 $ 537 $ 186 $ 142 $ 38 Ratio of expenses to average net assets(d) 0.75% 0.75% 0.75% 0.75% 0.75%(e) Total return(g) -12.42% 12.08% 2.55% 5.41% NA
USAA LIFE INCOME FUND ACCOUNT ------------------------------------------------------------------- Year Ended December 31, 2002 2001 2000 1999 1998(a) ------------ ------------ ------------ ------------ ----------- At end of period: Accumulation units (000) 18 17 15 9 - Accumulation unit value $ 17.110216 $ 15.969161 $ 15.007467 $ 13.262741 $ 14.089499 Net assets (000) $ 302 $ 277 $ 223 $ 119 $ - Ratio of expenses to average net assets(d) 0.75% 0.75% 0.75% 0.75% 0.75%(e) Total return(g) 6.64% 5.92% 12.24% -7.29% NA
VANGUARD DIVERSIFIED VALUE PORTFOLIO FUND ACCOUNT ------------------------------------------------------------------- Year Ended December 31, 2002 2001(b) ------------ ----------- At end of period: Accumulation units (000) 17 6 Accumulation unit value $ 7.947514 $ 9.336800 Net assets (000) $ 133 $ 60 Ratio of expenses to average net assets(d) 0.75% 0.75%(e) Total return(g) -15.42% -6.98%(f)
VANGUARD EQUITY INDEX PORTFOLIO FUND ACCOUNT ---------------------------------------------------------------------------- Year Ended December 31, 2002 2001(c) 2000 1999 1998(a) ----------- ----------- ----------- ----------- ----------- At end of period: Accumulation units (000) 145 125 97 54 1 Accumulation unit value $ 7.995176 $ 10.341906 $ 11.844646 $ 13.147788 $ 11.003536 Net assets (000) $ 1,162 $ 1,291 $ 1,147 $ 715 $ 3 Ratio of expenses to average net assets(d) 0.75% 0.75% 0.75% 0.75% 0.75%(e) Total return(g) -23.11% -13.05% -10.40% 18.20% NA
VANGUARD MID-CAP INDEX PORTFOLIO FUND ACCOUNT ------------------------------------------------------------------- Year Ended December 31, 2002 2001(b) ------------ ----------- At end of period: 33 9 Accumulation units (000) $ 8.397224 $ 9.912441 Accumulation unit value $ 274 $ 91 Net assets (000) Ratio of expenses to average net assets(d) 0.75% 0.75%(e) Total return(g) -15.79% -1.25%(f)
VANGUARD SMALL COMPANY GROWTH PORTFOLIO FUND ACCOUNT ------------------------------------------------------------------- Year Ended December 31, 2002 2001(c) 2000 1999 1998(a) ----------- ------------ ------------ ------------ ------------ At end of period: 47 35 18 7 - Accumulation units (000) $ 8.065415 $ 10.696387 $ 10.043462 $ 10.526480 $ 8.825971 Accumulation unit value $ 376 $ 379 $ 178 $ 78 $ - Net assets (000) Ratio of expenses to average net assets(d) 0.75% 0.75% 0.75% 0.75% 0.75%(e) Total return(g) -24.93% 6.11% -5.09% 17.88% NA
VANGUARD INTERNATIONAL PORTFOLIO FUND ACCOUNT ---------------------------------------------------------------------------- Year Ended December 31, 2002 2001(c) 2000 1999 1998(a) ----------- ----------- ----------- ----------- ----------- At end of period: Accumulation units (000) 31 22 9 1 1 Accumulation unit value $ 7.120925 $ 8.670638 $ 10.881890 $ 13.154856 $ 10.386978 Net assets (000) $ 224 $ 193 $ 98 $ 12 $ 2 Ratio of expenses to average net assets(d) 0.75% 0.75% 0.75% 0.75% 0.75%(e) Total return(g) -18.40% -20.73% -17.77% 25.12% NA
VANGUARD REIT INDEX PORTFOLIO FUND ACCOUNT ------------------------------------------------------------------- Year Ended December 31, 2002 2001(b) ------------ ------------- At end of period: Accumulation units (000) 21 10 Accumulation unit value $ 11.252063 $ 10.950003 Net assets (000) $ 240 $ 109 Ratio of expenses to average net assets(d) 0.75% 0.75%(e) Total return(g) 2.27% 9.13%(f)
VANGUARD HIGH YIELD BOND PORTFOLIO FUND ACCOUNT ------------------------------------------------------------------- Year Ended December 31, 2002 2001(b) ------------ ------------- At end of period: Accumulation units (000) 23 10 Accumulation unit value $ 9.946870 $ 9.869512 Net assets (000) $ 230 $ 103 Ratio of expenses to average net assets(d) 0.75% 0.75%(e) Total return(g) 0.22% -1.67%(f)
VANGUARD MONEY MARKET PORTFOLIO FUND ACCOUNT ---------------------------------------------------------------------------------- Year Ended December 31, 2002 2001(c) 2000 1999 1998(a) ------------ ------------ ------------ ----------- ------------ At end of period: Accumulation units (000) 881 1,016 782 276 1 Accumulation unit value $ 1.350997 $ 1.338044 $ 1.293846 $ 1.227534 $ 1.178565 Net assets (000) $ 1,190 $ 1,360 $ 1,013 $ 339 $ 1 Ratio of expenses to average net assets(d) 0.75% 0.75% 0.75% 0.75% 0.75%(e) Total return(g) 0.47% 2.94% 4.61% 2.65% NA
FIDELITY CONTRAFUND(R) PORTFOLIO FUND ACCOUNT ---------------------------------------------------------------------------------- Year Ended December 31, 2002 2001 (b) ------------ ------------ At end of period: Accumulation units (000) 13 4 Accumulation unit value $ 8.561012 $ 9.515065 Net assets (000) $ 114 $ 42 Ratio of expenses to average net assets(d) 0.75% 0.75%(e) Total return(g) -10.57% -5.21%(f)
FIDELITY EQUITY-INCOME PORTFOLIO FUND ACCOUNT ---------------------------------------------------------------------------------- Year Ended December 31, 2002 2001(b) ------------ ------------ At end of period: Accumulation units (000) 23 10 Accumulation unit value $ 7.771493 $ 9.427762 Net assets (000) $ 175 $ 96 Ratio of expenses to average net assets(d) 0.75% 0.75%(e) Total return(g) -18.10% -6.09%(f)
FIDELITY DYNAMIC CAP APPRECIATION PORTFOLIO ---------------------------------------------------------------------------------- Year Ended December 31, 2002 2001(b) ------------ ------------ At end of period: Accumulation units (000) 5 1 Accumulation unit value $ 7.809482 $ 8.464990 Net assets (000) $ 37 $ 7 Ratio of expenses to average net assets(d) 0.75% 0.75%(e) Total return(g) -8.37% -15.71%(f)
SCUDDER CAPITAL GROWTH PORTFOLIO FUND ACCOUNT ------------------------------------------------------------------------------------ Year Ended December 31, 2002 2001 2000 1999 1998(a) ------------ ------------ ------------ ------------ --------------- At end of period: Accumulation units (000) 22 27 22 12 1 Accumulation unit value $ 16.508497 $ 23.487941 $ 29.346175 $ 32.816021 $ 24.448446 Net assets (000) $ 370 $ 636 $ 649 $ 384 $ 3 Ratio of expenses to average net assets(d) 0.75% 0.75% 0.75% 0.75% 0.75%(e) Total return(g) -30.10% -20.28% -10.99% 32.82% NA
ALGER AMERICAN GROWTH PORTFOLIO FUND ACCOUNT ------------------------------------------------------------------------------------ Year Ended December 31, 2002 2001 2000 1999 1998(a) ------------ ------------ ------------ ------------ --------------- At end of period: Accumulation units (000) 47 45 33 15 - Accumulation unit value $ 17.520609 $ 26.344044 $ 30.100055 $ 35.583778 $ 26.806157 Net assets (000) $ 816 $ 1,193 $ 1,007 $ 546 $ - Ratio of expenses to average net assets(d) 0.75% 0.75% 0.75% 0.75% 0.75%(e) Total return(g) -33.85% -12.81% -15.78% 31.46% NA
(a) Variable fund accounts commenced operations August 31, 1998 with the following initial unit values per unit: USAA Life Growth and Income $ 16.937712 USAA Life Aggressive Growth 9.446371 USAA Life World Growth 14.981795 USAA Life Diversified Assets 16.007256 USAA Life Income 13.766435 Vanguard Equity Index Portfolio 8.561922 Vanguard Small Company Growth Portfolio 7.048653 Vanguard International Portfolio 8.920584 Vanguard Money Market Fund Portfolio 1.162018 Scudder Capital Growth Portfolio 18.614844 Alger American Growth Portfolio 19.521151
(b) Variable fund accounts commenced operations May 1, 2001 with an initial accumulation unit value of $10.00 per unit. (c) See accompanying Notes to Financial Statements for information on May 1, 2001 fund substitution. (d) The information for 2002 is based on actual expenses to the policyowner for the period, excluding the expenses of the underlying fund, and charges made directly to policyowner accounts through the redemption of units. Prior years have been restated to exclude the expenses of the underlying fund, and charges made directly to the policyowner accounts through the redemption of units. (e) Annualized. The ratio is not necessarily indicative of 12 months of operations. (f) Not annualized for periods less than one year. (g) The AUV total return figures are computed in accordance with a formula prescribed by the Securities and Exchange Commission, which includes deduction of policy charges. INDEPENDENT AUDITORS' REPORT ---------------------------- The Board of Directors USAA LIFE INSURANCE COMPANY: We have audited the accompanying consolidated balance sheets of USAA LIFE INSURANCE COMPANY and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2002. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of USAA LIFE INSURANCE COMPANY and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. KPMG LLP San Antonio, Texas March 14, 2003 USAA LIFE INSURANCE COMPANY Consolidated Balance Sheets December 31, 2002 and 2001 (Dollars in Thousands, Except Share Data) ASSETS 2002 2001 ------ ---- ---- Investments: Debt securities, at fair value $ 6,772,929 6,091,920 Loaned debt securities, at fair value 819,049 495,375 Equity securities, at fair value 251,064 226,797 Loaned equity securities, at fair value 4,364 - Mortgage loans 2,061 2,379 Policy loans 138,209 139,997 -------- -------- Total investments 7,987,676 6,956,468 Cash and cash equivalents 79,041 116,927 Premium balances receivable 4,890 4,903 Accounts receivable - affiliates 204 37 Furniture and equipment 1,081 2,840 Collateral for securities loaned at fair value 831,657 506,409 Accrued investment income 106,689 114,890 Deferred policy acquisition costs 332,620 313,537 Deferred tax 47,988 61,023 Reinsurance recoverable 677,533 584,691 Other assets 20,894 41,718 Separate account assets 286,300 378,098 ---------- --------- Total assets $ 10,376,573 9,081,541 ========== ========= LIABILITIES Insurance reserves $ 1,866,596 1,480,882 Funds on deposit 6,335,844 5,779,484 Accounts payable and accrued expenses 51,486 86,151 Accounts payable - affiliates 21,100 19,815 Payable upon return of securities loaned 831,657 506,409 Other liabilities 99,053 57,007 Separate account liabilities 286,300 378,098 ---------- ---------- Total liabilities 9,492,036 8,307,846 ---------- ---------- STOCKHOLDERS' EQUITY -------------------- Preferred capital stock, $100 par value; 1,200,000 shares authorized; 800,000 shares and 700,000 shares issued and outstanding at December 31, 2002 and 2001, respectively 80,000 70,000 Common capital stock, $100 par value; 30,000 shares authorized; 25,000 shares issued and outstanding 2,500 2,500 Additional paid-in capital 51,408 61,408 Accumulated other changes in equity from nonowner sources 48,474 13,169 Retained earnings 702,155 626,618 --------- --------- Total stockholders' equity 884,537 773,695 --------- --------- Total liabilities and stockholders' equity $ 10,376,573 9,081,541 =========== ========== See accompanying notes to consolidated financial statements. 1 USAA LIFE INSURANCE COMPANY Consolidated Statements of Income Years ended December 31, 2002, 2001, and 2000 (Dollars in Thousands) 2002 2001 2000 ---- ---- ---- REVENUES Premiums $ 485,248 478,265 428,191 Investment income, net 473,675 487,715 484,984 Fees, sales, and loan income 19,465 17,648 16,324 Net realized investment (losses) (21,144) (34,299) (65,989) Other revenues 81,980 68,252 66,682 ---------- ---------- --------- Total revenues 1,039,224 1,017,581 930,192 ---------- ---------- --------- BENEFITS AND EXPENSES Losses, benefits, and settlement expenses 653,743 655,869 582,999 Deferred policy acquisition costs 28,331 22,857 24,508 Dividends to policyholders 52,206 56,081 55,012 Other operating expenses 175,367 180,914 179,434 ---------- ---------- --------- Total benefits and expenses 909,647 915,721 841,953 ---------- ---------- --------- Income before income taxes 129,577 101,860 88,239 ---------- ---------- --------- Federal income tax expense (benefit): Current 52,088 32,355 35,156 Deferred (6,039) 2,863 (3,165) ---------- ---------- --------- Total Federal income tax expense 46,049 35,218 31,991 ---------- ---------- --------- Net income $ 83,528 66,642 56,248 ========== ========== ========= See accompanying notes to consolidated financial statements. 2 USAA LIFE INSURANCE COMPANY Consolidated Statements of Stockholders' Equity Years Ended December 31, 2002, 2001, and 2000 (Dollars in Thousands) 2002 2001 2000 ---- ---- ---- Capital Preferred capital stock $ 80,000 70,000 60,000 Common capital stock 2,500 2,500 2,500 Additional paid-in capital 51,408 61,408 51,408 ------- ------- ------- End of year 133,908 133,908 113,908 ------- ------- ------- ACCUMULATED OTHER CHANGES IN EQUITY FROM NONOWNER SOURCES, NET OF TAX Beginning of year 13,169 (15,618) (77,137) Unrealized gains on securities during year, net of income taxes and reclassification adjustments 35,305 28,787 61,519 ------- ------- -------- End of year 48,474 13,169 (15,618) ------- ------- -------- RETAINED EARNINGS Beginning of year 626,618 601,979 563,260 Net income 83,528 66,642 56,248 Dividends to stockholders (7,991) (42,003) (17,529) ------- -------- -------- End of year 702,155 626,618 601,979 ------- -------- -------- Total stockholders' equity $884,537 773,695 700,269 ======= ======== ======== SUMMARY OF CHANGES IN EQUITY FROM NONOWNER SOURCES Net income $ 83,528 66,642 56,248 Other changes in equity from nonowner sources, net of tax 35,305 28,787 61,519 ------- ------- ------- Total changes in equity from nonowner sources $118,832 95,429 117,767 ======= ======= ======= See accompanying notes to consolidated financial statements. 3 USAA LIFE INSURANCE COMPANY Consolidated Statements of Cash Flows Years ended December 31, 2002, 2001, and 2000 (Dollars in Thousands)
2002 2001 2000 ---- ---- ---- Cash flows from operating activities: Net income $ 83,528 66,642 56,248 Adjustments to reconcile net income to net cash provided by operating activities: Net realized investment losses 21,144 34,299 65,989 Interest credited on policyholder deposits 300,973 300,416 292,963 Increase in deferred policy acquisition costs (18,318) (31,196) (23,459) Depreciation and amortization (120) (4,558) (8,473) Deferred income tax expense (benefit) (6,039) 2,863 (3,165) (Increase) decrease in premium balances receivable 13 283 (2,326) (Increase) decrease in accounts receivable- affiliate (167) 62 (22) Increase in accrued investment income 8,201 (9,484) (8,976) Increase in reinsurance recoverable and other assets (61,393) (120,024) (87,034) Increase in insurance reserves 187,211 174,936 147,534 Increase (decrease) in accounts payable and accrued expense (34,665) 2,932 24,493 Increase (decrease) in accounts payable- affiliates 1,285 11,842 (6,253) Increase in other liabilities 31,421 3,651 616 Other (9,659) (3,596) (2,223) ----------- ----------- ----------- Net cash provided by operating activities 503,415 429,068 445,912 ----------- ----------- ----------- Cash flows from investing activities: Proceeds from sales and maturities of available-for-sale securities 2,036,825 1,594,188 1,137,153 Proceeds from maturities of held-to-maturity securities - - 46,039 Proceeds from principal collections on investments 340,507 397,397 95,891 Other investments sold 913 1,213 1,186 Securities purchased - available-for-sale (3,126,174) (2,353,779) (1,218,635) Other investments purchased (586) (730) (5,774) ----------- ----------- ----------- Net cash provided by (used in) investing activities (748,515) (361,711) 55,860 ----------- ----------- ----------- Cash flows from financing activities: Deposits to funds on deposit 524,539 394,599 270,294 Proceeds from short-term borrowings (2,600) 2,600 - Issuance of preferred stock - 20,000 - Withdrawals from funds on deposit (306,734) (421,240) (714,873) Dividends to stockholders (7,991) (41,977) (17,529) ----------- ----------- ----------- Net cash provided by (used in) financing activities 207,214 (46,018) (462,108) ----------- ----------- ----------- Net increase (decrease) in cash and cash equivalents (37,886) 21,339 39,664 Cash and cash equivalents at beginning of year 116,927 95,588 55,924 ----------- ----------- ----------- Cash and cash equivalents at end of year $ 79,041 116,927 95,588 =========== =========== ===========
See accompanying notes to consolidated financial statements. 4 USAA LIFE INSURANCE COMPANY (CONSOLIDATED BREAKOUT OF OTHER CASH FLOWS DECEMBER 31, 2002
ACCOUNT BALANCES 2000 2001 2002 02/01 ---------------- Insurance Reservces Per B/S (after FAS 113) 1,239,461,925 1,480,882,463 1,866,595,694 385,713,231 FAS 115 PH Reserve #301115 18,569,565 140,766,308 404,310,492 263,544,184 C/S U/R Gain Liab. PH reserve #301116 10,867,410 (30,148,625) (54,334,707) (24,186,082) PHIR (CMR) 25,891,172 27,101,628 475,694 (26,625,934) Current PHIR Inv. Income (CMR) 23,057,803 87,511,741 91,419,217 3,907,476 Reinsurance ceded reserve 475,997,363 559,337,288 658,736,533 99,399,245 Reinsurance Recoverable reserve 136,889,694 202,650,323 283,912,018 81,261,695 Change Insurance Reservces Per B/S (after FAS 113) 385,713,231 X Change FAS 115 PH Reserve #301115 239,358,102 Change PHIR (CMR) (26,625,934) Change Current PHIR Inv. Income (CMR) 3,907,476 ----------- 216,639,644 Y Change Reinsurance ceded reserve 99,399,245 Change Reinsurance Recoverable reserve 81,261,695 ----------- 18,137,550 Z 187,211,137 (10) X-Y+Z
USAA LIFE INSURANCE COMPANY December 31, 2002 and 2001 Notes to Consolidated Financial Statements (Dollars in Thousands) (1) Summary of significant accounting policies ------------------------------------------ (a) Organization ------------ USAA LIFE INSURANCE COMPANY (Life Company) is a wholly owned subsidiary of UNITED SERVICES AUTOMOBILE ASSOCIATION (USAA). Life Company markets individual life insurance policies, annuity contracts, group credit life and accident and health policies, and individual and group accident and health policies primarily to individuals eligible for membership in USAA. Life Company is licensed to do business in all states including the District of Columbia but excluding New York. Life Company has a subsidiary company, USAA Life Insurance Company of New York (Life of New York), licensed to sell life and annuity contracts in that state. Life Company's other subsidiary business, USAA Life General Agency (LGA), offers additional products of other insurance companies requested by USAA membership, which are not sold by Life Company. The consolidated financial statements include the accounts of Life Company and its subsidiaries, (collectively, the Company). All significant intercompany balances and transactions have been eliminated in consolidation. (b) Accounting Standards Issued --------------------------- Effective January 1, 2001, the Company adopted the provisions of Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended by SFAS Nos. 137 and 138. The standard requires companies to record derivatives on their balance sheet at fair value. Changes in the fair value of those derivatives would be reported in earnings or equity from non-owner sources depending on the use of the derivative and whether it qualifies for hedge accounting. The key criterion for hedge accounting is that the hedging relationship must be highly effective in offsetting changes in fair value of assets or liabilities or cash flows. The implementation of SFAS No. 133 did not have a material effect on the Company's financial position or results of operations. Effective April 1, 2001, the Company adopted Emerging Issues Task Force (EITF) Issue 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interest in Securitized Financial Assets". Under the consensus, investors in certain asset-backed securities are required to record changes in their estimated yield on a prospective basis and to evaluate these securities for an other than temporary decline in value. If the fair value of the asset-backed security has declined below its carrying amount and the decline is determined to be other than temporary, the security is written down to fair value. The adoption of EITF Issue 99-20 did not have an impact on the Company's financial position or results of operations. In September 2000, the FASB issued SFAS No. 140 "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities". SFAS No. 140 replaces SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities", and rescinds SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125". This statement, which is required to be applied prospectively with certain exceptions, is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. Additionally, this statement is effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. The adoption of this statement did not have a material impact on the Company's consolidated financial statements. (Continued) 5 USAA LIFE INSURANCE COMPANY Notes to Consolidated Financial Statements (Dollars in Thousands) Effective January 1, 2002, the Company adopted the provisions of FASB SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". The standard addresses financial accounting and reporting for the impairment or disposal of long-lived assets. The standard establishes a single accounting model, based on the framework established in SFAS 121 for long-lived assets to be disposed of by sale, and resolves significant implementation issues related to SFAS 121. The implementation of SFAS No. 144 did not have a material effect on the Company's financial position, results of operations, or liquidity. (c) Investments ----------- All debt securities, including bonds, mortgage-backed securities, and redeemable preferred stocks are classified as available-for-sale and are carried at fair value with unrealized gains or losses (net of related deferred income taxes, deferred policy acquisition costs, and insurance reserves) reflected in stockholders' equity. Bonds, at amortized cost of approximately $173,694, and $171,940 were on deposit with various state governmental agencies at December 31, 2002, and 2001, respectively. Mortgage-backed securities held at December 31, 2002 and 2001 represent participating interests in pools of long term first mortgage loans originated and serviced by the issuers of the securities. Market interest rate fluctuations can affect the prepayment speed of principal and the yield on the securities. All equity securities, which include common and non-redeemable preferred stocks, are classified as available-for-sale. Equity securities are carried at fair value with unrealized gains or losses (net of related deferred income taxes, deferred policy acquisition costs, and insurance reserves) reflected in stockholders' equity. Mortgage loans and policy loans are carried at their unpaid principal balances with interest rates ranging from 4.80% to 9.75% at December 31, 2002. Interest is recognized over the life of the note using the interest method. Mortgage loans are collateralized by a first lien on real estate while policy loans are collateralized by the cash surrender value of the related policy. Short-term securities, included in cash and cash equivalents, are carried at amortized cost, which approximates fair value. Principal or interest payments on debt securities or loans are determined to be uncollectible when they are 90 days past due, and the amounts determined to be uncollectible are written off through the Income Statement. Interest is not accrued on debt securities or loans for which principal or interest payments are determined to be uncollectible. Realized gains and losses are included in net income based upon specific identification of the investment sold. When impairment of the value of an investment is considered to be other than temporary, a provision for the write down to estimated net realizable value is recorded. Net realized capital gains (losses) of $(18,077), $25,943, and $1,455 for 2002, 2001 and 2000 respectively, allocable to future policyholder dividends and interest, were deducted from net realized capital gains (losses) and an offsetting amount was reflected in insurance reserves. Amortization of bond premium or discount is calculated using the scientific (constant yield) interest method. (Continued) 6 USAA LIFE INSURANCE COMPANY Notes to Consolidated Financial Statements (Dollars in Thousands) (d) Cash and cash equivalents ------------------------- For purposes of the consolidated statement of cash flows, all highly liquid marketable securities that have a maturity date at purchase of three months or less and money market mutual funds are considered to be cash equivalents. At December 31, 2002 and 2001, cash includes $414 and $41, respectively, of separate account purchases awaiting reinvestment. These funds are restricted from the Company's use. (e) Federal income taxes -------------------- Life Company and its subsidiaries are included in the consolidated federal income tax return filed by USAA. Taxes are allocated to the separate companies of USAA based on a tax allocation agreement, whereby companies receive a current benefit to the extent their losses are utilized by the consolidated group. Separate company current taxes are the higher of taxes computed at a 35% rate on regular taxable income or taxes computed at a 20% rate on alternative minimum taxable income adjusted for any consolidated benefits allocated to the companies based on the use of separate company losses within the group. Deferred income taxes are recognized for the tax consequences of "temporary differences" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred income taxes from a change in tax rates is recognized in income in the period that includes the enactment date. (f) Fair value of financial instruments ----------------------------------- The fair value estimates of the Company's financial instruments were made at a point in time, based on relevant market information and information about the related financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holding of a particular financial instrument. In addition, the tax ramifications related to the effect of fair market value estimates have not been considered in the estimates. (g) Use of estimates ---------------- The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America (GAAP), requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities, at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (h) Deferred policy acquisition costs --------------------------------- Policy acquisition costs, consisting primarily of certain underwriting and selling expenses, are deferred and amortized. Traditional individual life and health acquisition costs are amortized in proportion to anticipated premium income after allowing for lapses and terminations. The period for amortization is 20-30 years, but not to exceed the life of the policy. (Continued) 7 USAA LIFE INSURANCE COMPANY Notes to Consolidated Financial Statements (Dollars in Thousands) Acquisition costs for universal life and annuity policies are amortized in relation to the present value of estimated gross profits from surrender charges and investment, mortality and expense margins. The amortization period for universal life policy deferred acquisition costs is 20 years. The period for amortization for annuities deferred acquisition costs is either 20 or 30 years. Deferred policy acquisition costs are reviewed by line of business to determine that the unamortized portion does not exceed the present value of anticipated gross profits or the sum of the present value of expected gross premiums and the reserves held, less the present value of expected future benefits. (i) Insurance reserves ------------------ Included in insurance reserves are traditional life and health products and payout annuities with life contingencies. Traditional life and individual health reserves are computed using a net level premium method and are based on assumed or guaranteed investment yields and assumed rates of mortality, morbidity, withdrawals, expenses and anticipated future policyholder dividends. Payout annuity reserves are computed by discounting future payments at rates based on assumed or guaranteed investment yields and mortality. These assumptions vary by such characteristics as plan, year of issue, policy duration, date of receipt of funds and may include provisions for adverse deviation. (j) Funds on deposit ---------------- Funds on deposit are liabilities for universal life policies, payout annuities without life contingencies and deferred annuities. These liabilities are determined following the "retrospective deposit" method and consist principally of policy account balances before applicable surrender charges. (k) Insurance revenues and expenses ------------------------------- Premiums on traditional life insurance products and accident and health contracts are recognized as revenues as they become due. Benefits and expenses are matched with premiums in determining net income through the holding of reserves that provide for policy benefits and amortization of acquisition costs over the lives of the policies. Universal life policy and investment annuity contract revenues consist of investment earnings and policy charges for the cost of insurance, policy administration, and surrender charges assessed during the period. Expenses for these policies and contracts include interest credited to policy account balances, benefit claims incurred in excess of policy account balances, and administrative expenses. The related deferred policy acquisition costs are amortized in relation to the present value of expected gross profits from surrender charges, investment, mortality, and expense margins. (l) Participating business ---------------------- Certain life insurance policies contain dividend payment provisions, which enable the policyholder to participate in the earnings of the life insurance operations. The participating insurance in force accounted for 5% of the total life insurance in force at both December 31, 2002, and December 31, 2001. (Continued) 8 USAA LIFE INSURANCE COMPANY Notes to Consolidated Financial Statements (Dollars in Thousands) Participating policies accounted for 14%, 16%, and 18% of the premium income in 2002, 2001, and 2000, respectively. The provision for policyholders' dividends is based on benefit reserves and a future dividend liability based on the current dividend scales. The Company guarantees to pay dividends in aggregate, on all participating policies issued after December 31, 1983, in the total amount of $19,796 in 2003. Income attributable to participating policies in excess of policyholder dividends is restricted by several states for the benefit of participating policyholders of those states, otherwise income in excess of policyholder dividends is accounted for as belonging to the stockholders. (m) Reclassifications ----------------- Certain reclassifications of prior period amounts have been made to conform with the current year's presentation. (2) Basis of accounting ------------------- The Company prepares separate statutory financial statements in accordance with accounting practices prescribed or permitted by the insurance departments of the states of Texas and New York. Prior to the adoption of Codification of Statutory Accounting Principles (SAP) by the insurance departments of the states of Texas and New York on January 1, 2001, prescribed statutory accounting practices included a variety of publications of the National Association of Insurance Commissioners (NAIC) as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. The NAIC adopted SAP in March 1998. The Texas Department of Insurance and New York State Insurance Department adopted SAP in its entirety, except as provided in Title 28 Part 1 Chapter 7 Subchapter A Rule 7.18, "NAIC Accounting Practices and Procedures Manual" (Rule 7.18), of the Texas Administrative Code and in Regulation 172, "Financial Statement Filings and Accounting Practices and Procedures" (Reg. 172), respectively. The adoption of SAP resulted in an increase in statutory surplus of approximately $34,113. These consolidated financial statements have been prepared on the basis of GAAP, which differs from the statutory basis of accounting followed in reporting to insurance regulatory authorities. Reconciliation of statutory net income and capital and surplus, as determined using statutory accounting principles, to the amounts included in the accompanying consolidated financial statements, are as follows:
2002 2001 2000 ---- ---- ---- Statutory net income $ 60,761 47,809 72,901 Gain (loss) on sale of investments 15,496 (22,135) (34,800) Deferred policy acquisitions costs 18,246 31,526 23,809 Tax adjustments 4,692 3,176 (2,863) Participating policyholder earnings (loss) 119 (2,032) (73) Insurance reserves and other (15,786) 12,378 (6,806) ------- -------- -------- GAAP net income $ 83,528 66,642 56,248 ======== ======== ======== (Continued)
9 USAA LIFE INSURANCE COMPANY Notes to Consolidated Financial Statements (Dollars in Thousands) Statutory capital and surplus $ 601,853 584,857 528,830 Increases (decreases): Deferred policy acquisition costs 332,620 313,537 282,938 Federal income taxes 21,853 34,787 79,348 Asset valuation reserve 32,705 26,365 51,877 Participating policyholder liability (7,040) (7,223) (7,111) Policyholder reserve and funds (93,636) (99,166) (95,792) Deferred and uncollected premiums (133,637) (103,741) (87,993) Investment unrealized gain (loss) adjustments: Investment valuation difference 482,501 161,458 (6,579) Policyholder accounts and other assets (336,164) (110,618) (29,437) Other adjustments (16,518) (26,561) (15,812) ------- -------- -------- GAAP capital and surplus $ 884,537 773,695 700,269 ======= ======= =======
(3) Investments ----------- The amortized cost, estimated fair values, and carrying values of investments in debt and equity securities classified as available-for-sale as of December 31, 2002 are as follows:
Available-for-Sale --------------------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Carrying Cost Gains Losses Value Value --------------------------------------------------------------------- Debt securities --------------- U.S. Treasury securities and obligations of U.S. Government corporations $ 4,691 398 - 5,089 5,089 and agencies Obligations of states and political 89,624 4,321 - 93,945 93,945 subdivisions Debt securities issued by foreign governments and corporations 174,743 8,326 (1,440) 181,629 181,629 Mortgage-backed securities 2,109,009 126,577 (728) 2,234,858 2,234,858 Corporate securities 370,682 (31,770) 5,010,538 5,010,538 4,671,626 Redeemable preferred stock 65,476 814 (371) 65,919 65,919 --------- ------- ------- --------- --------- Total debt securities $ 7,115,169 511,118 (34,309) 7,591,978 7,591,978 ========= ======= ======= ========= ========= Equity securities ----------------- Common stock $ 304,011 - (54,335) 249,676 249,676 Non-redeemable preferred stock 5,715 37 - 5,752 5,752 --------- ------- ------- --------- --------- Total equity securities $ 309,726 37 (54,335) 255,428 255,428 ========= ======= ======= ========= ========= (Continued)
10 USAA LIFE INSURANCE COMPANY Notes to Consolidated Financial Statements (Dollars in Thousands) The amortized cost, estimated fair values, and carrying values of investments in debt and equity securities classified as available for sale as of December 31, 2001 were as follows:
Available-for-Sale --------------------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Carrying Cost Gains Losses Value Value --------------------------------------------------------------------- Debt securities --------------- U.S. Treasury securities and obligations of U.S. Government corporations and $ 3,529 369 - 3,898 3,898 agencies Obligations of states and political 37,192 946 - 38,138 38,138 subdivisions Debt securities issued by foreign governments and corporations 309,153 9,494 (1,492) 317,155 317,155 Mortgage-backed securities 991,016 26,139 (2,898) 1,014,257 1,014,257 Corporate securities 5,086,498 166,894 (39,545) 5,213,847 5,213,847 --------- ------- ------ --------- --------- Total debt securities $ 6,427,388 203,842 (43,935) 6,587,295 6,587.295 ========= ======= ====== ========= ========= Equity securities ----------------- Common stock $ 251,130 - (30,149) 220,981 220,981 Non-redeemable preferred stock 5,970 - (154) 5,816 5,816 --------- ------- ------ --------- --------- Total equity securities $ 257,100 - (30,303) 226,797 226,797 ========= ======= ====== ========= ========= The amortized cost and estimated fair values of debt securities classified as available-for-sale at December 31, 2002, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to prepay obligations.
Available-for-Sale ------------------------- Estimated Amortized Fair Cost Value ------------- ---------- Due in one year or less $ 424,421 431,167 Due after one year through five years 1,536,750 1,637,148 Due after five years through ten years 1,954,580 2,121,262 Due after ten years 1,090,409 1,167,543 --------- --------- 5,006,160 5,357,120 Mortgage-backed securities 2,109,009 2,234,858 ---------- --------- $ 7,115,169 7,591,978 ========== ========= Proceeds from sales of available-for-sale debt securities during 2002, 2001, and 2000 were $1,500,037, $1,381,444, and $995,947, respectively. Gross gains and losses of $50,848 and $58,737, respectively, for 2002, $25,832 and $21,651, respectively, for 2001, and $10,472 and $65,470, respectively, for 2000, were realized on those sales.
(Continued) 11 USAA LIFE INSURANCE COMPANY Notes to Consolidated Financial Statements (Dollars in Thousands) Included in such realized investment losses on the consolidated statement of income are other than temporary write-downs of debt securities of $978, $0, and $10,033 for 2002, 2001, and 2000, respectively. Proceeds from sales of equity securities during 2002, 2001, and 2000 were $50,593, $64,640, and $573, respectively. Gross gains and losses of $0 and $34,813, respectively, for 2002, $11,068 and $0, respectively, for 2001 and $67, and $70, respectively, for 2000 were realized on those sales. Gross investment income during 2002, 2001, and 2000 was $479,345, $494,179, and $490,890, respectively, and consists primarily of interest income on fixed maturity securities. Investment expenses were $5,670, $6,464, and $5,906 for 2002, 2001, and 2000, respectively. Life Company engages in securities lending whereby certain securities from its portfolio are loaned to other institutions for short periods of time. Initial cash collateral is required at a rate of 102% of the market value of a loaned security. The collateral is deposited by the borrower with a lending agent, and retained and invested by the lending agent according to the Company's guidelines to generate additional income or used for operations. The market value of the loaned securities is monitored on a daily basis with additional collateral obtained or refunded as the market value of the loaned securities fluctuates. At December 31, 2002 and 2001, net unrealized investment gains of $349,976 and $110,618, respectively, were allocated to insurance reserves for participating life insurance policies and interest sensitive contracts. In addition net unrealized losses of $912 and $146 were allocated against deferred policy acquisition costs in 2002 and 2001, respectively. (4) Federal income tax ------------------ The expected statutory federal income tax amounts for the years ended December 31, 2002, 2001, and 2000 differ from the actual tax amounts as follows:
2002 2001 2000 ---- ---- ---- Income before income taxes $ 129,577 101,860 88,239 ======= ======= ====== Federal income tax expense at 35% statutory rate 45,352 35,651 30,884 Increase (decrease) in tax resulting from: Dividends received deductions (157) (540) (189) Tax credits (53) (112) (556) Other, net 907 219 1,852 ------- ------- ------ Federal income tax expense $ 46,049 35,218 31,991 ======= ======= ======
Deferred income tax expense or benefit for the years ended December 31, 2002, 2001, and 2000 was primarily attributable to differences between the valuation of assets and insurance liabilities for financial reporting and tax purposes. (Continued) 12 USAA LIFE INSURANCE COMPANY Notes to Consolidated Financial Statements (Dollars in Thousands) The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31 are presented below:
2002 2001 ---- ---- Deferred tax assets: Insurance reserves $ 147,407 124,969 Accounts payable and accrued expenses 2,686 8,924 Policyholder dividends 4,347 4,909 Other, net 3,488 2,972 ----------- ------- Total gross deferred tax assets 157,928 141,774 Deferred tax liabilities: Investments 8,650 7,276 Depreciable assets (456) 729 Deferred policy acquisition costs 53,116 51,539 Other, net 22,923 14,510 ----------- ------- Total gross deferred tax liabilities 84,233 74,054 ----------- ------- Deferred tax asset (liability) on net unrealized gain (loss) on investments (25,707) (6,697) ----------- ------- Net deferred tax asset $ 47,988 61,023 =========== =======
Management believes that the realization of the deferred tax asset is more likely than not based on the expectation that such benefits will be utilized in the future consolidated tax returns of the USAA group. At December 31, 2002, other liabilities includes federal income tax payable of $10,625 and in 2001 other assets includes federal income tax receivable of $7,523. Aggregate cash payments to USAA for income taxes were $31,221, $35,004, and $32,988 for Life Company and $2,719, $1,554, and $956 for its subsidiaries during the years ended December 31, 2002, 2001, and 2000, respectively. 13 (Continued) USAA LIFE INSURANCE COMPANY Notes to Consolidated Financial Statements (Dollars in Thousands) Detailed tax amounts for items of total nonowner changes in equity are as follows:
Before- Tax Tax (Expense) Net-of-Tax Amount or Benefit Amount ---------- ----------- ------------ FOR THE YEAR ENDING DECEMBER 31, 2000 Unrealized gains on securities: Unrealized holding gains arising during year $ 69,788 (24,426) 45,362 Less: reclassification adjustment for losses realized in 24,857 (8,700) 16,157 income ------ ------ ------- Net unrealized gains from securities 94,645 (33,126) 61,519 ------ ------- ------- Other changes in equity from nonowner sources $ 94,645 (33,126) 61,519 ====== ======= ======= FOR THE YEAR ENDING DECEMBER 31, 2001 Unrealized gains on securities: Unrealized holding gains arising during year $ 28,759 (10,066) 18,693 Less: reclassification adjustment for losses realized in 15,529 (5,435) 10,094 income -------- ------ ------ Net unrealized gains from securities 44,288 (15,501) 28,787 -------- ------ ------ Other changes in equity from non-owner sources $ 44,288 (15,501) 28,787 ======== ====== ====== FOR THE YEAR ENDING DECEMBER 31, 2002 Unrealized gains on securities: Unrealized holding gains arising during year $ 67,150 (23,502) 43,648 Less: reclassification adjustment for gains realized in (12,835) 4,492 (8,343) income -------- ------ ------ Net unrealized gains from securities 54,315 (19,010) 35,305 -------- ------ ------ Other changes in equity from non-owner sources $ 54,315 (19,010) 35,305 ======== ====== ====== 14 (Continued)
USAA LIFE INSURANCE COMPANY Notes to Consolidated Financial Statements (Dollars in Thousands) (5) Fair value of financial instruments ----------------------------------- The following tables present the carrying values and estimated fair values of the Company's financial instruments at December 31. SFAS No. 107, "Disclosures about Fair Value of Financial Instruments", defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties.
2002 2001 ------------------------ ------------------------ Carrying Fair Carrying Fair Value Value Value Value ------------------------ ------------------------ Financial assets: Cash and cash equivalents 79,041 79,041 116,927 116,927 $ Debt securities 7,591,978 7,591,978 6,587,295 6,587,295 Equity securities 255,428 255,428 226,797 226,797 Mortgage loans 2,061 1,892 2,379 2,226 Policy loans 138,209 138,209 139,997 139,997 Premium balances receivable 4,890 4,890 4,903 4,903 Accounts receivable - affiliates 204 204 37 37 Collateral for securities loaned 831,657 831,657 506,409 506,409 Accrued investment income 106,689 106,689 114,890 114,890 Separate account 286,300 286,300 378,098 378,098 Financial liabilities: Deferred annuities and annuities without life 4,147,175 4,147,175 3,725,116 3,725,116 contingencies Policyholder dividend accumulations 35,198 35,198 34,309 34,309 Policy dividends declared but unpaid 28,124 28,124 30,993 30,993 Accounts payable and accrued expenses 51,486 51,486 86,151 86,151 Accounts payable - affiliates 21,100 21,100 19,815 19,815 Payable upon return of securities loaned 831,657 831,657 506,409 506,409 Separate account 286,300 286,300 378,098 378,098
All carrying values are included in the balance sheet under the indicated captions, except for deferred annuities and annuities without life contingencies, and policyholder dividend accumulations, both of which are included in funds on deposit, and policy dividends declared but unpaid which are included in other liabilities. The following methods and assumptions were used to estimate the fair value of each class of financial instruments: Cash and cash equivalents: The carrying value of cash and cash equivalents approximates fair value because of the short maturity. Debt and equity securities: The fair market values for bonds and stocks are determined using quoted market prices from Merrill Lynch Pricing Services, Bloomberg Services or individual brokers. 15 (Continued) USAA LIFE INSURANCE COMPANY Notes to Consolidated Financial Statements (Dollars in Thousands) Mortgage loans: The fair value of mortgage loans are estimated by discounting the future cash flows using interest rates currently being offered for mortgage loans with similar characteristics and maturities. Policy loans: In the Company's opinion, the book value of the policy loans approximates their fair value. Policy loans are shown on the financial statements at the aggregate unpaid balance, and carry interest rates ranging from 4.8% to 7.4% in advance. Premium balances receivable: The recorded amount for premiums receivable approximates fair value because only a slight percentage of total policies issued by the Company lapse. Accounts receivable and payable - affiliates: The carrying value of the accounts receivable and accounts payable for affiliates approximates its fair value because of the short-term nature of the obligations. Collateral for securities loaned and payable upon return of securities loaned: The carrying value of collateral for securities loaned and payable upon return of securities loaned approximates fair value because of the short maturity of the collateral. Accrued investment income: The accrued amount of investment income approximates its fair value because of the quality of the Company's investment portfolio combined with the short-term nature of the collection period. Deferred annuities and annuities without life contingencies: The fair value of the deferred annuities is equal to the current accumulated value without anticipation of any applicable surrender charges, which approximates the carrying value. The fair value of annuities without life contingencies is estimated as the commuted value of the annuity. Policyholder dividend accumulations: The fair value of policy holder dividend accumulations is estimated using the book value less a percentage of accrued interest anticipated to be forfeited as a result of policy cancellations. Estimated annual interest to be forfeited is not material. Policy dividends declared but unpaid: The carrying value of policy dividends declared but unpaid approximates the fair value because the carrying value reflects anticipated forfeitures as a result of policy cancellations. Estimated annual interest to be forfeited is not material. Accounts payable and accrued expenses: The fair value of accounts payable and accrued expenses approximates its carrying value because of the short-term nature of the obligations. Separate account assets and liabilities: The separate account assets reflect the net asset value of the underlying mutual funds, therefore, carrying value is considered fair value. The separate account liabilities are reflected at the underlying balances due to the contract holders, without consideration for applicable surrender charges, if any. 16 (Continued) USAA LIFE INSURANCE COMPANY Notes to Consolidated Financial Statements (Dollars in Thousands) (6) Borrowings ---------- The Company has no borrowing activity outside of the agreements described in Note 7 "Transactions with affiliates." (7) Transactions with affiliates ---------------------------- Certain services have been contracted from USAA and its affiliates, such as rental of office space, utilities, mail processing, data processing, printing, and employee benefits. USAA allocates these and other expenses to affiliates for administrative services performed by them. The contracted services and allocations are based upon various formulas or agreements with the net amounts included in expenses. The aggregate amount of such contracted services for Life Company and its affiliates was $117,742, $115,389, and $164,572 for 2002, 2001, and 2000, respectively. The Company has an agreement with USAA Investment Management Company regarding the reimbursement of costs for investment services provided. The aggregate amount of the USAA Investment Management Company contracted services was $5,651, $6,433 and $5,866 for 2002, 2001, and 2000, respectively. Life Company also received premium and annuity considerations from USAA of $9,259, $6,415, and $5,780 in 2002, 2001, and 2000, respectively, representing amounts received for structured settlements issued to claimants of USAA and for group insurance on USAA employees. Life Company provides credit life and disability insurance to members of the USAA Federal Savings Bank (USAA FSB) through an insurance arrangement with USAA FSB. Total credit life and disability premiums were $6,708, $6,468, and $5,732 in 2002, 2001 and 2000, respectively. Life Company has intercompany funding agreements with USAA Capital Corporation (CAPCO) and USAA Funding Company (FUNDCO) that provide for borrowing up to $50,000 at any one time on an unsecured basis. Borrowings are intended to be short-term (less than 270 days) and to be used for liquidity purposes. Interest rates on borrowings are based upon CAPCO's or FUNDCO's external cost of obtaining funds. As of December 31, 2002, 2001, and 2000, Life Company had $0, $2,600 and $0 liability for borrowed money. Life Company had short-term borrowings totaling $0, $53,918, and $0 in 2002, 2001, and 2000, respectively, through the use of these funding agreements. The maximum amount outstanding under such short-term borrowings by Life Company at any time during 2002, 2001, and 2000 was $0, $23,000, and $0, respectively. The interest associated with these intercompany funding agreements was $0, $10, and $0 in 2002, 2001, and 2000, respectively. Life Company has intercompany lending agreements with CAPCO and FUNDCO. Life Company is authorized to loan excess funds under guidelines established with the Texas Department of Insurance. The Company loaned $0, $6,800, and $0 during 2002, 2001, and 2000, respectively. There were no note receivables outstanding at December 31, 2002, 2001, and 2000. Interest income associated with these lending agreements was $0, $9, and $0 in 2002, 2001, and 2000, respectively. The Company purchased securitized notes created by USAA FSB. The notes were purchased on the open market through a third-party broker. The Company had $76,450, $68,618, and $37,200 of securitized notes at carrying value created by USAA FSB at December 31, 2002, 2001, and 2000, respectively. 17 (Continued) USAA LIFE INSURANCE COMPANY Notes to Consolidated Financial Statements (Dollars in Thousands) Life of New York has an intercompany funding agreement with CAPCO that provides for aggregate borrowings outstanding at any one time that shall not exceed an amount equal to 5 percent of Life of New York's prior year admitted assets. Life of New York did not borrow any money through the use of these funding agreements during 2002, 2001, or 2000. (8) Reinsurance ----------- The Company is party to several reinsurance treaties. Life Company's general policy is to reinsure that portion of any risk in excess of $600 with a $100 corridor on the life of any one individual. However, in 1997 Life Company entered into certain reinsurance treaties that are based on a first dollar quota share pool. Life Company retains 10% of the risk on each life policy up to the normal $600 retention and the remaining 90% is ceded to a coinsurance pool that is placed with a number of reinsurers on a quota share basis. Once Life Company's retention has been reached, the quota share pool reinsures all of the risk above Life Company's retention. Life of New York's general policy is the same except that they reinsure that portion of any risk in excess of $200 on the life of any one individual. Life Company cedes Bank Owned Life Insurance (BOLI) business through two reinsurance treaties, one Yearly Renewable Term (YRT) and one Coinsurance treaty, both of which are with one reinsurer on a first dollar basis, with Life Company retaining 50% of the business under the coinsurance arrangement. Assets backing the coinsurance reserves held by the reinsurer are held in a trust by the reinsurer. This trust arrangement should reduce the credit risk associated with the high reserve liability held by the reinsurer for Life Company. Although the ceding of reinsurance does not discharge the Company from its primary legal liability to a policyholder, the reinsuring company assumes responsibility to reimburse the Company for the related liability. Life insurance in force in the amounts of $4,817,402, $5,051,994 and $5,161,519 is ceded on a yearly renewable term basis and $66,414,798, $49,794,678 and $37,080,679 is ceded on a coinsurance basis at December 31, 2002, 2001, and 2000, respectively. Reinsurance amounts recoverable related to insurance reserves, funds on deposit, and paid losses totaled $668,118 and $576,141 at December 31, 2002, and 2001, respectively. Premium revenues and interest credited to policyholders were reduced by $140,041, $113,853 and $104,622 for reinsurance premiums ceded during the years ended December 31, 2002, 2001, and 2000, respectively. Losses, benefits and settlement expenses were reduced by $114,812, $101,813 and $91,618 for reinsurance recoverables during the years ended December 31, 2002, 2001, and 2000, respectively. Life Company assumes business through various assumption agreements, with most of the business assumed on a yearly renewable term basis. Such premium amounts were not significant in 2002, 2001, and 2000. 18 (Continued) USAA LIFE INSURANCE COMPANY Notes to Consolidated Financial Statements (Dollars in Thousands) (9) Deferred policy acquisition costs and future policy benefits ------------------------------------------------------------ Deferred policy acquisitions costs and premiums are summarized below:
Accident Life Annuity and Health Total ----------- ----------- ------------- --------- Balance at December 31, 1999 $ 184,840 60,131 22,143 267,114 ------- ------ ------ ------- Additions 31,925 9,279 6,763 47,967 Amortization (16,272) (4,375) (3,861) (24,508) Fair value adjustment 652 (8,287) - (7,635) ------- ------ ------ ------- Net changes 16,305 (3,383) 2,902 15,824 ------- ------ ------ ------- Balance at December 31, 2000 201,145 56,748 25,045 282,938 ------- ------ ------ ------- Additions 36,970 11,460 5,623 54,053 Amortization (13,721) (2.466) (6,670) (22,857) Fair value adjustment (607) 10 - (597) ------- ------ ------ ------- Net change 22,642 9,004 (1,047) 30,599 Balance at December 31, 2001 223,788 65,752 23,998 313,537 ------- ------ ------ ------- Additions 33,692 9,502 3,455 46,649 Amortization (15,979) (2,105) (10,248) (28,332) Fair value adjustment 288 478 - 766 ------- ------ ------ ------- Net change 18,001 7,875 (6,793) 19,083 ------- ------ ------ ------- Balance at December 31, 2002 $ 241,789 73,627 17,205 332,620 ======= ====== ======= ======= 2000 Premiums $ 296,640 10,626 120,925 428,191 ======= ====== ======= ======= 2001 Premiums $ 312,972 16,830 148,463 478,265 ======= ====== ======= ======= 2002 Premiums $ 322,485 27,356 135,407 485,248 ======= ====== ======= =======
(Continued) 19 USAA LIFE INSURANCE COMPANY Notes to Consolidated Financial Statements (Dollars in Thousands) The liabilities for future policy benefits and related insurance in force at December 31, 2002 and 2001 are summarized below: Future Policy Benefits ------------------------- 2002 2001 ---- ---- Life and annuity: Individual $ 1,786,341 1,401,140 Group 6,837 5,523 ----------- ---------- Total life and annuity $ 1,406,663 1,793,178 =========== ========== Accident and health $ 73,418 74,219 =========== ========== Insurance in Force ------------------------- 2002 2001 ---- ---- Life and annuity: Individual $ 64,814,140 64,934,370 Credit life 824,306 716,520 Group 2,581,568 2,618,975 ----------- ---------- Total life and annuity $ 68,220,014 68,269,865 =========== ========== Life Insurance and Annuities: Interest assumptions used in the calculation of future policy benefits for Traditional Life Policies are as follows: Participating term 9.28% Participating permanent 6.75% to 9.16% Non - Participating term 6.00% to 8.91% Non - Participating permanent 6.09% to 7.09% Future policy benefits for Payout Annuities use the original pricing interest rates. Mortality and lapse assumptions are based on the Company's experience. Health Insurance: Interest assumptions used for future policy benefits on the health policies are calculated using a level interest rate of 6%. Morbidity for Income Replacement policies for active lives is based on a modified 1985 CIDA and for disabled lives is based on the 1985 CIDA. Morbidity for In Hospital Cash policies is based on the 1966-67 Intercompany Experience table. The Active Life Reserves for Issue Age Standardized Medicare Supplement Plans, Attained Age Standardized Medicare Supplement Plans, and TRICARE Supplement Plans are valued on a net level basis using 6% interest, and each uses different modifications of 1994 Tillinghast claim costs. Termination assumptions are based on Life Company and industry experience. (Continued) 20 USAA LIFE INSURANCE COMPANY Notes to Consolidated Financial Statements (Dollars in Thousands) (10) Capital stock ------------- The Company has outstanding 600,000 shares of Annually Adjustable Cumulative Perpetual Preferred Stock, 100,000 shares each of Series A, Series B, Series C, Series D, Series E, and Series F issued at $100 (not in thousands) par value. During 2001, the Company issued 100,000 shares of Series G Annually Adjustable Noncumulative Perpetual Preferred Stock at $100 (not in thousands) par value plus $10,000 of additional paid-in capital. During 2002, the Company revised the previous issuance of Series G Annually Adjustable Noncumulative Perpetual Preferred Stock. The original additional paid-in capital of $10,000 was applied towards the issuance of an additional 100,000 shares at $100 (not in thousands) par value. To date, there has been a total issuance of 200,000 shares of Series G annually Adjustable Noncumulative Perpetual Preferred Stock at $100 (not in thousands) par value. All of the preferred stock is owned by FUNDCO. No other stock ranks Senior to the Series A through G preferred stock. The dividend rate for the Series A through F preferred stock is equal to 65% of the cost of the funds for CAPCO on Commercial paper having a 180-day maturity on the first business day of each dividend period. The dividend rate for the Series G preferred stock is 6.16% through December 15, 2006 when the rate will reset using the five-year treasury rate plus 1.75%. The preferred stock has a liquidation value of $100 (not in thousands) per share. The preferred stock shares are redeemable at the option of the Company for cash, in whole or in part, on the 15th day of each December for Series A and Series B and on the 15th day of each June for Series C, Series D, Series E, Series F, and Series G at par value plus accrued and unpaid dividends. Preferred stock dividends of $1,991, $1,977, and $2,529 were paid in 2002, 2001, and 2000, respectively and $73, $114, and $113 were accrued for each year after the last payments on December 15, 2002, 2001, and 2000, respectively. The Company has authorized 30,000 shares of common capital stock, $100 (not in thousands) par value, of which 25,000 shares were issued and outstanding at December 31, 2002, 2001, and 2000. Dividends of $6,000, $40,000, and $15,000 were paid in cash on the common stock during 2002, 2001, and 2000, respectively, as well as a $25 non-cash dividend during 2001. (11) Unassigned surplus and dividend restrictions -------------------------------------------- Texas law limits the payment of ordinary dividends to shareholders. The maximum ordinary dividend that may be paid without prior approval of the Insurance Commissioner is limited to the greater of net gain from operations of the preceding calendar year or 10% of capital and surplus as of the prior December 31, less any dividends made within the preceding 12 months. As a result, ordinary dividend payments to shareholders are limited to approximately $85,768 in 2003. Dividends are paid as determined by the Board of Directors and at its discretion. The Texas Department of Insurance imposes minimum risk-based capital (RBC) requirements on insurance companies that were developed by the NAIC. The formulas for determining the amount of RBC specify various weighting factors that are applied to statutory financial balances or various levels of activity based on the perceived degree of risk. Regulatory compliance is determined by a ratio of the company's regulatory total adjusted capital to its authorized control level RBC, as defined by the NAIC. Companies below specific trigger points or ratios are classified within certain levels, each of which requires specified corrective action. Life Company's and its subsidiaries' current statutory capital and surplus are in excess of the threshold RBC requirements. (Continued) 21 USAA LIFE INSURANCE COMPANY Notes to Consolidated Financial Statements (Dollars in Thousands) (12) Business segments ----------------- The significant business segments of the Company are life insurance, annuity products, and health insurance that are marketed primarily to individuals eligible for membership in USAA. The life insurance segment offers universal life, whole life, term, and other individual coverages. The annuity segment offers both fixed and variable annuity products. The health segment offers individual and group supplement accident and health policies. The following table shows total revenues, income before income taxes, and total assets for these segments as of and for the years ended December 31, 2002, 2001, and 2000:
2002 2001 2000 ---- ---- ---- Revenues: Premiums Life $ 322,485 312,972 296,640 Annuity 27,356 16,830 10,626 Health 135,407 148,463 120,925 --------- --------- -------- 485,248 478,265 428,191 --------- --------- -------- Investment income, net: Life 180,598 201,270 198,093 Annuity 288,691 282,037 282,882 Health 4,386 4,408 4,009 --------- --------- -------- 473,675 487,715 484,984 --------- --------- -------- Realized capital gains (losses), net: Life (9,748) (10,190) (16,067) Annuity 11,396) (24,109) (49,922) Health - - - --------- --------- -------- (21,144) (34,299) (65,989) --------- --------- -------- Fees, sales, loan income and other revenues: Life 64,516 53,157 49,237 Annuity 18,177 15,947 17,231 Health 18,752 16,796 16,538 --------- --------- -------- 101,445 85,900 83,006 --------- --------- -------- Total revenues: $ 1,039,224 1,017,581 930,192 $ ========== ========= ======== Income before income taxes: Life $ 87,324 94,809 107,483 $ Annuity 37,842 18,139 (1,664) Health 4,411 (11,088) (17,580) --------- --------- -------- $ 129,577 101,860 88,239 ========== ========= ======== Income tax expense (benefit): Life $ 30,755 32,777 43,330 $ Annuity 13,700 6,267 (4,414) Health 1,594 (3,826) (6,925) --------- --------- -------- $ 46,049 35,218 31,991 ========== ========= ======== (Continued)
22 USAA LIFE INSURANCE COMPANY Notes to Consolidated Financial Statements (Dollars in Thousands)
2002 2001 2000 ---- ---- ---- Total assets: ------------ Life $ 4,368,493 3,909,310 3,663,174 $ Annuity 5,949,531 5,081,762 4,932,744 Health 58,549 90,469 83,381 ---------- --------- --------- $ 10,376,573 9,081,541 8,679,299 $ ========== ========= =========
Effective March 6, 2002, the Company discontinued selling TRICARE supplement health insurance. The Company recognized the Department of Defense's reforms to the TRICARE program substantially improved health coverage for all military beneficiaries and reduced the Company's members' need for this supplemental health insurance. Effective December 1, 2002, the Company terminated its TRICARE group policy, and the individual certificates will expire on their paid-to dates. These events did not have a material impact on the operations of the Company. (13) Employee benefit plans ---------------------- (a) Pension plan ------------ Substantially all employees are covered under a pension plan administered by USAA which is accounted for on a group basis. The benefits are determined based on years of service and the employee's final average pay, as defined in the plan, at the date of retirement. The total net pension cost allocated to the Company on the basis of salary expense was $2,897, $3,572, and $3,922 in 2002, 2001, and 2000, respectively. At December 31, 2002, 2001, and 2000, a prepaid asset (liability) of $15,665, ($134), and ($2,157), respectively, has been recorded which represents the excess (deficit) of net periodic pension cost allocated to the Company over its allocated funding requirements. (b) Postretirement benefit plan --------------------------- Substantially all employees of the Company may become eligible for certain medical and life insurance benefits provided for retired employees under a plan administered by USAA if they meet minimum age and service requirements and retire while working for USAA. The postretirement benefit cost allocated to the Company based on the number of employees was $1,907, $1,358, and $1,555 in 2002, 2001, and 2000, respectively. At December 31, 2002 and 2001, a liability of $8,407, and $6,500, respectively, has been recorded which represents the excess of net periodic postretirement benefit cost allocated to the Company over its allocated funding requirements. (c) Contributory retirement plan ---------------------------- Substantially all employees of the Company are eligible to participate in USAA's contributory retirement plan. The Company matches participant contributions dollar for dollar to a maximum of 6% of a participant's compensation. During the first three years of credited service, the Company's contributions are 0% vested, and after three years of credited service, the Company's contributions are 100% vested. In 2002, 2001, and 2000, the Company's contributions to the plan totaled $2,848, $3,080, and $2,584, respectively. (Continued) 23 USAA LIFE INSURANCE COMPANY Notes to Consolidated Financial Statements (Dollars in Thousands) (14) Separate accounts ----------------- The Separate Account and the Life Insurance Separate Account (Separate Accounts) are segregated asset accounts established under Texas law through which Life Company invests the premium payments received from contract owners and policy owners, respectively. The Separate Accounts included seed money of Life Company in the amount of $6,624, $7,825, and $64,531 as of December 31, 2002, 2001, and 2000, respectively. The assets of the Separate Accounts are the property of Life Company. However, only the assets of the Separate Accounts in excess of the reserves, and other contract liabilities with respect to the Separate Accounts, are chargeable with liabilities arising out of any other business Life Company may conduct. In accordance with the contracts and policies, income, gains and losses, whether or not realized, are credited to, or charged against the Separate Accounts and excluded from Life Company. Life Company's obligations arising under the contracts and policies are general corporate obligations. Each Separate Account currently is divided into eighteen variable fund accounts, each of which invests in a corresponding fund. The funds that are available under this contract or policy include five funds of the USAA Life Investment Trust, the Capital Growth Portfolio of the Scudder Variable Life Investment Funds, the Growth Portfolio of the Alger American Funds, three funds of the Fidelity VIP portfolio, and eight funds of the Vanguard Variable Insurance Fund. The accumulated unit value of the contract or policy in a variable fund account will vary, primarily based on the investment experience of the Fund in whose shares the variable funds account invest. The value of the funds' securities is carried at market value. Life Company incurs mortality expenses on behalf of the Separate Accounts' contract holders and policy owners. Life Company also incurs administrative expenses on behalf of contract and policy owners. Life Company collects fees for these expenses from both contract holders and policy owners at set amounts. In addition, Life Company incurs various expenses related to conducting the business or operations of the USAA Life Investment Trust (Trust) as outlined by an underwriting and administrative services agreements. Life Company, out of its general account, has agreed to pay directly, or reimburse the Trust, for Trust expenses exceeding established limits. Such reimbursements were not significant in 2002, 2001, and 2000. (15) Commitments and contingencies ----------------------------- The Company is required by law to participate in the guaranty associations of the various states in which it does business. The state guaranty associations ensure payment of guaranteed benefits, with certain restrictions to policy holders of impaired or insolvent insurance companies, by assessing all other companies involved in similar lines of business. There are currently several insurance companies which have substantial amounts of life, annuity and health business in the process of liquidation or rehabilitation. The Company received net refunds of $78 and $336 and paid $62 to various state guaranty associations during the years ended December 31, 2002, 2001, and 2000, respectively. The Company accrues its best estimate for known insolvencies. At December 31, 2002 and 2001, other liabilities include $7,636 and $7,148 respectively, related to estimated assessments. The Company is party to various lawsuits and claims generally incidental to its business. The ultimate disposition of these matters is not expected to have a significant adverse effect on the Company's financial position or results of operations. 24 PART C: OTHER INFORMATION EXHIBITS -------- A. Resolution of Board of Directors of USAA Life Insurance Company establishing Life Insurance Separate Account of USAA Life Insurance Company. (The resolution is filed in lieu of a trust or indenture creating a unit investment trust.)(1) B. None. C. Underwriting Agreement by and between USAA Life Insurance Company and USAA Investment Management Company effective May 1, 2003 (filed herewith). D. Revised Form of Variable Universal Life Insurance Policy (Policy Form No. VUL 31891TX), including riders.(2) E. 1. Revised Form of Application for the Variable Universal Life Insurance Policy filed as Exhibit D.(2) 2. Form of Application for Variable Universal Life Insurance Policy Change.(2) 3. Section 1035 Exchange Form.(2) F. 1. Articles of Incorporation of USAA Life Insurance Company, as amended.(3) 2. Bylaws of USAA Life Insurance Company, as amended, February 20, 2000.(4) G. 1. Novation Agreement among USAA Life Insurance Company, Munich American Reassurance Company, and Continental Assurance Company (acquired by Munich) Effective June 30, 2001 (filed herewith). 2. Self-Administered Automatic Yearly Renewable Term Reinsurance Agreement Between USAA Life Insurance Company and Continental Assurance Company, Effective June 1, 1998(11) 3. Risk Premium Reinsurance Agreement between USAA Life Insurance Company and Reinsurance Group of America, Inc. Effective June 1, 1998 (filed herewith). 4. Yearly Renewable Term Reinsurance Agreement between USAA Life Insurance Company and The Lincoln National Life Insurance Company, Effective June 1, 1998(11) 5. Automatic Reinsurance Agreement Effective June 1, 1998 between USAA Life Insurance Company and Munich American Reassurance Company (filed herewith). 6. Automatic Reinsurance Agreement Effective June 1, 1998 between USAA Life Insurance Company and American Phoenix Life and Reassurance Company (filed herewith). 7. Automatic and Facultative Reinsurance Agreement Effective June 1, 1998 between USAA Life Insurance Company and Security Life of Denver Insurance Company (filed herewith) H. 1. Amended Participation Agreement by and between Scudder Variable Life Investment Fund and USAA Life Insurance Company, dated February 3, 1995, as amended May 21, 1998.(5) 2. Amended Participating Contract and Policy Agreement by and between Scudder Investor Services, Inc. and USAA Investment Management Company, dated February 3, 1995, as amended February 29, 1998.(5) 3. Amended Reimbursement Agreement by and between Scudder Kemper Investments, Inc. and USAA life Insurance Company, dated February 3, 1995, as amended May 21, 1998.(5) 4. Amended Letter Agreement by and between Scudder Kemper Investments, Inc., Scudder Investor Services, Inc., Scudder Variable Life Investment Fund, USAA Life Insurance VUL Part C -- 1 Company and USAA Investment Management Company, dated February 3, 1995, as amended March 16, 1998.(5) 5. Amended Participation Agreement by and between The Alger American Fund, Fred Alger Management, Inc., Fred Alger & Company, Incorporated, and USAA Life Insurance Company, dated December 16, 1994, as amended March 16, 1998.(4) 6. Amended Expense Allocation Agreement by and between Fred Alger Management, Inc., Fred Alger & Company, Inc., and USAA Life Insurance Company, dated December 16, 1994 as amended March 16, 1998.(2) 7. Participation Agreement by and between Vanguard Variable Insurance Funds, The Vanguard Group, Inc., Vanguard Marketing Corporation, and USAA Life Insurance Company, dated March 12, 2001.(9) 8. Participation Agreement by and between Variable Insurance Products Funds, Fidelity Distributors Corporation, and USAA Life Insurance Company, dated February 20, 2001.(9) I. 1. Administrative Services Agreement, by and between USAA Life Insurance Company and USAA Life Investment Trust effective May 1, 2003 (filed herewith). 2. Form of Administrative Services Agreement, by and between USAA Life Insurance Company and USAA Investment Management Company.(11) 3. Investment Advisory Agreement by and between USAA Life Investment Trust and USAA Investment Management Company, dated November 1, 2002.(7) 4. Subadvisory Agreement by and between USAA Life Investment Trust and MFS Investment Management with respect to the USAA Life World Growth Fund dated November 1, 2002.(7) 5. Subadvisory Agreement by and between USAA Life Investment Trust and Wellington Management Company LLP with respect to the USAA Life Diversified Assets Fund dated November 1, 2002.(7) 6. Subadvisory Agreement by and between USAA Life Investment Trust and Marsico Capital Management LLC with respect to the USAA Life Aggressive Growth Fund dated November 1, 2002.(7) 7. Transfer Agent Agreement by and between USAA Life Investment Trust and USAA Life Insurance Company, dated December 15, 1994.(8) 8. Letter Agreement by and between USAA Life Investment Trust and USAA Life Insurance Company, appointing USAA Life as the Transfer Agent and Dividend Disbursing Agent for Funds added to Trust, dated February 7, 1997.(8) 9. Amendment to Transfer Agent Agreement by and between USAA Life Investment Trust and USAA Life Insurance Company, to encompass variable universal life insurance, dated February 18, 1998.(8) 10. Amended and Restated Distribution and Administration Agreement by and between USAA Life Insurance Company and USAA Investment Management Company, dated December 16, 1994, and amended and restated, to encompass variable universal life insurance, March 30, 1998.(2) J. None. K. 1. Opinion and Consent of Cynthia A. Toles, Esq., Vice President and Assistant Secretary, USAA Life Insurance Company, as to the legality of the Policy interests being registered.(6) 2. Consent of Kirkpatrick & Lockhart LLP.(11) L. Not applicable. M. Not applicable. N. Other Opinions. 1. Consent of KPMG LLP, Independent Auditors. (Filed herewith.) VUL Part C -- 2 2. Power of Attorney for Robert G. Davis.(1) 3. Powers of Attorney for James M. Middleton, Bradford W. Rich, and Josue Robles, Jr.(3) 4. Powers of Attorney for Russell A. Evenson and Larkin W. Fields.(4) 5. Power of Attorney for Edward R. Dinstel.(9) O. None. P. Not applicable. Q. Not applicable. R. Persons Controlled by or Under Common Control with the Depositor or Registrant.11 ---------- 1 Previously filed on January 30, 1998, with the initial filing of this Registration Statement. 2 Previously filed on May 15, 1998, with the Pre-Effective Amendment to Registrant's Form S-6 Registration Statement. 3 Previously filed on April 27, 2000, with the Post-Effective Amendment No. 3 to Registrant's Form S-6 Registration Statement. 4 Previously filed on March 1, 2002, with the Post-Effective Amendment No. 5 to Registrant's Form S-6 Registration Statement. 5 Previously filed on February 26, 1999, with the Post-Effective Amendment No. 1 to Registrant's Form S-6 Registration Statement. 6 Previously filed on April 27, 2001, with the Post-Effective Amendment No. 4 to Registrant's Form S-6 Registration Statement. 7 Incorporated herein by reference to Post-Effective Amendment No. 11, filed on February 28, 2003, to the Form N-1A Registration Statement (File No. 33-82270) of USAA Life Investment Trust. 8 Incorporated herein by reference to Post-Effective Amendment No. 6, filed on March 2, 1998, to the Form N-1A Registration Statement (File No. 33-82270) of USAA Life Investment Trust. 9 Previously filed on April 30, 2002, with the Post-Effective Amendment No. 6 to Registrant's Form S-6 Registration Statement. 2 Incorporated herein by reference to Post-Effective Amendment No. 3, filed on February 14, 1997, to Form N-1A Registration Statement (File No. 33-82270) of USAA Life Investment Trust. 5 Incorporated herein by reference to Post-Effective Amendment No. 7, filed on February 26, 1999, to the Form N-1A Registration Statement (File No. 33-82270) of USAA Life Investment Trust. 7 Incorporated herein by reference to Post-Effective Amendment No. 8, filed on February 28, 2000, to the Form N-1A Registration Statement (File No. 33-82270) of USAA Life Investment Trust. 10 Incorporated herein by reference to Post-Effective Amendment No. 11, filed on April 26, 2002, to the Form N-1A Registration Statement (File No. 33-82270) of USAA Life Investment Trust. 11 Previously filed on March 20, 2003 with the Post Effective Amendment No. 7 under the 1933 Act and Amendment No. 2 under the 1940 Act to the N-6 Registration Statement (File Nos. 333-45343 and 811-08625) of USAA Life Investment Trust VUL Part C -- 3 DIRECTORS AND OFFICERS OF THE DEPOSITOR --------------------------------------- DIRECTORS. Set forth below are the Directors of USAA Life, the depositor of the Separate Account, who are engaged directly or indirectly in activities relating to the Registrant or the variable universal life policies offered by the Registrant, including each senior executive officer of USAA Life. The principal business address for all of the following Directors and officers of USAA Life is 9800 Fredericksburg Road, San Antonio, Texas 78288. NAME PRINCIPAL OCCUPATION ---- -------------------- Robert G. Davis Director and Chairman James M. Middleton Director and Vice Chairman Edward R. Dinstel Director Russell A. Evenson Director Larkin W. Fields Director Bradford W. Rich Director Josue Robles, Jr. Director OFFICERS (OTHER THAN DIRECTORS). -------------------------------- Set forth below are the officers of USAA Life, the depositor of the Separate Account, who are engaged directly or indirectly in activities relating to the Registrant or the variable universal life policies offered by the Registrant, including each senior executive officer of USAA Life. The principal business address of each person listed is same as the address of USAA Life, as shown on the cover page of this Prospectus. NAME POSITIONS & OFFICES WITH USAA LIFE: ---- ----------------------------------- James M. Middleton President and Chief Executive Officer Edward R. Dinstel Senior Vice President John W. Douglas Senior Vice President Russell A. Evenson Senior Vice President David M. Holmes Senior Vice President and Treasurer Mark S. Rapp Senior Vice President Bradford W. Rich Senior Vice President and Secretary Sharon L. Kaminsky Vice President and Assistant Treasurer Kristi A. Matus Vice President Pattie S. McWilliams Vice President Allen R. Pierce, Jr. Vice President Diana L. Scheel Vice President Cynthia A. Toles Vice President and Assistant Secretary Brenda E. Davis Assistant Vice President Michael P. Egan Assistant Vice President James M. Garvin Assistant Vice President Brian P. McGlinchey Assistant Vice President William J. Nabholz Assistant Vice President and Assistant Secretary Layne C. Roetzel Assistant Vice President Jane B. Wickstrom Assistant Vice President Lynda C. Cabell Assistant Treasurer PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH THE DEPOSITOR OR REGISTRANT ------------------------------------------------------------------------------ Registrant is a separate account of USAA Life that invests exclusively in mutual funds. Registrant may be deemed to be a control person of one or more of these mutual funds to the extent that it beneficially owns more than 25% of the voting securities thereof. It also may be deemed to be under common control with companies affiliated with its depositor, USAA Life. For further information, please refer to the organizational list that is filed as Exhibit R hereto and incorporated by reference in response to this item. VUL Part C -- 4 INDEMNIFICATION --------------- UNDERTAKING PURSUANT TO RULE 484(B)(1) UNDER THE SECURITIES ACT OF 1933 Rule 484(b)(1) under the Securities Act of 1933 requires a description of "[a]ny provision or arrangement . . . whereby the registrant may indemnify a director, officer or controlling person of the registrant against liabilities arising under the [Securities] Act." Registrant, the Life Insurance Separate Account of USAA Life Insurance Company, does not, as a technical matter, have any directors or officers. Nevertheless, Registrant, pursuant to Section 13 of the Amended and Restated Distribution and Administration Agreement, may indemnify, albeit indirectly, directors and/or officers of its depositor, USAA Life Insurance Company ("USAA Life"), as follows. Section 13 of such Agreement provides that Registrant shall indemnify the employees of USAA Investment Management Company ("IMCO"), Registrant's principal underwriter. To whatever extent any director or officer of USAA Life may be deemed to be an "employee" of IMCO, Registrant may be deemed to be permitted to indemnify such person pursuant to such Agreement, which is filed as Exhibit 1.(3)(a) to this Registration Statement and is herein incorporated by reference. Additionally, there are certain other provisions or arrangements whereby USAA Life, and/or certain of its affiliated persons, may be indemnified by parties or entities other than Registrant. Such provisions or arrangements are incorporated herein by reference, as follows: to Article IX of the By-Laws of USAA Life, filed as Exhibit 1.6(b) to this Registration Statement; to Section 9 of the Amended and Restated Underwriting and Administrative Services Agreement, filed as Exhibit 1.(8)(a) to this Registration Statement; to Section 12 of the Transfer Agent Agreement, as amended, filed as Exhibit 1.(8)(c) to this Registration Statement; to Section 5(b) of the Amended Participation Agreement, filed as Exhibit 1.8(d)(i) of this Registration Statement; to Section 6(b) of the Amended Reimbursement Agreement, filed as Exhibit 1.8(d)(iii) to this Registration Statement; to Section 12.2 of the Amended Participation Agreement, filed as Exhibit 1.8(e)(i) to this Registration Statement; to the Amended Expense Allocation Agreement, filed as Exhibit 1.8(e)(ii) to this Registration Statement; to Section 7 of the Participation Agreement, filed as Exhibit 1.8(f) to this Registration Statement; and to Section 8 of the Participation Agreement filed as Exhibit 1.8(g) to this Registration Statement. Insofar as indemnification for liability arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of Registrant pursuant to the foregoing provisions, or otherwise, Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by Registrant of expenses incurred or paid by a director, officer or controlling person of Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. PRINCIPAL UNDERWRITERS ---------------------- (a) Other Activity. USAA Investment Management Company ("USAA IMCO") is the principal underwriter for the Contracts. USAA IMCO also serves as the investment adviser and principal underwriter to USAA Life Investment Trust, USAA Investment Trust, USAA State Tax-Free Trust, USAA Mutual Fund, Inc., and USAA Tax Exempt Fund, Inc. (b) Management. Set forth below are the Directors and Officers of USAA IMCO who are engaged directly or indirectly in activities relating to the Registrant or the Contracts offered by the Registrant, including each senior executive officer of USAA IMCO. The principal business address for all of the following Directors and Officers of USAA IMCO is 9800 Fredericksburg Road, San Antonio, Texas 78288. Directors with Positions and Offices with USAA IMCO: Robert G. Davis Director and Chairman Christopher W. Claus Director and Vice Chairman VUL Part C -- 5 Officers with Positions with USAA IMCO: Christopher W. Claus CEO and President Clifford A. Gladson Senior Vice President, Fixed Income Investments David M. Holmes Senior Vice President, Senior Financial Officer and Treasurer Mark S. Howard Senior Vice President, Secretary and Counsel Terri L. Luensmann Senior Vice President, Investment Operations Mark S. Rapp Senior Vice President, Marketing Stuart H. Wester Vice president, Equity Investments (c) Compensation from Registrant. The following commissions and other compensation were received by each principal underwriter, directly or indirectly, from the Registrant during the Registrant's last fiscal year: NONE LOCATION OF ACCOUNTS AND RECORDS -------------------------------- The accounts and records of Registrant are located at the offices of its depositor, USAA Life, located at 9800 Fredericksburg Road, San Antonio, Texas, 78288; the offices of the principal underwriter of the Contracts, USAA IMCO, are located at 9800 Fredericksburg Road, San Antonio, Texas, 78288. FEE REPRESENTATIONS ------------------- REPRESENTATION REGARDING THE REASONABLENESS OF AGGREGATE FEES AND CHARGES DEDUCTED UNDER THE POLICIES PURSUANT TO SECTION 26(E)(2)(A) OF THE INVESTMENT COMPANY ACT OF 1940 USAA Life Insurance Company ("USAA Life") represents that the fees and charges deducted under the Policies, in the aggregate, are reasonable in relation to the services rendered, the expenses expected to be incurred, and the risks assumed by the Company under the Policies. USAA Life bases its representation on its assessment of all of the facts and circumstances, including such relevant factors as: the nature and extent of such services, expenses and risks; the need for USAA Life to earn a profit; the degree to which the Policies include innovative features; and the regulatory standards for exemptive relief under the Investment Company Act of 1940 used prior to October 1996, including the range of industry practice. This representation applies to all Policies sold pursuant to this Registration Statement, including those sold on the terms specifically described in the prospectus contained herein, or any variations therein, based on supplements, endorsements, or riders to any Policies or prospectus, or otherwise. VUL Part C -- 6 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, and the Investment company Act of 1940, as amended, the Registrant, Life Insurance Separate Account of USAA Life Insurance Company, certifies that it meets the requirements of Securities Act Rule 485(b) for effectiveness of this amended Registration Statement and has duly caused this amended Registration Statement to be signed on its behalf by the undersigned thereunto duly authorized, in the City of San Antonio, and State of Texas, on this 29th day of April, 2003. Signature: Life Insurance Separate Account of USAA Life Insurance Company (Registrant) By: USAA Life Insurance Company (Depositor) (On behalf of Registrant and itself) By: /s/ JAMES M. MIDDLETON ----------------------------- James M. Middleton President and Chief Executive Officer Attest: /s/ CYNTHIA A. TOLES --------------------- Cynthia A. Toles Vice President and Assistant Secretary Pursuant to the requirements of the Securities Act of 1933, this amended Registration Statement has been signed below by the following persons in the capacities and on the dates indicated. (NAME) (TITLE) (DATE) ---------------------- Robert G. Davis Chairman /s/ James M. Middleton ---------------------- James M. Middleton Vice Chairman, President and April 29, 2003 Chief Executive Officer /s/ Edward R. Dinstel --------------------- Edward R. Dinstel Director April 29, 2003 /s/ Russell A. Evenson ---------------------- Russell A. Evenson Director April 29, 2003 /s/ Mark S. Rapp ---------------- Mark S. Rapp Director April 29, 2003 /s/ David M. Holmes ------------------- David M. Holmes Director and Treasurer April 29, 2003 ------------------ Bradford W. Rich Director April ____, 2003 ------------------ Josue Robles, Jr. Director April ____, 2003 VUL Part C -- 7 EXHIBIT INDEX EXHIBITS -------- 1. Underwriting Agreement by and between USAA Life Insurance Company and USAA Investment Management Company, effective May 1, 2003 2. Novation Agreement among USAA Life Insurance Company, Munich American Reassurance Company, and Continental Assurance Company (acquired by Munich) Effective June 30, 2001 3. Risk Premium Reinsurance Agreement between USAA Life Insurance Company and Reinsurance Group of America, Inc. Effective June 1, 1998 4. Automatic Reinsurance Agreement Effective June 1, 1998 between USAA Life Insurance Company and Munich American Reassurance Company. 5. Automatic Reinsurance Agreement Effective June 1, 1998 between USAA Life Insurance Company and American Phoenix Life and Reassurance Company 6. Automatic and Facultative Reinsurance Agreement Effective June 1, 1998 between USAA Life Insurance Company and Security Life of Denver Insurance Company 7. Administrative Services Agreement, by and between USAA Life Insurance Company and USAA Life Investment Trust, effective May 1, 2003. 8. Consent of KPMG LLP, Independent Auditors. 9. Persons Controlled by or Under Common Control with the Depositor or Registrant VUL Part C -- 8