-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, H0V7Oehf1PxDuvymKRTtQ+yhb5FeVasJgidTxcMt8pc11k0iR00pXN66NrN43whn ZkHlRMWXzbL1mzgNctbzxg== 0001193125-04-081390.txt : 20040507 0001193125-04-081390.hdr.sgml : 20040507 20040507091041 ACCESSION NUMBER: 0001193125-04-081390 CONFORMED SUBMISSION TYPE: 497 PUBLIC DOCUMENT COUNT: 1 FILED AS OF DATE: 20040507 EFFECTIVENESS DATE: 20040507 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NORTHWESTERN MUTUAL VARIABLE LIFE ACCOUNT CENTRAL INDEX KEY: 0000742277 IRS NUMBER: 390509570 STATE OF INCORPORATION: WI FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 497 SEC ACT: 1933 Act SEC FILE NUMBER: 333-36865 FILM NUMBER: 04786962 BUSINESS ADDRESS: STREET 1: 720 E WISCONSIN AVE CITY: MILWAUKEE STATE: WI ZIP: 53202 BUSINESS PHONE: 4146652508 MAIL ADDRESS: STREET 1: 720 EAST WISCONSIN AVENUE CITY: MILWAUKEE STATE: WI ZIP: 53202 497 1 d497.txt NORTHWESTERN MUTUAL VARIABLE LIFE ACCOUNT/EXECUTIVE LIFE Variable Executive Life Flexible Premium Variable Life Insurance Policy April 30, 2004 [PICTURE] Prospectuses APRIL 30, 2004 Northwestern Mutual Series Fund, Inc., Fidelity VIP Mid Cap Portfolio and Russell Investment Funds [LOGO APPEARS HERE] The Northwestern Mutual Life Insurance Company 720 East Wisconsin Avenue Milwaukee, WI 53202 www.northwesternmutual.com (414) 271-1444 Contents for this Prospectus
Page ---- Prospectus........................................ 1 Northwestern Mutual Variable Executive Life....... 1 Summary of Benefits and Risks..................... 1 Benefits of the Policy........................... 1 Death Benefit.................................. 1 Access to Your Values.......................... 1 Flexibility.................................... 1 Tax Benefits................................... 1 Risks of the Policy.............................. 1 Investment Risk................................ 1 Policy as Long-Term Protection................. 1 Policy Lapse................................... 1 Limitations on Access to Your Values........... 1 Adverse Tax Consequences....................... 1 Fee Tables........................................ 2 Transaction Fees................................. 2 Periodic Charges Other Than Fund Operating Expenses............................. 2 Annual Fund Operating Expenses................... 3 Management Fees and Other Expenses for the Funds.......................................... 3 The Northwestern Mutual Life Insurance Company, Northwestern Mutual Variable Life Account, Northwestern Mutual Series Fund, Inc., Fidelity VIP Mid Cap Portfolio and Russell Investment Funds................................ 5 Northwestern Mutual.............................. 5 The Account...................................... 5 The Funds........................................ 5 Northwestern Mutual Series Fund, Inc........... 5 Fidelity VIP Mid Cap Portfolio................. 5 Russell Investment Funds....................... 5 Information About the Policy...................... 6 Availability Limitations......................... 6 Premiums......................................... 6 Policy Value..................................... 6 Death Benefit.................................... 6 Death Benefit Options.......................... 6 Choice of Tests for Tax Purposes............... 6 Death Benefit Changes.......................... 7
Page ---- Allocations to the Account................... 7 Charges and Expenses......................... 7 Premium Expense Charges..................... 7 Charges Against the Policy Value............ 8 Expenses of the Funds....................... 8 Policies Issued Prior to November 8, 1999... 8 Cash Value................................... 8 Policies with the Cash Value Amendment...... 9 Policies with the Return of Sales Load Amendment................................. 9 Policies issued Prior to November 8, 1999... 9 Policy Loans................................. 9 Withdrawals of Policy Value.................. 9 Termination and Reinstatement................ 10 Right to Return Policy....................... 10 Other Policy Provisions...................... 10 Owner....................................... 10 Beneficiary................................. 10 Incontestability............................ 10 Suicide..................................... 10 Misstatement of Age or Sex.................. 10 Collateral Assignment....................... 10 Deferral of Determination and Payment....... 10 Dividends................................... 10 Voting Rights................................ 10 Substitution of Fund Shares and Other Changes 11 Reports...................................... 11 Financial Statements......................... 11 Legal Proceedings............................ 11 Illustrations................................ 11 Tax Considerations........................... 11 General..................................... 11 Life Insurance Qualification................ 12 Tax Treatment of Life Insurance............. 12 Modified Endowment Contracts................ 12 Other Tax Considerations.................... 13
PROSPECTUS Northwestern Mutual Variable Executive Life Flexible Premium Variable Life Insurance Policy Summary of Benefits and Risks The following summary identifies some of the benefits and risks of the Policy. It omits important information which is included elsewhere in this prospectus, in the attached mutual fund prospectuses and in the terms of the Policy. Benefits of the Policy Death Benefit The primary benefit of your Policy is the life insurance protection that it provides. The Policy offers a choice of three death benefit options: Specified Amount (Option A); Specified Amount Plus Policy Value (Option B)--The Policy Value is the cumulative amount invested less withdrawals, adjusted for investment results and interest on Policy debt, reduced by the charges for insurance and other expenses; or Specified Amount Plus Premiums Paid (Option C). You select the Specified Amount when you purchase the Policy. In addition, we will increase the death benefit under any of the Options, if necessary to meet the definitional requirements for life insurance for federal income tax purposes. Access to Your Values You may surrender your Policy for the cash value at any time during the lifetime of the insured. You may make a withdrawal of Policy Value. You may borrow up to 90% of the Policy Value using the Policy as security. Flexibility You may select the death benefit option and Specified Amount subject to our availability limits. You control the amount and timing of premium payments, within limits. After a Policy is issued you may change the death benefit option, or increase or decrease the Specified Amount subject to our approval. You may direct the allocation of your premiums and apportion the Northwestern Mutual Variable Life Account ("Account") assets supporting your Policy among the 24 divisions of the Account. You may transfer accumulated amounts from one division to another. Tax Benefits You are generally not taxed on your Policy's investment gains until you surrender the Policy or make a withdrawal. Risks of the Policy Investment Risk Your Policy allows you to participate in the investment experience of the Account divisions you select. You bear the corresponding investment risks. You may find a comprehensive discussion of these risks in the attached prospectuses for the Funds. Policy as Long-Term Protection Your Policy is designed to serve your need for long-term life insurance protection. It is not a suitable vehicle for short-term goals. We have not designed the Policy for frequent trading. Policy Lapse Your Policy will lapse if you do not pay sufficient premium to keep it inforce. Favorable investment experience will reduce the required premium, but we do not guarantee investment experience. Policy loans or withdrawals of Policy Value may increase the premium required to keep the Policy inforce. Limitations on Access to Your Values A withdrawal of Policy Value may not reduce the loan value to less than any Policy debt outstanding. A withdrawn amount may not reduce the Specified Amount to less than the minimum amount we would issue at the time of the withdrawal. Following a withdrawal the remaining Policy Value, less any Policy debt outstanding, must be at least three times the current monthly charges for the cost of insurance and other expenses. The minimum amount for a withdrawal is $250. A withdrawal of Policy Value will reduce the death benefit. Adverse Tax Consequences Our understanding of the principal tax considerations for the Policy under current tax law is set forth in this prospectus. There are areas of some uncertainty under current law, and we do not address the likelihood of future changes in the law or interpretations thereof. Among other risks, your Policy may become a modified endowment contract if the cumulative premium you pay exceeds a defined limit; surrenders, withdrawals and loans under the Policy will then be taxable as ordinary income to the extent there are earnings in the Policy, and a 10% penalty may apply to these distributions. In addition, excessive Policy loans could cause a Policy to terminate with insufficient value to pay the tax due upon termination. Variable Executive Life Prospectus 1 Fee Tables The following tables describe the fees and expenses that you will pay when buying, owning, and surrendering the Policy. See "Charges and Expenses", p. 7, for a more detailed description. Transaction Fees This table describes the fees and expenses that you will pay when you pay premiums, transfer amounts between the Account divisions, make a withdrawal, change the Specified Amount or change the death benefit option. See "Charges and Expenses", p. 7, for a more detailed description.
Maximum Amount Charge When Charge is Deducted Current Amount Deducted Deducted - ----------------------------------------------------------------------------------------------------------------------------- Taxes Attributable to When you pay premiums 3.6% of the premium Same as current Premiums amount - ----------------------------------------------------------------------------------------------------------------------------- Sales Load When you pay premiums Up to 15% for the first Policy year; up to 6.8% for Policy Same as current years 2-6; up to 3% thereafter/(a)/ amount - ----------------------------------------------------------------------------------------------------------------------------- Fee for Transfer of When you make more Currently waived $25 Assets, Withdrawals or than 12 transfers of assets Change of Specified among the Account Amount divisions in a Policy year, make withdrawals or change the Specified Amount more than once in a Policy year - ----------------------------------------------------------------------------------------------------------------------------- Fee for Change in the When you change the Currently waived $250 Death Benefit Option death benefit option - -----------------------------------------------------------------------------------------------------------------------------
Periodic Charges Other than Fund Operating Expenses This table describes the fees and expenses, other than operating expenses for the Funds, that you will pay periodically during the time that you own the Policy. See "Charges and Expenses", p. 7, for a more detailed description.
Maximum Amount Charge When Charge is Deducted Current Amount Deducted Deducted - -------------------------------------------------------------------------------------------------------------------------------- Monthly Policy Monthly, on each monthly $0.19--$641.49 per year per $1,000 of net amount at $0.95--$1,000 per Charge--Cost of processing date risk/(c)/ year per $1,000 of net Insurance Charge/(b)/ amount at risk/(d)/ - -------------------------------------------------------------------------------------------------------------------------------- Monthly Policy Monthly, on each monthly 0.75% annually (monthly rate of 0.06250%) for the first 0.90% annually Charge--Mortality processing date ten Policy years and 0.32% annually (monthly rate of (monthly rate of and Expense Risk 0.02667%) thereafter/(f)/ 0.07500%) Charge/(e)/ - -------------------------------------------------------------------------------------------------------------------------------- Monthly Policy Monthly, on each monthly $180 annually ($15 monthly) for the first Policy year; $60 $180 annually ($15 Charge-- processing date annually ($5 monthly) thereafter monthly) for the first Administrative Charge Policy year; $120 annually ($10 monthly) thereafter - -------------------------------------------------------------------------------------------------------------------------------- Charge for Expenses Monthly, on each monthly 0.75% annually (monthly rate of 0.06250%) for the first 2% annually (monthly and Taxes Associated processing date ten Policy years; 0.20% annually (monthly rate of rate of 0.16667%) with Any Policy 0.01667%) thereafter Debt/(g)/ - --------------------------------------------------------------------------------------------------------------------------------
/(a)/The sales load in Policy years 1-6 is applied to the premiums paid up to the Target Premium. All other premiums are charged a 3% sales load. The initial Target Premium is generally based on a modified endowment contract seven-pay limit for the initial Specified Amount and the issue age and sex of the insured. Increases and decreases in the Specified Amount will be reflected in the Target Premium. /(b)/The cost of insurance rates shown in the table may not be representative of the charge that a particular Policyowner may pay. For information about the cost of insurance rate for your particular situation you may request a personalized illustration from your Northwestern Mutual Financial Representative. The cost of insurance charge is determined by multiplying the net amount at risk by the cost of insurance rate. The net amount at risk is equal to the death benefit currently in effect less the Policy Value. The cost of insurance rate reflects the issue age, sex and risk classification of the insured, Policy date, Policy duration and presence of the Cash Value Amendment if this applies. /(c)/For a sex neutral insured age 45 in the simplified issue non-tobacco risk classification, the current cost of insurance rate is $1.06 per year per $1,000 of net amount at risk. /(d)/For a sex neutral insured age 45 in the simplified issue non-tobacco risk classification, the maximum cost of insurance rate is $3.26 per year per $1,000 of net amount at risk. /(e)/The charge is applied to the Policy Value, less any Policy debt. /(f)/For Policies without the Cash Value Amendment the charge for Policy years eleven and later is 0.30% annually (monthly rate of 0.02500%). /(g)/The charge is applied to the Policy debt. We add unpaid interest to the amount of the loan. Interest on a Policy loan accrues and is payable on a daily basis at an annual effective rate of 5%. The amount of the Policy loan will be transferred from the Account divisions to our general account and credited on a daily basis with an annual earnings rate equal to the 5% Policy loan interest rate. 2 Variable Executive Life Prospectus Annual Fund Operating Expenses This table describes the fees and expenses for the Funds that you will pay daily during the time that you own the Policy. The table shows the range (minimum and maximum) of total operating expenses, including investment advisory fees, distribution (12b-1) fees and other expenses. The range shown in this table does not reflect fee waivers or expense limits and reimbursements. The information is based on operations for the year ended December 31, 2003. Information for the Russell Investment Funds has been restated to reflect current fee waivers and expense reimbursement as set forth in the footnotes for those funds. More details concerning these fees and expenses are contained in the attached prospectuses for the Funds.
Charge Minimum Maximum ------ ------- ------- Total Annual Fund Operating Expenses 0.20% 1.41%
Management Fees and Other Expenses for the Funds Fund operating expenses are expressed as a percentage of average net assets for the year ended December 31, 2003, except as otherwise set forth in the notes to this table.
Total Net Operating Expenses (Including Investment Total Contractual Waivers, Advisory Other 12b-1 Operating Limitations and Portfolio or Fund Fees Expenses Fees Expenses Reimbursements) - ----------------- ---------- -------- ----- --------- -------------------- Northwestern Mutual Series Fund, Inc. Small Cap Growth Stock Portfolio.................. 0.58% 0.01% -- 0.59% 0.59% T. Rowe Price Small Cap Value Portfolio/(a)/...... 0.85% 0.05% -- 0.90% 0.90% Aggressive Growth Stock Portfolio................. 0.52% 0.00% -- 0.52% 0.52% International Growth Portfolio/(b)/............... 0.75% 0.50% -- 1.25% 1.10% Franklin Templeton International Equity Portfolio. 0.67% 0.07% -- 0.74% 0.74% AllianceBernstein Mid Cap Value Portfolio/(c)/.... 0.85% 0.09% -- 0.94% 0.94% Index 400 Stock Portfolio......................... 0.25% 0.02% -- 0.27% 0.27% Janus Capital Appreciation Portfolio/(d)/......... 0.80% 0.10% -- 0.90% 0.90% Growth Stock Portfolio............................ 0.42% 0.01% -- 0.43% 0.43% Large Cap Core Stock Portfolio.................... 0.45% 0.01% -- 0.46% 0.46% Capital Guardian Domestic Equity Portfolio/(e)/... 0.65% 0.02% -- 0.67% 0.67% T. Rowe Price Equity Income Portfolio/(f)/........ 0.65% 0.12% -- 0.77% 0.75% Index 500 Stock Portfolio......................... 0.20% 0.00% -- 0.20% 0.20% Asset Allocation Portfolio/(g)/................... 0.59% 0.14% -- 0.73% 0.73% Balanced Portfolio................................ 0.30% 0.00% -- 0.30% 0.30% High Yield Bond Portfolio......................... 0.49% 0.03% -- 0.52% 0.52% Select Bond Portfolio............................. 0.30% 0.00% -- 0.30% 0.30% Money Market Portfolio/(h)/....................... 0.30% 0.00% -- 0.30% 0.00% Fidelity VIP Mid Cap Portfolio...................... 0.58% 0.12% 0.25% 0.95% 0.95% Russell Investment Funds Multi-Style Equity Fund/(j)/...................... 0.78% 0.17% -- 0.95% 0.87% Aggressive Equity Fund/(k)/....................... 0.95% 0.31% -- 1.26% 1.06% Non-U.S. Fund/(l)/................................ 0.95% 0.46% -- 1.41% 1.16% Core Bond Fund/(m)/............................... 0.60% 0.18% -- 0.78% 0.71% Real Estate Securities Fund/(n)/.................. 0.85% 0.10% -- 0.95% 0.95%
/(a)/T. Rowe Price Small Cap Value Portfolio Northwestern Mutual Series Fund's advisor, Mason Street Advisors, LLC ("MSA"), has contractually agreed to waive, at least until December 31, 2006, a portion of its 0.85% management fee, up to the full amount of that fee, equal to the amount by which the Portfolio's total operating expenses exceed 1.00% of the Fund's average daily net assets on an annual basis and to reimburse the Portfolio for all remaining expenses after fee waivers which exceed 1.00% of the average daily net assets on an annual basis. /(b)/International Growth Portfolio MSA has contractually agreed to waive, at least until December 31, 2006, a portion of its 0.75% management fee, up to the full amount of that fee, equal to the amount by which the Portfolio's total operating expenses exceed 1.10% of the Fund's average daily net assets on an annual basis and to reimburse the Portfolio for all remaining expenses after fee waivers which exceed 1.10% of the average daily net assets on an annual basis. Taking the fee waivers into account, the annual total operating expenses were 1.10% of the average net assets of the International Growth Portfolio. /(c)/AllianceBernstein Mid Cap Value Portfolio MSA has contractually agreed to waive, at least until December 31, 2008, a portion of its 0.85% management fee, up to the full amount of that fee, equal to the amount by which the Portfolio's total operating expenses exceed 1.00% of the Fund's average daily net assets on an annual basis and to reimburse the Portfolio for all remaining expenses after fee waivers which exceed 1.00% of the average daily net assets on an annual basis. /(d)/Janus Capital Appreciation Portfolio MSA has contractually agreed to waive, at least until December 31, 2008, a portion of its 0.80% management fee, up to the full amount of that fee, equal to the amount by which the Portfolio's total operating expenses exceed 0.90% of the Fund's average daily net assets on an annual basis and to reimburse the Portfolio for all remaining expenses after fee waivers which exceed 0.90% of the average daily net assets on an annual basis. Variable Executive Life Prospectus 3 /(e)/Capital Guardian Domestic Equity Portfolio MSA has contractually agreed to waive, at least until December 31, 2006, a portion of its 0.65% management fee, up to the full amount of that fee, equal to the amount by which the Portfolio's total operating expenses exceed 0.75% of the Fund's average daily net assets on an annual basis and to reimburse the Portfolio for all remaining expenses after fee waivers which exceed 0.75% of the average daily net assets on an annual basis. /(f)/T. Rowe Price Equity Income Portfolio MSA has contractually agreed to waive, at least until December 31, 2008, a portion of its 0.65% management fee, up to the full amount of that fee, equal to the amount by which the Portfolio's total operating expenses exceed 0.75% of the Fund's average daily net assets on an annual basis and to reimburse the Portfolio for all remaining expenses after fee waivers which exceed 0.75% of the average daily net assets on an annual basis. Taking the fee waivers into account, the annual total operating expenses were 0.75% of the average net assets of the T. Rowe Price Equity Income Portfolio. /(g)/Asset Allocation Portfolio MSA has contractually agreed to waive, at least until December 31, 2006, a portion of its 0.59% management fee, up to the full amount of that fee, equal to the amount by which the Portfolio's total operating expenses exceed 0.75% of the Fund's average daily net assets on an annual basis and to reimburse the Portfolio for all remaining expenses after fee waivers which exceed 0.75% of the average daily net assets on an annual basis. /(h)/Money Market Portfolio MSA has voluntarily waived its management fee since December 2, 2002. Taking the fee waiver into account the total operating expenses were 0.00% of the average net assets of the Money Market Portfolio. /(j)/Multi-Style Equity Fund The Fund's Manager, Frank Russell Investment Management Company (FRIMCo) has contractually agreed to waive, at least until April 30, 2005, a portion of its 0.78% management fee, up to the full amount of that fee, equal to the amount by which the Fund's total operating expenses exceed 0.87% of the Fund's average daily net assets on an annual basis and to reimburse the Fund for all remaining expenses, after fee waivers, which exceed 0.87% of the average daily net assets on an annual basis. /(k)/Aggressive Equity Fund FRIMCo has contractually agreed to waive, at least until April 30, 2005, a portion of its 0.95% management fee, up to the full amount of that fee, equal to the amount by which the Fund's total operating expenses exceed 1.05% of the Fund's average daily net assets on an annual basis and to reimburse the Fund for all remaining expenses, after fee waivers, which exceed 1.05% of the average daily net assets on an annual basis. /(l)/Non-U.S. Fund FRIMCo has contractually agreed to waive, at least until April 30, 2005, a portion of its 0.95% management fee, up to the full amount of that fee, equal to the amount by which the Fund's total operating expenses exceed 1.15% of the Fund's average daily net assets on an annual basis and to reimburse the Fund for all remaining expenses, after fee waivers, which exceed 1.15% of the average daily net assets on an annual basis. /(m)/Core Bond Fund FRIMCo has contractually agreed to waive, at least until April 30, 2005, a portion of its 0.60% management fee, up to the full amount of that fee, equal to the amount by which the Fund's total operating expenses exceed 0.70% of the Fund's average daily net assets on an annual basis and to reimburse the Fund for all remaining expenses, after fee waivers, which exceed 0.70% of the average daily net assets on an annual basis. /(n)/Real Estate Securities Fund FRIMCo has contractually agreed to waive, at least until April 30, 2005, a portion of its 0.85% management fee, up to the full amount of that fee, equal to the amount by which the Fund's total operating expenses exceed 1.10% of the Fund's average daily net assets on an annual basis and to reimburse the Fund for all remaining expenses, after fee waivers, which exceed 1.10% of the average daily net assets on an annual basis. 4 Variable Executive Life Prospectus The Northwestern Mutual Life Insurance Company, Northwestern Mutual Variable Life Account, Northwestern Mutual Series Fund, Inc., Fidelity VIP Mid Cap Portfolio and Russell Investment Funds Northwestern Mutual The Northwestern Mutual Life Insurance Company is a mutual life insurance company organized by a special act of the Wisconsin Legislature in 1857. It is licensed to conduct a conventional life insurance business in the District of Columbia and in all states of the United States. The total assets of Northwestern Mutual exceed $113.7 billion. Northwestern Mutual sells life and disability insurance policies and annuity contracts through its own field force of approximately 7,000 full time producing agents. Our Home Office is at 720 East Wisconsin Avenue, Milwaukee, Wisconsin 53202. "We" in this prospectus means Northwestern Mutual. The Account We established Northwestern Mutual Variable Life Account by action of our Trustees on November 23, 1983, in accordance with the provisions of Wisconsin insurance law. Under Wisconsin law the income, gains and losses, realized or unrealized, of the Account are credited to or charged against the assets of the Account without regard to our other income, gains or losses. We use the Account only for variable life insurance policies, including other variable life insurance policies which are described in other prospectuses. The Account is registered with the Securities and Exchange Commission as a unit investment trust under the Investment Company Act of 1940. This registration does not involve supervision of management or investment practices or policies. The Account has 24 divisions. All of the assets of each division are invested in shares of the corresponding Portfolio or Fund described below. The Funds Northwestern Mutual Series Fund, Inc. Northwestern Mutual Series Fund, Inc. is a mutual fund of the series type registered under the Investment Company Act of 1940 as an open-end diversified management investment company. The Account buys shares of each Portfolio at their net asset value without any sales charge. The investment adviser for the Fund is Mason Street Advisors, LLC ("MSA"), our wholly-owned company. MSA has retained Templeton Investment Counsel, LLC, Capital Guardian Trust Company, T. Rowe Price Associates, Inc., Alliance Capital Management L.P. and Janus Capital Management LLC under investment sub-advisory agreements to provide investment advice to six of the Portfolios. The types of investments for each of the Portfolios of the Fund are indicated by the names of the Portfolios. For information about the investment objectives and policies, the attendant risk factors and expenses see the attached prospectus for Northwestern Mutual Series Fund, Inc. Fidelity VIP Mid Cap Portfolio The Fidelity(R) VIP Mid Cap Portfolio is a fund of Variable Insurance Products Fund III, a mutual fund of the series type registered under the Investment Company Act of 1940 as an open-end diversified management investment company. The Account buys Service Class 2 shares of the Fidelity(R) VIP Mid Cap Portfolio at their net asset value. The investment adviser for the Fidelity(R) VIP Mid Cap Portfolio is Fidelity Management and Research Company. The Fidelity(R) VIP Mid Cap Portfolio normally invests at least 80% of its assets in securities of companies with medium market capitalization. These are companies with market capitalizations similar to companies in the Russell Midcap(R) Index or the Standard & Poor's(R) MidCap 400 Index. The Portfolio normally invests primarily in common stocks. For information about the investment objectives and policies, the attendant risk factors and expenses see the attached prospectus for the Fidelity(R) Variable Insurance Products Service Class 2 Mid Cap Portfolio. Russell Investment Funds The Russell Investment Funds comprise a mutual fund of the series type registered under the Investment Company Act of 1940 as an open-end diversified management investment company. The Account buys shares of each of the Russell Investment Funds at their net asset value without any sales charge. The assets of each of the Russell Investment Funds are invested by one or more investment management organizations researched and recommended by Frank Russell Company ("Russell"), and an affiliate of Russell, Frank Russell Investment Management Company ("FRIMCo"). FRIMCo also advises, operates and administers the Russell Investment Funds. Russell is our majority-owned subsidiary. The types of investments for each of the Russell Investment Funds are indicated by the names of the Funds. For information about the investment objectives and policies, the attendant risk factors and expenses see the attached prospectus for the Russell Investment Funds. Variable Executive Life Prospectus 5 Information About the Policy Availability Limitations We have designed the Variable Executive Life Policy for use with non-tax qualified executive benefit plans. We offer the Policy for use with corporate-sponsored plans where the first year premium for the plan will be at least $25,000. In addition, we offer this Policy where no corporate sponsor is involved and the first year premium for each Policy will be at least $25,000. We will permit exceptions in some cases and additional requirements may apply. Each case must be approved at our Home Office. Premiums The Policy permits you to pay premiums at any time before the Policy anniversary that is nearest the insured's 95th birthday and in any amounts within the limits described in this section. We use the Specified Amount you select when you purchase the Policy to determine the minimum initial premium. The minimum initial premium varies with the issue age and sex of the insured. We use the Target Premium to determine the sales load. The initial Target Premium is generally based on the modified endowment contract seven-pay limit for the initial Specified Amount and the age and sex of the insured. Increases and decreases in Specified Amount will be reflected in the Target Premium. After a Policy is issued, there are no minimum premiums, except that we will not accept a premium of less than $25. The Policy will remain inforce during the insured's lifetime so long as the Policy Value, less the amount of any Policy debt, is sufficient to pay the monthly cost of insurance charge and other current charges. The Policy sets no maximum on premiums, but we will accept a premium that would increase the net amount at risk only if the insurance, as increased, will be within our issue limits, the insured meets our insurability requirements and we receive the premium prior to the anniversary nearest the insured's 75th birthday. We will not accept a premium if it would disqualify the Policy as life insurance for federal income tax purposes. We will accept a premium, however, even if it would cause the Policy to be classified as a modified endowment contract. See "Tax Considerations", p. 11. We accept premium payment by various means, including check and electronic funds transfer (EFT). Policy Value The Policy Value is the cumulative amount invested, less withdrawals, adjusted for daily investment results and interest on Policy debt, reduced by the charges for insurance and other expenses. Death Benefit Death Benefit Options The Policy provides for three death benefit options: Specified Amount (Option A) Specified Amount Plus Policy Value (Option B) See "Policy Value" above. Specified Amount Plus Premiums Paid (Option C) You select the Specified Amount when you purchase the Policy. In addition, under any of the options, we will increase the Death Benefit if necessary to meet the definitional requirements for life insurance for federal income tax purposes as discussed below. Under any of the death benefit options the death benefit will be equal to the Policy Value at all times on and after the Policy anniversary nearest the 100th birthday of the insured. Choice of Tests for Tax Purposes A Policy must satisfy one of two testing methods to qualify as life insurance for federal income tax purposes. You may choose either the Guideline Premium/Cash Value Corridor Test or the Cash Value Accumulation Test. Both tests require the Policy to meet minimum ratios, or multiples, of death benefit to the Policy Value. The minimum multiple decreases as the age of the insured advances. You make the choice of testing methods when you purchase a Policy and it may not be changed. For the Guideline Premium/Cash Value Corridor Test the minimum multiples of death benefit to the Policy Value are shown below.
Guideline Premium/Cash Value ---------------------------- Corridor Test Multiples ----------------------- Policy Policy Attained Age Value % Attained Age Value % ------------ ------- ------------ ------- 40 or under. 250 61......... 128 41.......... 243 62......... 126 42.......... 236 63......... 124 43.......... 229 64......... 122 44.......... 222 65......... 120 45.......... 215 66......... 119 46.......... 209 67......... 118 47.......... 203 68......... 117 48.......... 197 69......... 116 49.......... 191 70......... 115 50.......... 185 71......... 113 51.......... 178 72......... 111 52.......... 171 73......... 109 53.......... 164 74......... 107 54.......... 157 75-90...... 105 55.......... 150 91......... 104 56.......... 146 92......... 103 57.......... 142 93......... 102 58.......... 138 94......... 101 59.......... 134 95 or over. 100 60.......... 130
6 Variable Executive Life Prospectus For the Cash Value Accumulation Test the minimum multiples of death benefit to the Policy Value are calculated using net single premiums based on the attained age of the insured and the Policy's underwriting classification, using a 4% interest rate. The Guideline Premium/Cash Value Corridor Test has lower minimum multiples than the Cash Value Accumulation Test, usually resulting in better cash value accumulation for a given amount of premium and Specified Amount. This is because the Guideline Premium/Cash Value Corridor Test generally requires a lower death benefit and therefore a lower cost of insurance charge. But the Guideline Premium/Cash Value Corridor Test limits the amount of premium that may be paid in each Policy year. The Cash Value Accumulation Test has no such annual limitation, and allows more premium to be paid during the early Policy years. Death Benefit Changes After we issue a Policy you may change the death benefit option, or increase or decrease the Specified Amount, subject to our approval. Changes are subject to insurability requirements and issue limits. We will not permit a change if it results in a Specified Amount less than the minimum for a new Policy that we would issue on that date. A change in the death benefit option, or an increase or decrease in the Specified Amount, will be effective on the monthly processing date next following receipt of a written request at our Home Office. Administrative charges of up to $250 for a change in the death benefit option, and up to $25 per change for more than one change in the Specified Amount in a Policy year, may apply. We will deduct any such charges from the Policy Value. We are currently waiving these charges. A change in the death benefit option, or an increase or decrease in the Specified Amount, may have important tax effects. See "Tax Considerations", p. 11. The cost of insurance charge will increase if a change results in a larger net amount at risk. See "Charges Against the Policy Value" p. 8. Allocations to the Account We place the initial net premium in the Account on the Policy date. Net premiums you pay thereafter are placed in the Account on the date we receive them at our Home Office. Net premiums are premiums less premium expense charges. See "Premium Expense Charges", below. We invest premiums we place in the Account prior to the initial allocation date in the Money Market Division of the Account. If you pay the initial premium and we issue the Policy as applied for, the initial allocation date is identified in the Policy and is the date the application is approved. Otherwise the initial allocation date is the later of the date we receive the initial premium at our Home Office or the date the Policy is delivered to the owner. A different initial allocation date applies in those states which require a refund of at least the premium paid during the period when the Policy may be returned. In those states, the initial allocation date will be the later of the date we receive the initial premium at our Home Office or one day after the end of the period during which the policyowner has the right to return the Policy, based on the applicable state laws. See "Right to Return Policy", p. 10. On the initial allocation date we invest the amount in the Money Market Division into the Account divisions as you have directed in the application for the Policy. You may change the allocation for future net premiums at any time by written request and the change will be effective for premiums we place in the Account thereafter. Allocations must be in whole percentages. You may transfer accumulated amounts from one division of the Account to another. Transfers are effective on the date we receive a written request at our Home Office. If you contemplate the transfer of funds from one division to another, you should consider the risk inherent in a switch from one investment medium to another. In general, frequent transfers based on short-term expectations for the stock and bond markets, especially transfers of large sums, will tend to accentuate the danger that a transfer will be made at an inopportune time. Frequent transfers, or transfers that are large in relation to the assets of the Portfolio or Fund in which a division invests, may also be disruptive and may disadvantage other investors. We reserve the right to limit the frequency or amount of transfers. See the attached prospectuses for the Funds for more information about their frequent trading policies. We will assist the Funds in the implementation of their policies. We reserve the right to charge a fee of up to $25, to cover administrative costs of transfers, if there are more than twelve transfers in a Policy year. We are currently waiving these fees. Charges and Expenses Premium Expense Charges We deduct a charge for taxes attributable to premiums from each premium. The total amount of this deduction is 3.6% of the premium. Of this amount, 2.35% is for state premium taxes. This 2.35% rate is an average rate since premium tax rates vary from state to state (they currently range from 0% to 3.5% of life insurance premiums). We do not expect to profit from this charge. The remainder of the deduction, 1.25% of each premium, is for federal income taxes measured by premiums. We believe that this charge does not exceed a reasonable estimate of our federal income taxes attributable to the treatment of deferred acquisition costs. We may change the charge for taxes to reflect any changes in the law. We generally deduct a charge for sales costs from each premium. Except as described below, the charge is 15% of premiums paid during the first Policy year up to the Target Premium, 6.8% of premiums paid during each of Policy years 2-6 up to the Target Premium, and 3% of all other premiums. The initial Target Premium is generally based on the modified endowment contract seven-pay limit for the initial Specified Amount and the issue age and sex of the insured. Increases and decreases in Specified Amount will be reflected in the Target Premium. See "Modified Endowment Contracts", p. 12. To the extent that sales expenses exceed the amounts deducted, we will pay the expenses from our other assets. These assets may include, among other things, any gain Variable Executive Life Prospectus 7 realized from the monthly charge against the Policy Value for the mortality and expense risks we have assumed, as described below. In certain cases involving a group of Policies purchased by an employer, where large amounts of aggregate first year premium are anticipated, we may waive the charge for sales costs for those Policies in the group representing anticipated first year premiums in excess of an aggregate amount we determine from time to time. If you are such an employer, you must present a request for a waiver of the charge prior to the time you apply for the Policies. It generally will be to your economic advantage to have no charge for sales costs deducted from at least some Policies in a group, as those Policies will generally have higher values than Policies where a charge has been deducted. However, if you seek to provide similar Policies and values to similarly situated employees (for example, in cases where the Policies may be transferred to employees as part of an employee benefit plan), you may prefer to have the charge for sales costs be determined on the same basis for all Policies in the group. Please ask your financial representative to provide you with further information on the waiver of charges for sales costs. Charges against the Policy Value We deduct a Monthly Policy Charge from the Policy Value on each monthly processing date. The Monthly Policy Charge includes the Cost of Insurance Charge, the Mortality and Expense Risk Charge, and the Monthly Administrative Charge. These three components of the Monthly Policy Charge are described in the following three paragraphs. As part of the Monthly Policy Charge, we deduct a Cost of Insurance Charge. We determine the amount by multiplying the net amount at risk by the cost of insurance rate. The net amount at risk is equal to the death benefit currently in effect less the Policy Value. The net amount at risk will be affected by investment performance, the amount and timing of premiums, and the charges and expenses for the Policy. The cost of insurance rate reflects the issue age, sex and risk classification of the insured, Policy date, Policy duration and presence of the Cash Value Amendment (if applicable). See "Cash Value", below. The maximum cost of insurance rates are included in the Policy. The second part of the Monthly Policy Charge is the Mortality and Expense Risk Charge. The maximum amount of the charge is equal to an annual rate of 0.90% (0.07500% monthly rate) of the Policy Value, less any Policy debt. Currently the charge is equal to an annual rate of 0.75% (0.06250% monthly rate) of Policy Value, less any Policy debt, for the first ten Policy years and 0.32% (0.02667% monthly rate) thereafter for Policies with the Cash Value Amendment, or 0.30% (0.02500% monthly rate) thereafter for Policies without the Cash Value Amendment. See "Cash Value" below. The mortality risk is that insureds may not live as long as we estimated. The expense risk includes the risk that expenses of issuing and administering the Policies may exceed the estimated costs. We will realize a gain from this charge to the extent it is not needed to provide benefits and pay expenses under the Policies. The third part of the Monthly Policy Charge is the Monthly Administrative Charge of not more than $15 monthly for the first Policy year and $10 monthly thereafter. Currently this charge will be $5 monthly after the first Policy year. This charge is for administrative expenses, including costs of premium collection, processing claims, keeping records and communicating with Policyowners. We do not expect to profit from this charge. In addition to the Monthly Policy Charge, we deduct a charge for the expenses and taxes associated with the Policy debt, if any. The aggregate charge is at the current annual rate of 0.75% (0.06250% monthly rate) of the Policy debt for the first 10 Policy years and 0.20% (0.01667% monthly rate) thereafter. The Policy provides for transaction fees to be deducted from the Policy Value on the dates on which transactions take place. These charges are $25 per change for more than one change in the Specified Amount in a Policy year, withdrawals or transfers of assets among the divisions of the Account if more than twelve transfers take place in a Policy year. The fee for a change in the death benefit option is $250. Currently we are waiving all of these fees. We will apportion deductions from the Policy Value among the divisions of the Account in proportion to the amounts invested in the divisions. For policies with the Monthly Charges From One Division Amendment, the policyowner may elect in writing to have Cost of Insurance Charges, Mortality and Expense Risk Charges, Monthly Administrative Charges, and charges for expenses and taxes associated with the Policy debt, if any, deducted from one division. We reserve the right to determine which divisions to make available for this election. Currently, the Money Market Division is available for this election. If the amount in the specified division is not sufficient to pay these charges, the remainder of these charges is deducted from each division in proportion to the amounts invested in the divisions. This amendment is available only to corporate-sponsored plans where at least five Policies will be issued, each on a life of a different eligible insured person. Expenses of the Funds The investment performance of each division of the Account reflects all expenses borne by the corresponding Portfolio or Fund. The expenses are summarized on page 3. See the attached mutual fund prospectuses for more information about those expenses. Policies Issued Prior to November 8, 1999 For Policies issued prior to November 8, 1999, including Policies issued after that date in states where the current Policy form had not been approved at the time of policy issuance, the deduction from premiums for sales costs is 15% of premiums paid during the first Policy year up to the Target Premium and 3% of all other premiums. Cash Value You may surrender a Policy for the cash value at any time during the lifetime of the insured. The cash value for the Policy will change daily in response to investment results. No 8 Variable Executive Life Prospectus minimum cash value is guaranteed. The cash value is equal to the Policy Value reduced by any Policy debt outstanding. We determine the cash value for a Policy at the end of each valuation period. Each business day, together with any non-business days before it, is a valuation period. A business day is any day on which the New York Stock Exchange is open for trading. In accordance with the requirements of the Investment Company Act of l940, we may also determine the cash value for a Policy on any other day on which there is sufficient trading in securities to materially affect the value of the securities held by the Portfolios or Funds. You may effectively accomplish a partial surrender of your Policy by a withdrawal of Policy Value. See "Withdrawals of Policy Value" below. Policies with the Cash Value Amendment The cash value of the Policy is increased in the first, second, and third Policy years assuming the Policy is not in a grace period on the date on which you surrender the Policy. The increase in cash value in the first three policy years is (c) multiplied by the sum of (a) plus (b), where: (a) is the cumulative sales load deducted from premiums paid to date, (b) is 4% of the sum of premiums paid to date, and (c) is an adjustment factor equal to 100.00% in the first Policy year, 66.67% in the second Policy year, and 33.33% in the third Policy year. This increase in cash value is available only for Policies issued on or after January 15, 2003 to corporate-sponsored plans where at least five Policies will be issued, each on a life of a different eligible insured person. This increase in cash value is not available for Policies (1) for individuals where no corporate sponsor is involved, (2) for corporate-sponsored plans with fewer than five Policies, and (3) for corporate-sponsored plans issued prior to January 15, 2003. Policies with the Return of Sales Load Amendment The cash value of the Policy is increased in the first, second, and third Policy years assuming the Policy is not in a grace period on the date on which you surrender the Policy. During the first Policy year the cash value is increased by the amount of sales loads previously deducted from premiums, during the second Policy year the cash value is increased by 66.67% of previous sales load deductions and during the third Policy year the cash value is increased by 33.33% of the previous sales load deductions. This increase in cash value is available only for policies issued November 8, 1999 or later in approved states, but before approval of the Cash Value Amendment described above, to corporate-sponsored plans where at least five policies will be issued, each on a life of a different eligible insured person. This increase in cash value is not available in New Jersey. Policies issued prior to November 8, 1999 For policies issued prior to November 8, 1999, including policies issued after that date in states where the current Policy form had not been approved, the cash value of the Policy is increased in the first and second Policy years assuming the Policy is not in a grace period on the date on which you surrender the Policy. During the first Policy year the cash value is increased by the amount of sales load deducted from premiums, and during the second Policy year the cash value is increased by 50% of previous sales load deductions. This increase in cash value is not available in New Jersey. Policy Loans You may borrow up to 90% of the Policy Value using the Policy as security. If a Policy loan is already outstanding, the maximum amount for any new loan is 90% of the Policy Value, less the amount already borrowed. Interest on a Policy loan accrues and is payable on a daily basis at an annual effective rate of 5%. We add unpaid interest to the amount of the loan. If the amount of the loan equals or exceeds the Policy Value on a monthly processing date, the Policy will enter the grace period. See "Termination and Reinstatement", p. 10. We will send you a notice at least 61 days before the termination date. The notice will show how much you must pay to keep the Policy inforce. We will take the amount of a Policy loan from the Account divisions in proportion to the amounts in the divisions. We will transfer the amounts withdrawn to our general account and will credit them on a daily basis with an annual earnings rate equal to the 5% Policy loan interest rate. A Policy loan, even if you repay it, will have a permanent effect on the Policy Value because the amounts borrowed will not participate in the Account's investment results while the loan is outstanding. The effect may be either favorable or unfavorable depending on whether the earnings rate credited to the loan amount is higher or lower than the rate credited to the unborrowed amount left in the Account. You may repay a Policy loan, and any accrued interest outstanding, in whole or in part, at any time. We will credit payments as of the date we receive them and will transfer those amounts from our general account to the Account divisions, in proportion to the premium allocation in effect, as of the same date. A Policy loan may have important tax consequences. See "Tax Considerations", p. 11. Withdrawals of Policy Value You may make a withdrawal of Policy Value. A withdrawal may not reduce the loan value to less than any Policy debt outstanding. The loan value is 90% of the Policy Value. A withdrawal amount may not reduce the Specified Amount to less than the minimum amount we would issue at the time of the withdrawal. Following a withdrawal the remaining Policy Value, less any Policy debt outstanding, must be at least three times the current monthly charges for the cost of insurance and other expenses. The minimum amount for withdrawals is $250. We permit up to four withdrawals in a Policy year. An administrative charge of up to $25 may apply, but we are currently waiving this charge. A withdrawal of Policy Value decreases the death benefit and may also decrease the Specified Amount. The amount of the decrease depends on the death benefit option and the amount of any prior increases in death benefit required to meet the Variable Executive Life Prospectus 9 definitional requirements for life insurance for federal income tax purposes. In some situations, the death benefit may decrease by more than the amount of the withdrawal. We will take the amount withdrawn from Policy Value from the Account divisions in proportion to the amounts in the divisions. The Policy makes no provision for repayment of amounts withdrawn. A withdrawal of Policy Value may have important tax consequences. See "Tax Considerations", p. 11. Termination and Reinstatement If the Policy Value, less any Policy debt outstanding, is less than the monthly charges for the cost of insurance and other expenses on any monthly processing date, we allow a grace period of 61 days for a premium payment to keep the Policy inforce. The grace period begins on the date that we send you a notice. The notice will state the minimum amount of premium required to keep the Policy inforce and the date by which you must pay the premium. The Policy will terminate unless you pay the required amount before the grace period expires. After a Policy has terminated, it may be reinstated within one year. The insured must provide satisfactory evidence of insurability. The minimum amount of premium required for reinstatement will be the monthly charges that were due when the Policy terminated plus the charges for three more months. Reinstatement of a Policy will be effective on the first monthly processing date after an application for reinstatement is received at our Home Office, subject to our approval. Any Policy debt that was outstanding when the Policy terminated will also be reinstated. The Policy Value when a Policy is reinstated is equal to the premium paid, less premium expense charges, less the sum of all monthly charges for the cost of insurance and other expenses for the grace period and for the current month. Any Policy debt on the date of termination will also be reinstated and added to the Policy Value. We will allocate the Policy Value less Policy debt among the Account divisions based on the allocations for premiums currently in effect. A Policy may not be reinstated after the Policy has been surrendered for its cash value. See "Tax Considerations", p. 11, for a discussion of the tax effects associated with termination and reinstatement of a Policy. Right to Return Policy You may return a Policy within 45 days after you signed the application for insurance or within 10 days (or later where required by state law) after you receive the Policy, whichever is later. You may mail or deliver the Policy to the agent who sold it or to our Home Office. If you return it, we will consider the Policy void from the beginning. We will refund the sum of the amounts deducted from the premium paid plus the value of the Policy in the Account on the date we receive a written request for the return of the premium at our Home Office. In some states, the amount we refund will not be less than the premium you paid. Other Policy Provisions Owner The owner is identified in the Policy. The owner may exercise all rights under the Policy while the insured is living. Ownership may be transferred to another. We must receive written proof of the transfer at our Home Office. "You" in this prospectus means the owner or prospective purchaser of a Policy. Beneficiary The beneficiary is the person to whom the death benefit is payable. The beneficiary is named in the application. After we issue the Policy you may change the beneficiary in accordance with the Policy provisions. Incontestability We will not contest a Policy after it has been inforce during the lifetime of the insured for two years from the date of issue. We will not contest an increase in the amount of insurance that was subject to insurability requirements after the increased amount has been inforce during the lifetime of the insured for two years from the date of issuance of the increase. Suicide If the insured dies by suicide within one year from the date of issue, the amount payable under the Policy will be limited to the premiums paid, less the amount of any Policy debt and withdrawals. If the insured dies by suicide within one year of the date of issuance of an increase in the amount of insurance, which was subject to insurability requirements, the amount payable with respect to the increase will be limited to the amounts charged for the cost of insurance and other expenses attributable to the increase. Misstatement of Age or Sex If the age or sex of the insured has been misstated, we will adjust the charges for cost of insurance and other expenses under a Policy to reflect the correct age and sex. Collateral Assignment You may assign a Policy as collateral security. We are not responsible for the validity or effect of a collateral assignment and will not be deemed to know of an assignment before receipt of the assignment in writing at our Home Office. Deferral of Determination and Payment We will ordinarily pay Policy benefits within seven days after we receive all required documents at our Home Office. However, we may defer determination and payment of benefits during any period when it is not reasonably practicable to value securities because the New York Stock Exchange is closed or an emergency exists or the Securities and Exchange Commission, by order, permits deferral for the protection of Policyowners. Dividends The Policy may share in our divisible surplus to the extent that the Policy contributes to the surplus. Since we do not expect the Policies to contribute to divisible surplus, we do not expect to pay any dividends. Voting Rights We are the owner of the shares of the mutual funds in which all assets of the Account are invested. As the owner of the shares we will exercise our right to vote the shares to elect directors of the mutual funds, to vote on matters required to be 10 Variable Executive Life Prospectus approved or ratified by mutual fund shareholders under the Investment Company Act of 1940 and to vote on any other matters that may be presented to any mutual fund shareholders' meeting. However, we will vote the mutual fund shares held in the Account in accordance with instructions from owners of the Policies. We will vote any shares of the mutual funds held in our general account in the same proportions as the shares for which we have received voting instructions. If the applicable laws or regulations change so as to permit us to vote the shares in our own discretion, we may elect to do so. The number of mutual fund shares for each division of the Account for which the owner of a Policy may give voting instructions is determined by dividing the amount of the Policy Value apportioned to that division, if any, by the per share value for the corresponding Portfolio or Fund. The number will be determined as of a date we choose, but not more than 90 days before the shareholders' meeting. Fractional votes are counted. We will solicit voting instructions with written materials at least 14 days before the meeting. We will vote shares as to which we receive no instructions in the same proportion as the shares as to which we receive instructions. We may, if required by state insurance officials, disregard voting instructions which would require mutual fund shares to be voted for a change in the sub-classification or investment objectives of a Portfolio or Fund, or to approve or disapprove an investment advisory agreement for one or more of the mutual funds. We may also disregard voting instructions that would require changes in the investment policy or investment adviser for either a Portfolio or a Fund, provided that we reasonably determine to take this action in accordance with applicable federal law. If we disregard voting instructions, we will include a summary of the action and reasons therefore in the next semiannual report to the owners of the Policies. Substitution of Fund Shares and Other Changes If, in our judgment, a Portfolio or Fund becomes unsuitable for continued use with the Policies because of a change in investment objectives or restrictions, shares of another Portfolio or Fund or another mutual fund may be substituted. Any substitution of shares will be subject to any required approval of the Securities and Exchange Commission, the Wisconsin Commissioner of Insurance or other regulatory authority. We have also reserved the right, subject to applicable federal and state law, to operate the Account or any of its divisions as a management company under the Investment Company Act of 1940, or in any other form permitted, or to terminate registration of the Account if registration is no longer required, and to change the provisions of the Policies to comply with any applicable laws. Reports At least once each Policy year you will receive a statement showing the death benefit, cash value, Policy Value and any Policy loan, including loan interest. This report will show the apportionment of invested assets among the Account divisions. You will also receive annual and semiannual reports for the Account and for each of the mutual funds, including financial statements. Financial Statements Financial statements of the Account and financial statements of Northwestern Mutual appear in the Statement of Additional Information. Legal Proceedings We are engaged in litigation of various kinds which in our judgment is not of material importance in relation to our total assets. There are no legal proceedings pending to which the Account is a party. Illustrations Your financial representative will provide you with illustrations for a Policy upon your request. The illustrations show how the death benefit and cash value for a Policy would vary based on hypothetical investment results. The illustrations will be based on the information you give us about the insured person and will reflect such factors as the Specified Amount, death benefit option and premium payments that you select. These should be based upon realistic expectations given your own individual situation. Illustrations for variable life insurance policies do not project or predict investment results. The illustrated values assume that non-guaranteed elements such as policy charges and level investment returns will not change. Given the volatility of the securities markets over time, the illustrated scenario is unlikely to occur and the policy's actual cash value, death benefit, and certain expenses (which will vary with the investment performance of the portfolios) will be more or less than those illustrated. In addition, the actual timing and amounts of payments, deductions, expenses and any values removed from the policy will also impact product performance. Due to these variations, even a portfolio that averaged the same return as illustrated will produce values which will be more or less than those which were originally illustrated. Tax Considerations General The following discussion provides a general description of federal income tax considerations relating to the Policy. The discussion is based on current provisions of the Internal Revenue Code ("Code") as currently interpreted by the Internal Revenue Service. We do not intend this as tax advice. The discussion is not exhaustive, it does not address the likelihood of future changes in federal income tax law or interpretations thereof, and it does not address state or local tax considerations which may be significant in the purchase and ownership of a Policy. The Economic Growth and Tax Relief Reconciliation Act of 2001, enacted on June 7, 2001, made substantial changes to the estate, gift and generation skipping transfer tax. The Act increases the amount of an estate exempt from tax from Variable Executive Life Prospectus 11 $675,000 in 2001 to $1 million in 2002, $2 million in 2006 and $3.5 million in 2009. The Act reduces the top estate, gift and generation skipping transfer tax rate from 55% in 2001 to 45% in 2009. In 2010, the estate tax and generation skipping transfer tax are repealed and the gift tax is reduced to 35%. All of these changes are sunsetted or repealed in 2011, unless extended or made permanent. It is generally believed that the estate tax repeal will not be made permanent but that further changes may be made. Life Insurance Qualification Section 7702 of the Code defines life insurance for federal income tax purposes. The Code provides two alternative tests for determining whether the death benefit is a sufficient multiple of the Policy Value. See "Choice of Tests for Tax Purposes", p. 6. We have designed the Policy to comply with these rules. We will return premiums that would cause a Policy to be disqualified as life insurance, or take any other action that may be necessary for the Policy to qualify as life insurance. Section 817(h) of the Code authorizes the Secretary of the Treasury to set standards for diversification of the investments underlying variable life insurance policies. Final regulations have been issued pursuant to this authority. Failure to meet the diversification requirements would disqualify the Policies as life insurance for purposes of Section 7702 of the Code. We intend to comply with these requirements. On July 24, 2003, the Internal Revenue Service issued Rev. Ruls, 2003-91 and 2003-92 that provide guidance on when a policyowner's control of separate account assets will cause the policyowner, and not the life insurance company, to be treated as the owner of those assets. Important indicators of investor control are the ability of the policyowner to select the investment advisor, the investment strategy or particular investments of the separate account. If the owner of a Policy were treated as the owner of the Fund shares held in the Account, the income and gains related to those shares would be included in the owner's gross income for federal income tax purposes. We believe that we own the assets of the Account under current federal income tax law. Tax Treatment of Life Insurance While a Policy is inforce, increases in the Policy Value as a result of investment experience are not subject to federal income tax until there is a distribution as defined by the Code. The death benefit received by a beneficiary will not be subject to federal income tax. Unless the Policy is a modified endowment contract, as described below, a loan received under a Policy will not be treated as a distribution subject to current federal income tax. Interest paid by individual owners of the Policies will ordinarily not be deductible. You should consult a qualified tax adviser as to the deductibility of interest paid, or accrued, by other purchasers of the Policies. See "Other Tax Considerations", p. 13. As a general rule, the proceeds from a withdrawal of Policy Value will be taxable only to the extent that the withdrawal exceeds the basis of the Policy. The basis of the Policy is generally equal to the premiums paid less any amounts previously received as tax-free distributions. In certain circumstances, a withdrawal of Policy Value during the first 15 Policy years may be taxable to the extent that the Policy Value exceeds the basis of the Policy. This means that the amount withdrawn may be taxable even if that amount is less than the basis of the Policy. Caution must be used when taking cash out of a Policy through policy loans. If interest is not paid annually, it is added to the principal amount and the total amount will continue to accrue for as long as the loan is maintained on the Policy. If the Policy remains inforce until death, the loan will be repaid from the tax-free death benefit. However, if the Policy terminates by any method other than death, the total cash value of the Policy, plus the total amount of the loan, will be taxable to the extent it exceeds the basis of the Policy. In extreme situations, policyowners can face what is called the "surrender squeeze". The surrender squeeze occurs when there is neither enough unborrowed value remaining in the Policy to cover the interest payment required to keep the Policy inforce, nor to cover the tax due if the Policy terminates. Either the interest would have to be paid annually or the Policy would terminate and any income tax due would have to be paid with other assets. Special tax rules may apply when ownership of a Policy is transferred. You should seek qualified tax advice if you plan a transfer of ownership. Modified Endowment Contracts A Policy will be classified as a modified endowment contract if the cumulative premium paid during the first seven Policy years exceeds a defined "seven-pay" limit. The seven-pay limit is based on a hypothetical life insurance policy issued on the same insured person and for the same initial death benefit which, under specified conditions (which include the absence of expense and administrative charges) will be fully paid for after seven level annual payments. A Policy will be treated as a modified endowment contract unless cumulative premiums paid under the Policy, at all times during the first seven Policy years, are less than or equal to the cumulative seven-pay premiums which would have been paid under the hypothetical policy on or before such times. Whenever there is a "material change" under a Policy, it will generally be treated as a new contract for purposes of determining whether the Policy is a modified endowment contract, and subjected to a new seven-pay period and a new seven-pay limit. The new seven-pay limit would be determined taking into account the Policy Value of the Policy at the time of such change. A materially changed Policy would be considered a modified endowment contract if it failed to satisfy the new seven-pay limit. A material change could occur as a result of a change in the death benefit option, a change in the Specified Amount, and certain other changes. If the benefits are reduced during the first seven Policy years after entering into the Policy (or within seven years after a material change), for example, by requesting a decrease in the Specified Amount or, in some cases, by lapsing the Policy or making a withdrawal of Policy Value, the seven-pay premium 12 Variable Executive Life Prospectus limit will be redetermined based on the reduced level of benefits and applied retroactively for purposes of the seven-pay test. If the premiums previously paid are greater than the recalculated seven-pay premium limit, the Policy will become a modified endowment contract. A life insurance policy which is received in exchange for a modified endowment contract will also be considered a modified endowment contract. If a Policy is a modified endowment contract, any distribution from the Policy will be taxed on a gain-first basis. Distributions for this purpose include a loan (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 a withdrawal of Policy Value. Any such distributions will be considered taxable income to the extent the Policy Value exceeds the basis in the Policy. For modified endowment contracts, the basis would be increased by the amount of any prior loan under the Policy that was considered taxable income. For purposes of determining the taxable portion of any distribution, all modified endowment contracts issued by Northwestern Mutual to the same policyowner (excluding certain qualified plans) during any calendar year are to be aggregated. The Secretary of the Treasury has authority to prescribe additional rules to prevent avoidance of gain-first taxation on distributions from modified endowment contracts. A 10% penalty tax will apply to the taxable portion of a distribution from a modified endowment contract. The penalty tax will not, however, apply to distributions (i) to taxpayers 59 1/2 years of age or older, (ii) in the case of a disability (as defined in the Code) or (iii) received as part of a series of substantially equal periodic annuity payments for the life (or life expectancy) of the taxpayers or the joint lives (or joint life expectancies) of the taxpayer and his beneficiaries. If a Policy is surrendered, the excess, if any, of the Policy Value over the basis of the Policy will be subject to federal income tax and, unless one of the above exceptions applies, the 10% penalty tax. The exceptions generally do not apply to life insurance policies owned by corporations or other entities. If a Policy terminates while there is a Policy loan, the cancellation of the loan and accrued loan interest will be treated as a distribution to the extent not previously treated as such and could be subject to tax, including the penalty tax, as described under the above rules. If a Policy becomes a modified endowment contract, distributions that occur during the Policy year it becomes a modified endowment contract and any subsequent Policy year will be taxed as described in the two preceding paragraphs. In addition, distributions from a Policy within two years before it becomes a modified endowment contract will be subject to tax in this manner. This means that a distribution made from a Policy that is not a modified endowment contract could later become taxable as a distribution from a modified endowment contract. The Secretary of the Treasury has been authorized to prescribe rules which would treat similarly other distributions made in anticipation of a policy becoming a modified endowment contract. Other Tax Considerations Business-owned life insurance may be subject to certain additional rules. Section 264(a)(1) of the Code generally disallows a deduction for premiums paid on Policies by anyone who is directly or indirectly a beneficiary under the Policy. Increases in Policy Value may also be subject to tax under the corporation alternative minimum tax provisions. Section 264(a)(4) of the Code limits the Policyowner's deduction for interest on loans taken against life insurance policies to interest on an aggregate total of $50,000 of loans per covered life only with respect to life insurance policies covering key persons. Generally, a key person means an officer or a 20% owner. However, the number of key persons will be limited to the greater of (a) five individuals, or (b) the lesser of 5% of the total officers and employees of the taxpayer or 20 individuals. Deductible interest for these Policies will be subject to limits based on current market rates. In addition, Section 264(f) disallows a proportionate amount of a business' interest deduction on non-life insurance indebtedness based on the amount of unborrowed cash value of non-exempt life insurance policies held in relation to other business assets. Exempt policies include policies held by natural persons unless the business is a direct or indirect beneficiary under the policy and policies owned by a business and insuring employees, directors, officers and 20% owners (as well as joint policies insuring 20% owners and their spouses). Congress also is considering limiting the tax free death benefit on business-owned life insurance to policies insuring highly compensated employees who consent to the coverage. Finally, life insurance purchased under a split dollar arrangement is subject to special tax rules. Under prior Internal Revenue Service rulings, a split dollar arrangement was taxable to the employee in the amount of the annual value of the economic benefit to the employee measured by the insurer's lowest one year term rates as defined by the various Internal Revenue Service rulings or the government's P.S. 58 rate table. Then on January 3, 2002, the Internal Revenue Service published Notice 2002-8 which: (1) provided that, until the issuance of further guidance, life insurance protection can be valued using Table 2001 rates or the insurer's lower one year term rates (after 2003, the alternate term rates for arrangements entered into after January 28, 2002 must satisfy additional sales requirements); and (2) provided that, for split dollar arrangements entered into prior to the publication of final regulations, (a) the annual accrual of income will not, by itself, be enough to trigger a taxable transfer; (b) equity (cash surrender value in excess of the amount payable to the employer) will not be taxed regardless of the level of the employer's economic interest in the life insurance policy as long as the value of the life insurance protection is treated and reported as an economic benefit; (c) the employee can elect loan treatment at any time, provided all premiums paid by the employer are treated as a loan entered into at the beginning of the first year in which payments are treated as loans; and (d) for arrangements entered into before January 28, 2002, equity Variable Executive Life Prospectus 13 is not taxed if the split dollar arrangement is terminated prior to January 1, 2004 or if the arrangement is converted to a loan beginning on or after January 1, 2004 and all payments by the employer from the beginning of the arrangement are treated as loans. On September 17, 2003, the Treasury and Internal Revenue Service issued final regulations regarding the taxation of split dollar arrangements. The regulations provide that split dollar arrangements must be taxed under one of two mutually exclusive tax regimes depending on the ownership of the underlying life insurance policy. Collateral assignment split dollar arrangements, in which the employee owns the policy, must be taxed under a loan regime. Where such an arrangement imposes a below market or no interest rate, the employee is taxed on the imputed interest under Section 7872 of the Code. Endorsement split dollar arrangements, in which the employer owns the policy, must be taxed under an economic benefit regime. Under this regime, the employee is taxed each year on (i) the current life insurance protection transferred to the employee, (ii) the amount of policy cash value to which the employee has current access, and (iii) the value of any other economic benefits provided to the employee during the taxable year. The final regulations apply only to arrangements entered into or materially changed after September 17, 2003. The Treasury and the Internal Revenue Service are currently developing additional guidance on the appropriate method of valuing life insurance protection in split-dollar arrangements. Depending on the circumstances, the exchange of a Policy, a Policy loan, a change in ownership or an assignment of the Policy may have federal income tax consequences. In addition, federal, state and local transfer, estate, inheritance, and other tax consequences of Policy ownership, premium payments and receipt of Policy proceeds depend on the circumstances of each Policyowner or beneficiary. If you contemplate any such transaction you should consult a qualified tax adviser. On July 30, 2002, the Sarbanes-Oxley Act of 2002 was signed into law. One provision of the Act provides that it is a criminal offense for a public employer to extend or arrange a personal loan to a director or executive officer after July 30, 2002. One issue that has not been clarified is whether each premium paid by a public employer under a split dollar arrangement with a director or executive officer is a personal loan subject to the new law. On February 28, 2003 and December 29, 2003, the Treasury and the Internal Revenue Service issued regulations that require taxpayers to annually report all "reportable transactions" as defined in the regulations. "Reportable transactions" include transactions that are offered under conditions of confidentiality as to tax treatment and involve an advisor who receives a fee of $250,000 or more, investments by a public company or a business with assets of $100 million or more that produce a book-tax difference of $10 million or more, or transactions that include a tax indemnity. Rev. Proc. 2003-25 further held that the purchase of life insurance policies by a business does not, by itself, constitute a "reportable transaction". 14 Variable Executive Life Prospectus Additional information about Northwestern Mutual Variable Life Account is provided in a Statement of Additional Information which we have filed with the Securities and Exchange Commission. The Statement of Additional Information is incorporated herein by reference. The Statement of Additional Information is available without charge if you call 1-888-455-2232. Variable Executive Life Prospectus 15 More information about Northwestern Mutual Series Fund, Inc. is included in the Fund's Statement of Additional Information (SAI), incorporated by reference in this prospectus, which is available free of charge. More information about the Fund's investments is included in the Fund's annual and semi-annual reports, which discuss the market conditions and investment strategies that significantly affected each Portfolio's performance during the previous fiscal period. To request a free copy of the Fund's SAI, or current annual or semi-annual report, call us at 1-888-455-2232. Information about the Fund (including the SAI) can be reviewed and copied at the Public Reference Room of the Securities and Exchange Commissions (SEC) in Washington, DC. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. Reports and other information about the Fund are available on the SEC's Internet site at http://www.sec.gov. Copies of the information may be obtained upon payment of a duplicating fee, by writing the Public Reference Section of the SEC, Washington, DC 20549-6009. Northwestern Mutual Northwestern Mutual Variable Executive Life Northwestern Mutual Variable Life Account Northwestern Mutual Series Fund, Inc. Fidelity VIP Mid Cap Portfolio Russell Investment Funds The Northwestern Mutual Prospectuses Life Insurance Company . Milwaukee, WI Investment Company Act www.northwesternmutual.com File Nos. 811-3990, 811-5371 and 811-7205 34-1011 (0501) (REV 0404) [LOGO APPEARS HERE] P.O. Box 3095 Milwaukee, WI 53201-3095 PRSRT STD US POSTAGE PAID MILWAUKEE WI PERMIT NO. 426 STATEMENT OF ADDITIONAL INFORMATION VARIABLE EXECUTIVE LIFE (Flexible Premium Variable Life Insurance Policy) NORTHWESTERN MUTUAL VARIABLE LIFE ACCOUNT (the "Account"), a separate investment account of The Northwestern Mutual Life Insurance Company ("Northwestern Mutual") - -------------------------------------------------------------------------------- This Statement of Additional Information is not a prospectus but supplements and should be read in conjunction with the prospectus for the Policy. A copy of the prospectus may be obtained from The Northwestern Mutual Life Insurance Company, 720 East Wisconsin Avenue, Milwaukee, Wisconsin 53202, telephone number (414) 271-1444. - -------------------------------------------------------------------------------- The Date of the Prospectus to which this Statement of Additional Information Relates is April 30, 2004. The Date of this Statement of Additional Information is April 30, 2004. B-1 DISTRIBUTION OF THE POLICIES The Policies are offered on a continuous basis exclusively through individuals who, in addition to being life insurance agents of Northwestern Mutual, are registered representatives of Northwestern Mutual Investment Services, LLC ("NMIS"). NMIS is our wholly-owned company. The principal business address of NMIS is 720 East Wisconsin Avenue, Milwaukee, Wisconsin 53202. NMIS may be considered the underwriter of the Policies for purposes of the federal securities laws. The following amounts of commissions were paid on sales of variable life insurance policies issued in connection with the Account during each of the last three years: Year Amount - ---- ------------- 2003 $ 85,607,978 2002 $ 97,054,099 2001 $ 120,720,024 Commissions paid to our agents will not exceed 15% of the premium up to the Target Premium for the first year, 5.75% of the premium up to the Target Premium for the second through sixth years, and 2-3/4% of all other premium. During the sixth Policy year and thereafter agents will receive compensation at the annual rate of .20% of the cash value of a Policy. Agents who meet certain productivity and persistency standards receive additional compensation. We may pay new agents differently during a training period. General agents and district agents who are registered representatives of NMIS and have supervisory responsibility for sales of the Policies receive commission overrides and other compensation. EXPERTS The financial statements of the Account as of December 31, 2003 and for each of the two years in the period ended December 31, 2003 and of Northwestern Mutual as of December 31, 2003 and 2002 and for each of the three years in the period ended December 31, 2003 included in this Statement of Additional Information have been so included in reliance on the reports of PricewaterhouseCoopers LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting. PricewaterhouseCoopers LLP provides audit services for the Account. The address of PricewaterhouseCoopers LLP is 100 East Wisconsin Avenue, Suite 1500, Milwaukee, Wisconsin 53202. B-2 Financial Statements Northwestern Mutual Variable Life Account Statement of Assets and Liabilities December 31, 2003 (in thousands) Assets Investments at Market Value: Northwestern Mutual Series Fund, Inc. Small Cap Growth Stock 71,874 shares (cost $126,863)....................................... $139,149 T. Rowe Price Small Cap Value 38,113 shares (cost $39,901).................................. 49,090 Aggressive Growth Stock 121,140 shares (cost $385,267)....................................... 329,743 International Growth 12,218 shares (cost $10,652)........................................ 13,330 Franklin Templeton International Equity 183,865 shares (cost $261,756)........... 259,618 AllianceBernstein Mid Cap Value 2,384 shares (cost $2,816)................................... 3,135 Index 400 Stock 94,511 shares (cost $102,846).... 120,502 Janus Capital Appreciation 2,011 shares (cost $2,198)......................................... 2,405 Growth Stock 133,563 shares (cost $268,910)...... 250,163 Large Cap Core Stock 141,455 shares (cost $180,784)....................................... 150,790 Capital Guardian Domestic Equity 41,115 shares (cost $35,114)........................... 41,321 T. Rowe Price Equity Income 4,127 shares (cost $4,638)................................... 5,031 Index 500 Stock 209,962 shares (cost $579,838)... 572,148 Asset Allocation 17,197 shares (cost $15,879).... 17,507 Balanced 141,468 shares (cost $248,075).......... 261,857 High Yield Bond 71,695 shares (cost $51,040)..... 51,979 Select Bond 73,483 shares (cost $89,471)......... 92,736 Money Market 123,622 shares (cost $123,622)...... 123,622 Fidelity VIP Mid Cap Portfolio 183 shares (cost $3,838).................................... 4,386 Russell Investment Funds Multi-Style Equity 8,635 shares (cost $104,624)....................................... 99,823 Aggressive Equity 4,121 shares (cost $45,602).... 55,509 Non-U.S. 6,235 shares (cost $56,561)............. 60,851 Core Bond 3,219 shares (cost $33,389)............ 33,704 Real Estate Securities 3,764 shares (cost $41,849)........................................ 51,604 $2,790,003 -------- Due from Northwestern Mutual Life Insurance Company........................................... 623 ---------- Total Assets.................................... $2,790,626 ========== Liabilities Due to Northwestern Mutual Life Insurance Company... $ 229 ---------- Total Liabilities............................... 229 ---------- Equity Variable Life Policies Issued Before October 11, 1995.............................................. 481,069 Variable Complife Policies Issued On or After October 11, 1995.................................. 2,083,152 Variable Executive Life Policies Issued On or After March 2, 1998............................... 118,104 Variable Joint Life Policies Issued On or After December 10, 1998................................. 108,072 ---------- Total Equity.................................... 2,790,397 ---------- Total Liabilities and Equity.................... $2,790,626 ==========
The Accompanying Notes are an Integral Part of the Financial Statements Northwestern Mutual Variable Life Account B-3 Financial Statements Northwestern Mutual Variable Life Account Statements of Operations (in thousands)
Investment Income ------------------------------------------- Dividend Mortality and Net Investment Income Expense Risks Taxes Income (Loss) - ---------------------------------------------------------------------------------------------- Year Ended December 31, 2003 Small Cap Growth Stock Division.................. $ -- $ (606) $ (17) $ (623) T. Rowe Price Small Cap Value Division........... -- (180) (8) (188) Aggressive Growth Stock Division................. -- (1,584) (96) (1,680) International Growth Division.................... 84 (39) (1) 44 Franklin Templetion International Equity Division 3,268 (1,096) (73) 2,099 AllianceBernstein Mid Cap Value Division #....... 11 (5) -- 6 Index 400 Stock Division......................... 658 (492) (14) 152 Janus Capital Appreciation Division #............ 1 (5) -- (4) Growth Stock Division............................ 1,701 (1,176) (50) 475 Large Cap Core Stock Division.................... 1,205 (706) (37) 462 Capital Guardian Domestic Equity Division........ 545 (143) (9) 393 T. Rowe Price Equity Income Division #........... 44 (8) -- 36 Index 500 Stock Division......................... 6,704 (2,525) (182) 3,997 Asset Allocation Division........................ 282 (65) (5) 212 Balanced Division................................ 7,375 (1,208) (260) 5,907 High Yield Bond Division......................... 91 (230) (11) (150) Select Bond Division............................. 3,350 (414) (29) 2,907 Money Market Division............................ 1,516 (644) (17) 855 Fidelity VIP Mid Cap Division #.................. -- (7) (1) (8) Russell Multi-Style Equity Division.............. 554 (373) (7) 174 Russell Aggressive Equity Division............... 46 (202) (5) (161) Russell Non-U.S. Division........................ 1,335 (207) (5) 1,123 Russell Core Bond Division....................... 1,291 (87) (4) 1,200 Russell Real Estate Securities Division.......... 2,110 (201) (6) 1,903 Year Ended December 31, 2002 Small Cap Growth Stock Division.................. $ 131 $ (487) $ (18) $ (374) T. Rowe Price Small Cap Value Division........... 124 (86) (6) 32 Aggressive Growth Stock Division................. 238 (1,457) (101) (1,320) International Growth Division.................... 23 (15) (1) 7 Franklin Templetion International Equity Division 3,431 (954) (70) 2,407 Index 400 Stock Division......................... 502 (354) (13) 135 Growth Stock Division............................ 2,122 (1,057) (52) 1,013 Large Cap Core Stock Division.................... 1,053 (655) (39) 359 Capital Guardian Domestic Equity Division........ 222 (59) (4) 159 Index 500 Stock Division......................... 5,269 (2,191) (181) 2,897 Asset Allocation Division........................ 129 (28) (3) 98 Balanced Division................................ 7,713 (1,069) (252) 6,392 High Yield Bond Division......................... 3,479 (161) (8) 3,310 Select Bond Division............................. 2,499 (258) (24) 2,217 Money Market Division............................ 1,835 (592) (17) 1,226 Russell Multi-Style Equity Division.............. 356 (285) (6) 65 Russell Aggressive Equity Division............... -- (146) (5) (151) Russell Non-U.S. Division........................ 629 (159) (5) 465 Russell Core Bond Division....................... 661 (52) (3) 606 Russell Real Estate Securities Division.......... 1,291 (118) (6) 1,167
# The initial investment in this Division was made on May 1, 2003. The Accompanying Notes are an Integral Part of the Financial Statements Northwestern Mutual Variable Life Account B-4
Realized and Unrealized Gain (Loss) on Investments - ------------------------------------------------------- Realized Gain Unrealized Appreciation Net Gain Increase (Decrease) (Loss) on (Depreciation) of Investments (Loss) on in Equity Derived from Investments During the Period Investments Investment Activity - ------------------------------------------------------------------------------ $ (891) $ 33,526 $ 32,635 $ 32,012 201 10,725 10,926 10,738 (5,832) 69,733 63,901 62,221 (22) 2,841 2,819 2,863 (1,700) 70,906 69,206 71,305 43 319 362 368 (235) 28,826 28,591 28,743 32 207 239 235 (4,730) 41,613 36,883 37,358 (2,807) 30,073 27,266 27,728 (111) 8,718 8,607 9,000 39 393 432 468 61 114,875 114,936 118,933 (25) 2,223 2,198 2,410 (501) 32,210 31,709 37,616 (1,078) 11,836 10,758 10,608 2,745 (1,552) 1,193 4,100 -- -- -- 855 41 548 589 581 (1,818) 21,714 19,896 20,070 (1,673) 17,264 15,591 15,430 (1,188) 15,804 14,616 15,739 1,353 (425) 928 2,128 267 10,286 10,553 12,456 $ (736) $ (17,491) $ (18,227) $ (18,601) 172 (2,018) (1,846) (1,814) (2,733) (59,041) (61,774) (63,094) (297) (173) (470) (463) (2,938) (33,186) (36,124) (33,717) (236) (11,036) (11,272) (11,137) (1,528) (45,647) (47,175) (46,162) (2,575) (38,293) (40,868) (40,509) (94) (2,814) (2,908) (2,749) 5,110 (112,454) (107,344) (104,447) (22) (654) (676) (578) (625) (23,644) (24,269) (17,877) (1,107) (3,189) (4,296) (986) 704 3,467 4,171 6,388 -- -- -- 1,226 (1,625) (14,783) (16,408) (16,343) (937) (5,584) (6,521) (6,672) (3,644) (2,812) (6,456) (5,991) 976 573 1,549 2,155 206 (1,082) (876) 291
Northwestern Mutual Variable Life Account B-5 Financial Statements Northwestern Mutual Variable Life Account Statements of Changes in Equity (in thousands)
Operations ------------------------------------------------------- Net Increase Change in (Decrease) in Net Net Unrealized Equity Derived Investment Realized Appreciation from Investment Income (Loss) Gain (Loss) (Depreciation) Activity - --------------------------------------------------------------------------------------------------------- Year Ended December 31, 2003 Small Cap Growth Stock Division................. $ (623) $ (891) $ 33,526 $ 32,012 T. Rowe Price Small Cap Value Division.......... (188) 201 10,725 10,738 Aggressive Growth Stock Division................ (1,680) (5,832) 69,733 62,221 International Growth Division................... 44 (22) 2,841 2,863 Franklin Templeton International Equity Division 2,099 (1,700) 70,906 71,305 AllianceBernstein Mid Cap Value Division #...... 6 43 319 368 Index 400 Stock Division........................ 152 (235) 28,826 28,743 Janus Capital Appreciation Division #........... (4) 32 207 235 Growth Stock Division........................... 475 (4,730) 41,613 37,358 Large Cap Core Stock Division................... 462 (2,807) 30,073 27,728 Capital Guardian Domestic Equity Division....... 393 (111) 8,718 9,000 T. Rowe Price Equity Income Division #.......... 36 39 393 468 Index 500 Stock Division........................ 3,997 61 114,875 118,933 Asset Allocation Division....................... 212 (25) 2,223 2,410 Balanced Division............................... 5,907 (501) 32,210 37,616 High Yield Bond Division........................ (150) (1,078) 11,836 10,608 Select Bond Division............................ 2,907 2,745 (1,552) 4,100 Money Market Division........................... 855 -- -- 855 Fidelity VIP Mid Cap Division #................. (8) 41 548 581 Russell Multi-Style Equity Division............. 174 (1,818) 21,714 20,070 Russell Aggressive Equity Division.............. (161) (1,673) 17,264 15,430 Russell Non-U.S. Division....................... 1,123 (1,188) 15,804 15,739 Russell Core Bond Division...................... 1,200 1,353 (425) 2,128 Russell Real Estate Securities Division......... 1,903 267 10,286 12,456 Year Ended December 31, 2002 Small Cap Growth Stock Division................. $ (374) $ (736) $ (17,491) $ (18,601) T. Rowe Price Small Cap Value Division.......... 32 172 (2,018) (1,814) Aggressive Growth Stock Division................ (1,320) (2,733) (59,041) (63,094) International Growth Division................... 7 (297) (173) (463) Franklin Templeton International Equity Division 2,407 (2,938) (33,186) (33,717) Index 400 Stock Division........................ 135 (236) (11,036) (11,137) Growth Stock Division........................... 1,013 (1,528) (45,647) (46,162) Large Cap Core Stock Division................... 359 (2,575) (38,293) (40,509) Capital Guardian Domestic Equity Division....... 159 (94) (2,814) (2,749) Index 500 Stock Division........................ 2,897 5,110 (112,454) (104,447) Asset Allocation Division....................... 98 (22) (654) (578) Balanced Division............................... 6,392 (625) (23,644) (17,877) High Yield Bond Division........................ 3,310 (1,107) (3,189) (986) Select Bond Division............................ 2,217 704 3,467 6,388 Money Market Division........................... 1,226 -- -- 1,226 Russell Multi-Style Equity Division............. 65 (1,625) (14,783) (16,343) Russell Aggressive Equity Division.............. (151) (937) (5,584) (6,672) Russell Non-U.S. Division....................... 465 (3,644) (2,812) (5,991) Russell Core Bond Division...................... 606 976 573 2,155 Russell Real Estate Securities Division......... 1,167 206 (1,082) 291
# The initial investment in this Division was made on May 1, 2003. The Accompanying Notes are an Integral Part of the Financial Statements Northwestern Mutual Variable Life Account B-6
Equity Transactions Equity - -------------------------------------------------------------------------------- ------------------ Increase Transfers Transfers (Decrease) in Net Policy Loans, from Other to Other Equity Derived Increase Beginning End Policyowners' Surrenders, and Mortality and Divisions Divisions from Equity (Decrease) of of Net Payments Death Benefits Other (net) or Sponsor or Sponsor Transactions in Equity Period Period - -------------------------------------------------------------------------------------------------------------- $ 27,434 $ (9,924) $ (5,738) $19,899 $ (13,246) $18,425 $ 50,437 $ 88,739 $139,176 7,786 (1,952) (1,727) 16,289 (5,684) 14,712 25,450 23,643 49,093 60,234 (23,756) (13,144) 24,161 (25,415) 22,080 84,301 245,570 329,871 1,787 (409) (395) 7,087 (2,032) 6,038 8,901 4,429 13,330 39,949 (15,249) (9,144) 21,577 (12,400) 24,733 96,038 163,460 259,498 157 (17) (39) 2,883 (218) 2,766 3,134 -- 3,134 20,801 (7,075) (4,639) 19,312 (8,557) 19,842 48,585 71,919 120,504 57 (11) (29) 2,616 (463) 2,170 2,405 -- 2,405 50,569 (17,909) (10,550) 22,213 (18,323) 26,000 63,358 186,888 250,246 29,172 (10,449) (5,860) 11,799 (11,558) 13,104 40,832 110,027 150,859 6,504 (1,333) (1,360) 14,259 (4,575) 13,495 22,495 18,831 41,326 103 (21) (56) 4,815 (279) 4,562 5,030 -- 5,030 100,972 (34,018) (21,978) 44,892 (28,934) 60,934 179,867 392,362 572,229 3,039 (804) (603) 7,018 (1,444) 7,206 9,616 7,900 17,516 33,357 (14,745) (8,943) 18,756 (13,440) 14,985 52,601 209,313 261,914 7,849 (2,601) (2,190) 12,672 (7,086) 8,644 19,252 32,717 51,969 16,297 (5,347) (4,256) 31,858 (25,381) 13,171 17,271 75,496 92,767 163,443 (17,489) (12,821) 56,729 (186,977) 2,885 3,740 119,904 123,644 203 (27) (52) 4,423 (744) 3,803 4,384 -- 4,384 19,042 (6,524) (4,144) 15,128 (5,824) 17,678 37,748 62,079 99,827 8,625 (3,111) (1,995) 25,231 (18,789) 9,961 25,391 30,118 55,509 10,589 (3,623) (2,181) 8,442 (3,681) 9,546 25,285 35,554 60,839 4,050 (1,346) (2,035) 8,251 (12,046) (3,126) (998) 34,723 33,725 8,375 (2,861) (2,047) 13,386 (6,600) 10,253 22,709 28,893 51,602 $ 28,498 $ (7,487) $ (5,498) $20,009 $ (10,825) $24,697 $ 6,096 $ 82,643 $ 88,739 4,209 (708) (738) 20,173 (3,781) 19,155 17,341 6,302 23,643 67,922 (20,224) (13,292) 30,778 (31,416) 33,768 (29,326) 274,896 245,570 808 (158) (147) 6,020 (2,767) 3,756 3,293 1,136 4,429 43,862 (13,590) (8,065) 22,387 (18,085) 26,509 (7,208) 170,668 163,460 20,450 (4,145) (3,916) 22,086 (6,096) 28,379 17,242 54,677 71,919 56,456 (15,648) (10,956) 24,065 (16,982) 36,935 (9,227) 196,115 186,888 34,103 (9,579) (6,256) 13,448 (12,836) 18,880 (21,629) 131,656 110,027 3,500 (338) (597) 15,134 (1,690) 16,009 13,260 5,571 18,831 111,260 (33,947) (21,509) 45,341 (30,043) 71,102 (33,345) 425,707 392,362 1,179 (269) (262) 6,375 (739) 6,284 5,706 2,194 7,900 32,640 (14,335) (6,804) 20,990 (13,327) 19,164 1,287 208,026 209,313 7,500 (2,307) (1,496) 6,166 (3,757) 6,106 5,120 27,597 32,717 12,009 (3,313) (2,922) 30,764 (10,812) 25,726 32,114 43,382 75,496 192,709 (15,625) (17,291) 51,384 (199,919) 11,258 12,484 107,420 119,904 22,082 (4,487) (3,993) 11,287 (7,331) 17,558 1,215 60,864 62,079 9,224 (2,165) (1,852) 8,160 (5,758) 7,609 937 29,181 30,118 11,645 (2,408) (1,943) 13,956 (12,413) 8,837 2,846 32,708 35,554 5,412 (804) (1,096) 13,069 (3,048) 13,533 15,688 19,035 34,723 5,955 (1,897) (1,256) 14,905 (4,872) 12,835 13,126 15,767 28,893
Northwestern Mutual Variable Life Account B-7 Financial Highlights Northwestern Mutual Variable Life Account (For a unit outstanding during the period)
Dividend Income as a % Expense Ratio, Unit Value(3), of Average Lowest to Total Return(4), Division Lowest to Highest Net Assets Highest Lowest to Highest - ------------------------------------------------------------------------------------------------------------------ Small Cap Growth Stock Year Ended 12/31/03.................. $1.662679 to $ 20.745671 0.00% .20% to .75% 32.13% to 33.06% Year Ended 12/31/02.................. $1.258323 to $ 15.591407 0.15% .20% to .75% (18.99%) to (18.42%) Year Ended 12/31/01.................. $1.553320 to $ 19.112629 0.01% .20% to .75% (4.44%) to (3.76%) T. Rowe Price Small Cap Value (1) Year Ended 12/31/03.................. $1.276782 to $ 12.985287 0.00% .20% to .75% 34.21% to 35.15% Year Ended 12/31/02.................. $0.951303 to $ 9.607906 0.72% .20% to .75% (6.24%) to (5.58%) Period Ended 12/31/01................ $1.014592 to $ 10.175772 0.42% .20% to .75% 1.46% to 1.76% Aggressive Growth Stock Year Ended 12/31/03.................. $1.814891 to $ 47.932675 0.00% .20% to .75% 23.83% to 24.69% Year Ended 12/31/02.................. $1.464237 to $ 38.441232 0.09% .20% to .75% (21.70%) to (21.15%) Year Ended 12/31/01.................. $1.868189 to $ 48.753408 21.57% .20% to .75% (20.44%) to (19.87%) International Growth Stock (1) Year Ended 12/31/03.................. $1.085420 to $ 11.039080 1.06% .20% to .75% 38.02% to 38.99% Year Ended 12/31/02.................. $0.786402 to $ 7.942434 0.78% .20% to .75% (12.95%) to (12.34%) Period Ended 12/31/01................ $0.903343 to $ 9.060000 0.00% .20% to .75% (9.67%) to (9.40%) Franklin Templeton International Equity Year Ended 12/31/03.................. $1.465045 to $ 2.471833 1.64% .20% to .75% 39.49% to 40.46% Year Ended 12/31/02.................. $1.216308 to $ 1.759773 1.99% .20% to .75% (17.98%) to (17.40%) Year Ended 12/31/01.................. $1.481423 to $ 2.130553 10.20% .20% to .75% (14.60%) to (14.00%) AllianceBernstein Mid Cap Value (2) Period Ended 12/31/03................ $1.325376 to $ 13.315544 1.14% .20% to .75% 32.54% to 33.16% Index 400 Stock Year Ended 12/31/03.................. $1.294360 to $ 15.159273 0.70% .20% to .75% 34.08% to 35.01% Year Ended 12/31/02.................. $1.038438 to $ 11.227976 0.75% .20% to .75% (15.14%) to (14.54%) Year Ended 12/31/01.................. $1.223656 to $ 13.138452 1.13% .20% to .75% (1.35%) to (0.65%) Janus Capital Appreciation (2) Period Ended 12/31/03................ $1.193442 to $ 11.990097 0.09% .20% to .75% 19.34% to 19.90% Growth Stock Year Ended 12/31/03.................. $1.908431 to $ 25.471804 0.79% .20% to .75% 18.12% to 18.94% Year Ended 12/31/02.................. $1.645371 to $ 21.414901 1.10% .20% to .75% (21.38%) to (20.83%) Year Ended 12/31/01.................. $2.090785 to $ 27.049526 4.25% .20% to .75% (14.82%) to (14.22%) Large Cap Core Stock Year Ended 12/31/03.................. $1.085867 to $ 20.737771 0.94% .20% to .75% 23.19% to 24.05% Year Ended 12/31/02.................. $1.296529 to $ 16.717038 0.90% .20% to .75% (28.70%) to (28.20%) Year Ended 12/31/01.................. $1.816535 to $ 23.281928 3.45% .20% to .75% (8.42%) to (7.77%) Capital Guardian Domestic Equity (1) Year Ended 12/31/03.................. $1.018090 to $ 10.354264 1.88% .20% to .75% 33.48% to 34.41% Year Ended 12/31/02.................. $0.762737 to $ 7.703469 1.77% .20% to .75% (21.79%) to (21.24%) Period Ended 12/31/01................ $0.975250 to $ 9.781208 0.73% .20% to .75% (2.48%) to (2.19%) T. Rowe Price Equity Income (2) Period Ended 12/31/03................ $1.230617 to $ 12.363579 2.79% .20% to .75% 23.06% to 23.64% Index 500 Stock Year Ended 12/31/03.................. $2.081264 to $ 45.268617 1.43% .20% to .75% 27.54% to 28.43% Year Ended 12/31/02.................. $1.630187 to $ 35.246385 1.30% .20% to .75% (22.61%) to (22.07%) Year Ended 12/31/01.................. $2.104460 to $ 45.228886 4.26% .20% to .75% (12.50%) to (11.88%) Asset Allocation (1) Year Ended 12/31/03.................. $1.042045 to $ 10.598020 2.23% .20% to .75% 19.79% to 20.63% Year Ended 12/31/02.................. $0.869901 to $ 8.785751 2.35% .20% to .75% (10.88%) to (10.26%) Period Ended 12/31/01................ $0.976111 to $ 9.789803 1.19% .20% to .75% (2.39%) to (2.10%) Balanced Year Ended 12/31/03.................. $1.923623 to $ 99.686821 3.15% .20% to .75% 17.17% to 17.99% Year Ended 12/31/02.................. $1.640075 to $ 84.486469 3.70% .20% to .75% (8.18%) to (7.54%) Year Ended 12/31/01.................. $1.784400 to $ 91.372736 7.58% .20% to .75% (3.83%) to (3.15%) High Yield Bond Year Ended 12/31/03.................. $0.908491 to $ 20.482734 0.21% .20% to .75% 28.16% to 29.06% Year Ended 12/31/02.................. $1.276280 to $ 15.870922 11.64% .20% to .75% (3.57%) to (2.89%) Year Ended 12/31/01.................. $1.322201 to $ 16.343831 11.57% .20% to .75% 4.29% to 5.03%
(1)Division commenced operations on July 31, 2001. (2)Division commenced operations on May 1, 2003. (3)The lowest and highest unit value is as of the respective period-end date. (4)Total Return includes deductions for management and other expenses; excludes deductions for sales loads and other charges. Returns are not annualized for periods less than one year. The Accompanying Notes are an Integral Part of the Financial Statements Northwestern Mutual Variable Life Account B-8 Financial Highlights Northwestern Mutual Variable Life Account, continued (For a unit outstanding during the period)
Dividend Income as a % Expense Ratio, Unit Value(3), of Average Lowest to Total Return(4), Division Lowest to Highest Net Assets Highest Lowest to Highest - --------------------------------------------------------------------------------------------------------- Select Bond Year Ended 12/31/03......... $1.423053 to $127.939501 3.78% .20% to .75% 4.76% to 5.49% Year Ended 12/31/02......... $1.624374 to $121.279756 4.23% .20% to .75% 11.31% to 12.09% Year Ended 12/31/01......... $1.457873 to $108.200259 5.07% .20% to .75% 9.59% to 10.37% Money Market Year Ended 12/31/03......... $1.035206 to $ 34.553668 1.22% .20% to .75% 0.53% to 1.23% Year Ended 12/31/02......... $1.339422 to $ 34.132616 1.63% .20% to .75% 0.95% to 1.65% Year Ended 12/31/01......... $1.325528 to $ 33.577318 3.73% .20% to .75% 3.19% to 3.92% Fidelity VIP Mid Cap (2) Period Ended 12/31/03....... $1.400160 to $ 14.066904 0.00% .20% to .75% 40.02% to 40.67% Russell Multi-Style Equity Year Ended 12/31/03......... $0.754341 to $ 11.740732 0.70% .20% to .75% 27.96% to 28.86% Year Ended 12/31/02......... $0.589495 to $ 6.221208 0.58% .20% to .75% (23.72%) to (23.19%) Year Ended 12/31/01......... $0.772852 to $ 8.099453 2.00% .20% to .75% (14.81%) to (14.21%) Russell Aggressive Equity Year Ended 12/31/03......... $1.163121 to $ 13.489469 0.11% .20% to .75% 44.59% to 45.60% Year Ended 12/31/02......... $0.804447 to $ 8.707578 0.00% .20% to .75% (19.62%) to (19.06%) Year Ended 12/31/01......... $1.000805 to $ 10.757522 0.11% .20% to .75% (3.05%) to (2.36%) Russell Non-U.S. Year Ended 12/31/03......... $0.948548 to $ 10.238075 2.98% .20% to .75% 37.82% to 38.79% Year Ended 12/31/02......... $0.688244 to $ 7.095865 1.79% .20% to .75% (15.74%) to (15.15%) Year Ended 12/31/01......... $0.816787 to $ 8.362558 0.67% .20% to .75% (22.58%) to (22.03%) Russell Core Bond Year Ended 12/31/03......... $1.329405 to $ 13.532112 3.47% .20% to .75% 5.41% to 6.15% Year Ended 12/31/02......... $1.261197 to $ 12.748590 2.67% .20% to .75% 3.08% to 3.80% Year Ended 12/31/01......... $1.166871 to $ 11.713217 5.52% .20% to .75% 7.08% to 7.84% Russell Real Estate Securities Year Ended 12/31/03......... $1.782914 to $ 18.123797 5.39% .20% to .75% 36.26% to 37.21% Year Ended 12/31/02......... $1.308500 to $ 13.208871 5.44% .20% to .75% 8.08% to 8.84% Year Ended 12/31/01......... $1.269394 to $ 12.725061 5.23% .20% to .75% 6.65% to 7.41%
(1)Division commenced operations on July 31, 2001. (2)Division commenced operations on May 1, 2003. (3)The lowest and highest unit value is as of the respective period-end date. (4)Total Return includes deductions for management and other expenses; excludes deductions for sales loads and other charges. Returns are not annualized for periods less than one year. The Accompanying Notes are an Integral Part of the Financial Statements Northwestern Mutual Variable Life Account B-9 Notes to Financial Statements Northwestern Mutual Variable Life Account December 31, 2003 Note 1 -- Northwestern Mutual Variable Life Account ("the Account") is registered as a unit investment trust under the Investment Company Act of 1940 and is a segregated asset account of The Northwestern Mutual Life Insurance Company ("Northwestern Mutual" or "NM") used to fund variable life insurance policies. Note 2 -- The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America 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. Principal accounting policies are summarized below. Note 3 -- All assets of each Division of the Account are invested in shares of the corresponding Portfolio of Northwestern Mutual Series Fund, Inc., Fidelity VIP Mid Cap Portfolio and the Russell Investment Funds (collectively known as "the Funds"). The shares are valued at the Funds' offering and redemption prices per share. The Funds are open-end investment companies registered under the Investment Company Act of 1940. Note 4 -- Dividend income and distributions of net realized gains from the Funds are recorded on the ex-date of the dividends. Transactions in the Funds' shares are accounted for on the trade date. The basis for determining cost on sale of Funds' shares is identified cost. Purchase and sales of the Funds' shares for the period ended December 31, 2003 by each Division are shown as follows: (in thousands)
Division Purchases Sales -------- --------- ------- Small Cap Growth Stock................. $ 30,041 $12,264 T. Rowe Price Small Cap Value.......... 17,350 2,831 Aggressive Growth Stock................ 48,755 28,372 International Growth................... 6,716 626 Franklin Templeton International Equity 45,771 18,741 AllianceBernstein Mid Cap Value........ 2,851 51 Index 400 Stock........................ 28,703 8,735 Janus Capital Appreciation............. 2,217 46 Growth Stock........................... 47,883 21,459 Large Cap Core Stock................... 26,082 12,538 Capital Guardian Domestic Equity....... 16,140 2,248 T. Rowe Price Equity Income............ 4,686 65 Index 500 Stock........................ 108,689 41,261 Asset Allocation....................... 8,575 1,162 Balanced............................... 38,532 17,672 High Yield Bond........................ 11,970 3,477 Select Bond............................ 25,233 7,341 Money Market........................... 40,778 37,052 Fidelity VIP Mid Cap................... 3,883 86 Russell Multi-Style Equity............. 26,298 8,427 Russell Aggressive Equity.............. 13,761 3,959 Russell Non-U.S........................ 15,290 4,602 Russell Core Bond...................... 3,322 4,645 Russell Real Estate Securities......... 15,906 3,760
Note 5 -- A deduction for mortality and expense risks is determined daily and paid to Northwestern Mutual. Generally, for Variable Life policies issued before October 11, 1995, and Variable CompLife policies issued on or after October 11, 1995 the deduction is at an annual rate of .50% and .60%, respectively, of the net assets of the Account. A deduction for the mortality and expense risks for Variable Executive Life policies issued on or after March 2, 1998 is determined monthly at an annual rate of .75% of the amount invested in the Account for the Policy for the first ten Policy years, and .32% thereafter for policies with the Cash Value Amendment, or .30% thereafter for policies without the Cash Value Amendment. A deduction for the mortality and expense risks for Variable Joint Life policies issued on or after December 10, 1998 is determined monthly at an annual rate of .20% of the amounts invested in the Account for the Policy. The mortality risk is that insureds may not live as long as estimated. The expense risk is that expenses of issuing and administering the policies may exceed the estimated costs. Certain deductions are also made from the annual, single or other premiums before amounts are allocated to the Account. These deductions are for (1) sales load, (2) administrative expenses, (3) taxes and (4) a risk charge for the guaranteed minimum death benefit. Additional mortality costs are deducted from the policy annually for Variable Life and Variable CompLife policies, and monthly for Variable Executive Life and Variable Joint Life policies, and are paid to Northwestern Mutual to cover the cost of providing insurance protection. For Variable Life and Variable CompLife policies this cost is actuarially calculated based upon the insured's age, the 1980 Commissioners Standard Ordinary Mortality Table and the amount of insurance provided under the policy. For Variable Executive Life and Variable Joint Life policies the cost reflects expected mortality costs based upon actual experience. Note 6 -- Northwestern Mutual is taxed as a "life insurance company" under the Internal Revenue Code. The variable life insurance policies, which are funded in the Account, are taxed as part of the operations of Northwestern Mutual. Policies provide that a charge for taxes may be made against the assets of the Account. Generally, for Variable Life policies issued before October 11, 1995, Northwestern Mutual charges the Account at an annual rate of .20% of the Account's net assets and reserves the right to increase, decrease or eliminate the charge for taxes in the future. Generally, for Variable CompLife policies issued on or after October 11, 1995, and for Variable Executive Life policies issued on or after March 2, 1998, and Variable Joint Life Northwestern Mutual Variable Life Account B-10 Notes to Financial Statements policies issued on or after December 10, 1998, there is no charge being made against the assets of the Account for federal income taxes, but Northwestern Mutual reserves the right to charge for taxes in the future. Note 7 -- The Account is credited for the policyowners' net annual premiums at the respective policy anniversary dates regardless of when policyowners actually pay their premiums. Northwestern Mutual's equity represents any unpaid portion of net annual premiums. This applies to Variable Life and Variable CompLife policies only. Note 8 -- The changes in units outstanding for the years ended December 31, 2003 and 2002 by each Division are shown as follows: (in thousands)
Net Units Units Increase Issued Redeemed (Decrease) --------------------------------------------------------------------------- Year Ended December 31, 2003 Small Cap Growth Stock Division................. 19,518 7,767 11,751 T. Rowe Price Small Cap Value Division.......... 13,219 2,089 11,130 Aggressive Growth Stock Division................ 28,858 15,092 13,766 International Growth Division................... 5,512 545 4,967 Franklin Templeton International Equity Division 28,643 11,477 17,166 AllianceBernstein Mid Cap Value Division #...... 1,859 28 1,831 Index 400 Stock Division........................ 21,656 6,417 15,239 Janus Capital Appreciation Division #........... 1,756 38 1,718 Growth Stock Division........................... 24,361 10,438 13,923 Large Cap Core Stock Division................... 16,288 7,413 8,875 Capital Guardian Domestic Equity Division....... 14,784 1,962 12,822 T. Rowe Price Equity Income Division #.......... 3,184 45 3,139 Index 500 Stock Division........................ 48,109 18,742 29,367 Asset Allocation Division....................... 7,099 881 6,218 Balanced Division............................... 13,284 5,007 8,277 High Yield Bond Division........................ 6,953 2,035 4,918 Select Bond Division............................ 9,860 3,417 6,443 Money Market Division........................... 24,722 24,254 468 Fidelity VIP Mid Cap Division #................. 2,438 48 2,390 Russell Multi-Style Equity Division............. 34,575 10,681 23,894 Russell Aggressive Equity Division.............. 12,760 3,541 9,219 Russell Non-U.S. Division....................... 16,087 4,949 11,138 Russell Core Bond Division...................... 4,233 1,627 2,606 Russell Real Estate Securities Division......... 8,150 2,163 5,987 Year Ended December 31, 2002 Small Cap Growth Stock Division................. 21,879 5,762 16,117 T. Rowe Price Small Cap Value Division.......... 16,289 940 15,349 Aggressive Growth Stock Division................ 31,706 11,971 19,735 International Growth Division................... 3,807 217 3,590 Franklin Templeton International Equity Division 27,941 9,938 18,003 Index 400 Stock Division........................ 25,275 4,282 20,993 Growth Stock Division........................... 26,801 8,696 18,105 Large Cap Core Stock Division................... 18,061 6,580 11,481 Capital Guardian Domestic Equity Division....... 14,522 514 14,008 Index 500 Stock Division........................ 51,427 17,640 33,787 Asset Allocation Division....................... 5,076 233 4,843 Balanced Division............................... 15,354 4,320 11,034 High Yield Bond Division........................ 5,744 1,807 3,937 Select Bond Division............................ 15,933 1,922 14,011 Money Market Division........................... 46,015 38,122 7,893 Russell Multi-Style Equity Division............. 29,772 7,757 22,015 Russell Aggressive Equity Division.............. 10,595 2,767 7,828 Russell Non-U.S. Division....................... 13,195 3,672 9,523 Russell Core Bond Division...................... 4,535 771 3,764 Russell Real Estate Securities Division......... 10,466 1,648 8,818
# The initial investment in this Division was made on May 1, 2003. The changes in units outstanding do not include Variable Life policies issued before October 11, 1995. Northwestern Mutual Variable Life Account B-11 Notes to Financial Statements Note 9 -- Equity Values by Division are shown as follows: (in thousands, except accumulation unit values)
Variable Life Policies Issued Before October 11, 1995 Equity of: ---------------------- Total Division Policyowners NM Equity ----------------------------------------------------------------------- Small Cap Growth Stock................. $ 10,037 $ 374 $ 10,411 T. Rowe Price Small Cap Value.......... 5,377 192 5,569 Aggressive Growth Stock................ 52,337 2,487 54,824 International Growth................... 960 29 989 Franklin Templeton International Equity 43,982 1,923 45,905 AllianceBernstein Mid Cap Value........ 433 18 451 Index 400 Stock........................ 8,512 283 8,795 Janus Capital Appreciation............. 149 3 152 Growth Stock........................... 26,543 1,212 27,755 Large Cap Core Stock................... 20,123 1,025 21,148 Capital Guardian Domestic Equity....... 5,216 235 5,451 T. Rowe Price Equity Income............ 875 42 917 Index 500 Stock........................ 103,700 3,702 107,402 Asset Allocation....................... 2,888 98 2,986 Balanced............................... 138,824 3,316 142,140 High Yield Bond........................ 5,944 259 6,203 Select Bond............................ 12,601 428 13,029 Money Market........................... 8,582 229 8,811 Fidelity VIP Mid Cap................... 808 24 832 Russell Multi-Style Equity............. 4,494 164 4,658 Russell Aggressive Equity.............. 3,411 117 3,528 Russell Non-U.S........................ 3,282 117 3,399 Russell Core Bond...................... 1,598 71 1,669 Russell Real Estate Securities......... 3,927 118 4,045 -------- ------- -------- $464,603 $16,466 $481,069 ======== ======= ========
Variable Complife Policies Issued On or After October 11, 1995 Equity of: --------------------------- Total Division Policyowners NM Equity ------------------------------------------------------------------------------ Small Cap Growth Stock................. $ 102,674 $ 17,191 $ 119,865 T. Rowe Price Small Cap Value.......... 33,154 5,476 38,630 Aggressive Growth Stock................ 233,096 31,656 264,752 International Growth................... 8,404 1,615 10,019 Franklin Templeton International Equity 178,279 23,978 202,257 AllianceBernstein Mid Cap Value........ 2,082 318 2,400 Index 400 Stock........................ 86,805 14,238 101,043 Janus Capital Appreciation............. 1,774 255 2,029 Growth Stock........................... 180,341 26,255 206,596 Large Cap Core Stock................... 107,668 14,939 122,607 Capital Guardian Domestic Equity....... 26,073 4,459 30,532 T. Rowe Price Equity Income............ 3,357 480 3,837 Index 500 Stock........................ 374,316 52,932 427,248 Asset Allocation....................... 11,007 1,911 12,918 Balanced............................... 95,495 13,653 109,148 High Yield Bond........................ 36,223 4,778 41,001 Select Bond............................ 52,974 7,610 60,584 Money Market........................... 79,177 20,379 99,556 Fidelity VIP Mid Cap................... 2,812 513 3,325 Russell Multi-Style Equity............. 66,307 11,393 77,700 Russell Aggressive Equity.............. 38,262 6,215 44,477 Russell Non-U.S........................ 39,223 6,438 45,661 Russell Core Bond...................... 12,751 2,178 14,929 Russell Real Estate Securities......... 36,101 5,937 42,038 ---------- -------- ---------- $1,808,355 $274,797 $2,083,152 ========== ======== ==========
Northwestern Mutual Variable Life Account B-12 Notes to Financial Statements
Variable Executive Variable Joint Life Policies Life Policies Issued On or After Issued On or After March 2, 1998 December 10, 1998 Division Total Equity Total Equity ----------------------------------------------------------------------------- Small Cap Growth Stock................. $ 3,001 $ 5,900 T. Rowe Price Small Cap ValueTotal..... 1,630 3,264 Aggressive Growth Stock................ 4,588 5,707 International Growth................... 1,271 1,051 Franklin Templeton International Equity 4,867 6,469 AllianceBernstein Mid Cap Value........ 72 211 Index 400 Stock........................ 4,000 6,667 Janus Capital Appreciation............. 174 49 Growth Stock........................... 8,218 7,676 Large Cap Core Stock................... 3,344 3,761 Capital Guardian Domestic Equity....... 1,667 3,675 T Rowe Price Equity Income............. 67 209 Index 500 Stock........................ 11,220 26,359 Asset Allocation....................... 546 1,067 Balanced............................... 3,485 7,141 High Yield Bond........................ 3,360 1,405 Select Bond............................ 14,416 4,737 Money Market........................... 8,517 6,759 Fidelity VIP Mid Cap................... 18 209 Russell Multi-Style Equity............. 11,590 5,879 Russell Aggressive Equity.............. 5,101 2,403 Russell Non-U S........................ 8,104 3,675 Russell Core Bond...................... 16,238 889 Russell Real Estate Securities......... 2,610 2,910 -------- -------- $118,104 $108,072 ======== ========
Northwestern Mutual Variable Life Account B-13 Accountants' Report [LOGO] PRICEWATERHOUSECOOPERS Report of Independent Auditors To The Northwestern Mutual Life Insurance Company and Contract Owners of Northwestern Mutual Variable Life Account In our opinion, the accompanying statement of assets and liabilities and the related statements of operations and of changes in equity and the financial highlights present fairly, in all material respects, the financial position of Northwestern Mutual Variable Life Account and its Small Cap Growth Stock Division, T. Rowe Price Small Cap Value Division, Aggressive Growth Stock Division, International Growth Stock Division, Franklin Templeton International Equity Division, AllianceBernstein Mid Cap Value Division, Index 400 Stock Division, Janus Capital Appreciation Division, Growth Stock Division, Large Cap Core Stock Division, Capital Guardian Domestic Equity Division, T. Rowe Price Equity Income Division, Index 500 Stock Division, Asset Allocation Division, Balanced Division, High Yield Bond Division, Select Bond Division, Money Market Division, Fidelity VIP Mid Cap Portfolio, Russell Multi-Style Equity Division, Russell Aggressive Equity Division, Russell Non-U.S. Division, Russell Core Bond Division, and Russell Real Estate Securities Division at December 31, 2003, and the results of each of their operations, the changes in each of their equity and their financial highlights for the periods indicated, in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as "financial statements") are the responsibility of The Northwestern Mutual Life Insurance Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included direct confirmation of securities owned at December 31, 2003 with Northwestern Mutual Series Fund, Inc., Fidelity VIP Mid Cap Portfolio and the Russell Insurance Funds, provide a reasonable basis for our opinion. /s/ PRICEWATERHOUSECOOPERS LLP Milwaukee, Wisconsin January 28, 2004 B-14 Accountants' Report FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Consolidated Statement of Operations (in millions) - -------------------------------------------------------------------------------- The following financial statements of Northwestern Mutual should be considered only as bearing upon the ability of Northwestern Mutual to meet its obligations under the Policies. December 31, ----------------------- 2003 2002 ---------- ---------- Assets: Bonds $ 55,571 $ 50,597 Common and preferred stocks 6,577 4,902 Mortgage loans 16,426 15,692 Real estate 1,481 1,503 Policy loans 9,546 9,292 Other investments 4,851 4,242 Cash and temporary investments 2,594 1,814 ---------- ---------- Total investments 97,046 88,042 Due and accrued investment income 1,126 1,100 Net deferred tax assets 1,198 1,887 Deferred premium and other assets 1,790 1,660 Separate account assets 12,662 10,246 ---------- ---------- Total assets $ 113,822 $ 102,935 ========== ========== Liabilities and Surplus: Reserves for policy benefits $ 81,280 $ 74,880 Policyowner dividends payable 3,770 3,765 Interest maintenance reserve 815 521 Asset valuation reserve 2,568 1,268 Income taxes payable 737 777 Other liabilities 4,443 4,261 Separate account liabilities 12,662 10,246 ---------- ---------- Total liabilities 106,275 95,718 Surplus 7,547 7,217 ---------- ---------- Total liabilities and surplus $ 113,822 $ 102,935 ========== ========== The accompanying notes are an integral part of these financial statements. B-15 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Consolidated Statement of Operations (in millions) - -------------------------------------------------------------------------------- For the year ended December 31, ------------------------------------ 2003 2002 2001 ---------- ---------- ---------- Revenue: Premiums $ 10,307 $ 10,108 $ 9,447 Net investment income 5,737 5,477 5,431 Other income 501 439 467 ---------- ---------- ---------- Total revenue 16,545 16,024 15,345 ---------- ---------- ---------- Benefits and expenses: Benefit payments to policyowners and beneficiaries 4,079 3,902 3,808 Net additions to policy benefit reserves 6,260 6,186 5,367 Net transfers to separate accounts 288 242 502 ---------- ---------- ---------- Total benefits 10,627 10,330 9,677 Commissions and operating expenses 1,690 1,580 1,453 ---------- ---------- ---------- Total benefits and expenses 12,317 11,910 11,130 ---------- ---------- ---------- Gain from operations before dividends and taxes 4,228 4,114 4,215 Policyowner dividends 3,765 3,792 3,651 ---------- ---------- ---------- Gain from operations before taxes 463 322 564 Income tax expense (benefit) (90) (442) 173 ---------- ---------- ---------- Net gain from operations 553 764 391 Net realized capital gains (losses) 139 (606) 259 ---------- ---------- ---------- Net income $ 692 $ 158 $ 650 ========== ========== ========== The accompanying notes are an integral part of these financial statements. B-16 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Consolidated Statement of Changes in Surplus (in millions) - -------------------------------------------------------------------------------- For the year ended December 31, ------------------------------------ 2003 2002 2001 ---------- ---------- ---------- Beginning of year balance $ 7,217 $ 6,892 $ 5,896 Net income 692 158 650 Change in net unrealized capital gains (losses) 1,171 (517) (555) Change in net deferred income tax (137) 44 73 Change in nonadmitted assets and other (96) (126) (124) Change in reserve valuation bases (Note 5) -- -- (61) Change in asset valuation reserve (1,300) 766 264 Cumulative effect of changes in accounting principles (Note 15) -- -- 749 ---------- ---------- ---------- Net change in surplus 330 325 996 ---------- ---------- ---------- End of year balance $ 7,547 $ 7,217 $ 6,892 ========== ========== ========== The accompanying notes are an integral part of these financial statements. B-17 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Consolidated Statement of Cash Flows (in millions) - -------------------------------------------------------------------------------- For the year ended December 31, ------------------------------------ 2003 2002 2001 ---------- ---------- ---------- Cash flows from operating activities: Premiums and other income received $ 6,984 $ 6,947 $ 6,607 Investment income received 5,727 5,224 5,328 Disbursement of policy loans, net of repayments (254) (264) (524) Payments to policyowners and beneficiaries (4,312) (4,130) (3,996) Net transfers to separate accounts (284) (257) (534) Commissions, expenses and taxes paid (1,637) (1,855) (1,698) ---------- ---------- ---------- Net cash provided by operating activities 6,224 5,665 5,183 ---------- ---------- ---------- Cash flows from investing activities: Proceeds from investments sold or matured: Bonds 75,838 60,865 35,318 Common and preferred stocks 2,392 1,766 15,465 Mortgage loans 1,843 1,532 1,174 Real estate 356 468 244 Other investments 1,047 1,646 494 ---------- ---------- ---------- 81,476 66,277 52,695 ---------- ---------- ---------- Cost of investments acquired: Bonds 79,994 67,398 38,915 Common and preferred stocks 2,708 2,003 15,014 Mortgage loans 2,534 2,005 2,003 Real estate 191 191 353 Other investments 1,387 748 1,106 ---------- ---------- ---------- 86,814 72,345 57,391 ---------- ---------- ---------- Net cash applied to investing activities (5,338) (6,068) (4,696) ---------- ---------- ---------- Cash flows from financing and miscellaneous sources: Net deposits on deposit-type contract funds and other liabilities without life or disability contingencies 142 249 203 Other cash provided (applied) (248) (50) 111 ---------- ---------- ---------- Net cash provided by financing and other activities: (106) 199 314 ---------- ---------- ---------- Net increase (decrease) in cash and temporary investments 780 (204) 801 Cash and temporary investments, beginning of year 1,814 2,018 1,217 ---------- ---------- ---------- Cash and temporary investments, end of year $ 2,594 $ 1,814 $ 2,018 ========== ========== ========== The accompanying notes are an integral part of these financial statements. B-18 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- 1. Basis of Presentation and Changes in Accounting Principles The accompanying consolidated statutory financial statements include the accounts of The Northwestern Mutual Life Insurance Company and its wholly-owned subsidiary, Northwestern Long Term Care Insurance Company (together, "the Company"). All intercompany balances and transactions have been eliminated. The Company offers life, annuity, disability income and long-term care insurance products to the personal, business, and estate markets. The consolidated financial statements were prepared in conformity with accounting practices prescribed or permitted by the Office of the Commissioner of Insurance of the State of Wisconsin ("statutory basis of accounting"). Financial statements prepared on the statutory basis of accounting differ from financial statements prepared in accordance with generally accepted accounting principles ("GAAP"), primarily because on a GAAP basis: (1) certain policy acquisition costs are deferred and amortized, (2) investment valuations and policy benefit reserves use different methods and assumptions, (3) deposit-type contracts, for which premiums, benefits and reserve changes are not included in revenue or benefits as reported in the statement of operations, are defined differently, (4) majority-owned, non-insurance subsidiaries are consolidated, (5) changes in deferred taxes are reported as a component of net income, and (6) no deferral of realized investment gains and losses is permitted. The effects on the financial statements of the Company attributable to the differences between the statutory basis of accounting and GAAP are material. 2. Summary of Significant Accounting Policies The preparation of financial statements in conformity with the statutory basis of accounting required management to use assumptions or make estimates that affected the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual future results could differ from these assumptions and estimates. Investments See Note 3 regarding the reported statement value and estimated fair value of the Company's investments in bonds, common and preferred stocks, mortgage loans and real estate. Policy Loans Policy loans primarily represent amounts borrowed from the Company by life insurance policyowners, secured by the cash value of the related policies. They are reported in the financial statements at unpaid principal balance. Other Investments Other investments consist primarily of real estate joint ventures, partnership investments (including real estate, venture capital and leveraged buyout fund limited partnerships), leveraged leases and unconsolidated non-insurance subsidiaries. These investments are valued based on the equity method of accounting, which approximates fair value. Other investments also include derivative financial instruments. See Note 4 regarding the Company's use of derivatives and their valuation in the financial statements. Temporary Investments Temporary investments represent securities that had maturities of one year or less at purchase, and are reported at amortized cost, which approximates fair value. B-19 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- Net Investment Income Net investment income primarily represents interest and dividends received or accrued on bonds, mortgage loans, policy loans and other investments. It also includes amortization of any purchase premium or discount using the interest method, adjusted prospectively for any change in estimated yield-to-maturity. Accrued investment income more than 90 days past due is nonadmitted and reported as a direct reduction of surplus. Accrued investment income that is ultimately deemed uncollectible is reported as a reduction of net investment income in the period that such determination is made. Net investment income also includes dividends paid to the Company from accumulated earnings of joint ventures, partnerships, and unconsolidated subsidiaries. Net investment income is reduced by investment management expenses, real estate depreciation, depletion related to energy assets and interest costs associated with securities lending. Interest Maintenance Reserve The Company is required to maintain an interest maintenance reserve ("IMR"). The IMR is used to defer realized gains and losses, net of income tax, on fixed income investments that are attributable to changes in interest rates. Net realized gains and losses deferred to the IMR are amortized into investment income over the estimated remaining term to maturity of the investment sold. Investment Capital Gains and Losses Realized capital gains and losses are recognized based upon specific identification of securities sold. Realized capital losses also include valuation adjustments for impairment of bonds, stocks, mortgage loans, real estate and other investments that have experienced a decline in fair value that management considers to be other-than-temporary. Factors considered in evaluating whether a decline in value is other-than-temporary include: (1) whether the decline is substantial, (2) the Company's ability and intent to retain the investment for a period of time sufficient to allow for an anticipated recovery in value, (3) the duration and extent to which the fair value has been less than cost, and (4) the financial condition and near-term prospects of the issuer. Realized capital gains and losses as reported in the consolidated statement of operations exclude any IMR deferrals. See Note 3 regarding details of realized capital gains and losses. Unrealized capital gains and losses primarily represent changes in the reported fair value of common stocks and changes in valuation adjustments made for bonds in or near default. Changes in the Company's share of undistributed earnings of joint ventures, partnerships, and unconsolidated subsidiaries are also classified as changes in unrealized capital gains and losses. See Note 3 regarding details of changes in unrealized capital gains and losses. Asset Valuation Reserve The Company is required to maintain an asset valuation reserve ("AVR"). The AVR represents a general reserve liability for invested asset valuation using a formula prescribed by the National Association of Insurance Commissioners ("NAIC"). The AVR is designed to protect surplus against potential declines in the value of the Company's investments. Increases or decreases in AVR are reported as direct adjustments to surplus. Separate Accounts See Note 7 regarding separate account assets and liabilities reported by the Company. Premium Revenue Life insurance premiums are recognized as revenue at the beginning of each policy year. Annuity, disability income and long-term care insurance premiums are recognized as revenue when received by the Company. Considerations received on supplementary insurance contracts B-20 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- without life contingencies are deposit-type transactions and thereby excluded from revenue in the consolidated statement of operations. Premium revenue is reported net of ceded reinsurance, see Note 9. Other Income Other income primarily represents ceded reinsurance expense allowances and various insurance policy charges. Benefit Payments to Policyowners and Beneficiaries Benefit payments to policyowners and beneficiaries include death, surrender and disability benefits, as well as matured endowments and payments on supplementary insurance contracts that include life contingencies. Benefit payments on supplementary insurance contracts without life contingencies are deposit-type transactions and thereby excluded from benefits in the consolidated statement of operations. Benefit payments are reported net of ceded reinsurance recoveries, see Note 9. Reserves for Policy Benefits See Note 5 regarding the methods and assumptions used to establish the Company's reserves for future insurance policy benefits. Commissions and Operating Expenses Commissions and other operating costs, including costs of acquiring new insurance policies, are generally charged to expense as incurred. Electronic Data Processing Equipment and Software The cost of electronic data processing ("EDP") equipment and operating system software used in the Company's business is generally capitalized and depreciated over three years using the straight-line method. Non-operating system software is generally capitalized and depreciated over a maximum of five years. EDP equipment and operating software assets of $25 million and $20 million at December 31, 2003 and 2002, respectively, are reported in other assets in the consolidated statement of financial position and are net of accumulated depreciation of $56 million and $48 million, respectively. Non-operating software costs, net of accumulated depreciation, are nonadmitted assets and thereby excluded from reported assets and surplus in the consolidated statement of financial position. Depreciation expense totaled $42 million, $27 million and $14 million for the years ended December 31, 2003, 2002 and 2001, respectively. Furniture and Equipment The cost of furniture, fixtures and equipment, including leasehold improvements, is generally capitalized and depreciated over the useful life of the assets using the straight-line method. Furniture, fixtures and equipment costs, net of accumulated depreciation, are nonadmitted assets and thereby excluded from reported assets and surplus in the consolidated statement of financial position. Depreciation expense totaled $6 million, $6 million and $5 million for the years ended December 31, 2003, 2002 and 2001, respectively. Policyowner Dividends Almost all life insurance and disability income policies and certain annuity contracts and long-term care policies issued by the Company are participating. Annually, the Company's Board of Trustees approves dividends payable on participating policies during the subsequent fiscal year, which are accrued and charged to operations when approved. Participating policyowners generally have the option to direct their dividends to be paid in cash, used to reduce future premiums due or used to purchase additional insurance. A majority of dividends are used by policyowners to purchase additional insurance and are reported as premiums in the consolidated B-21 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- statement of operations, but are not included in premiums received or policy benefits paid in the consolidated statement of cash flows. Nonadmitted Assets Certain assets are designated as nonadmitted on the statutory basis of accounting. Such assets, principally assets related to pension funding, amounts advanced to or due from the Company's financial representatives and furniture, fixtures, equipment, and non-operating software (net of accumulated depreciation) are excluded from reported assets and surplus in the consolidated statement of financial position. Changes in nonadmitted assets are reported as a direct adjustment to surplus. Reclassifications Certain financial statement balances have been reclassified to conform to the current year presentation. 3. Investments Bonds Investments in bonds are reported in the financial statements at amortized cost, less any valuation adjustment. The interest method is used to amortize any purchase premium or discount. Use of the interest method for loan-backed bonds and structured securities includes estimates of future prepayments obtained from independent sources. Prepayment assumptions are updated at least annually, with the prospective adjustment method used to recognize related changes in the estimated yield-to-maturity of such securities. Valuation adjustments are made for bonds in or near default, which are reported at the lower of amortized cost or fair value, or for bonds with a decline in fair value that management considers to be other-than-temporary. Estimated fair value is based upon values published by the Securities Valuation Office ("SVO") of the NAIC. In the absence of SVO-published values, estimated fair value is based upon quoted market prices, if available. For bonds without quoted market prices, fair value is estimated using independent pricing services or internally developed pricing models. Statement value and estimated fair value of bonds at December 31, 2003 and 2002 were as follows: December 31, 2003 Reconciliation to Estimated Fair Value - ---------------------------- ------------------------------------------------- Gross Gross Estimated Statement Unrealized Unrealized Fair Value Gains Losses Value ---------- ---------- ---------- ---------- (in millions) U.S. Government $ 9,233 $ 476 $ (42) $ 9,667 States, territories and possessions 374 56 (4) 426 Special revenue and assessments 10,037 253 (41) 10,249 Public utilities 2,516 213 (6) 2,723 Banks, trust and insurance companies 3,227 82 (24) 3,285 Industrial and miscellaneous 30,184 2,303 (241) 32,246 ---------- ---------- ---------- ---------- Total $ 55,571 $ 3,383 $ (358) $ 58,596 ========== ========== ========== ========== B-22 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- December 31, 2002 Reconciliation to Estimated Fair Value - ---------------------------- ------------------------------------------------- Gross Gross Estimated Statement Unrealized Unrealized Fair Value Gains Losses Value ---------- ---------- ---------- ---------- (in millions) U.S. Government $ 8,933 $ 531 $ (21) $ 9,443 States, territories and possessions 396 61 -- 457 Special revenue and assessments 7,576 400 (1) 7,975 Public utilities 2,501 251 (25) 2,727 Banks, trust and insurance companies 1,355 71 (15) 1,411 Industrial and miscellaneous 29,836 2,150 (688) 31,298 ---------- ---------- ---------- ---------- Total $ 50,597 $ 3,464 $ (750) $ 53,311 ========== ========== ========== ========== Statement value and estimated fair value of bonds by contractual maturity at December 31, 2003 are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Statement Estimated Value Fair Value ---------- ---------- (in millions) Due in one year or less $ 634 $ 648 Due after one year through five years 8,593 9,105 Due after five years through ten years 13,775 14,819 Due after ten years 14,349 15,402 ---------- ---------- 37,351 39,974 Mortgage-backed and structured securities 18,220 18,622 ---------- ---------- Total $ 55,571 $ 58,596 ========== ========== Common and Preferred Stocks Common stocks are generally reported in the financial statements at fair value, which is based upon quoted market prices, if available. For common stocks without quoted market prices, fair value is estimated using independent pricing services or internally developed pricing models. The equity method is used to value investments in common stock of unconsolidated subsidiaries. Preferred stocks rated "1" (highest quality), "2" (high quality), or "3" (medium quality) by the SVO are reported in the financial statements at amortized cost. All other preferred stock is reported at the lower of amortized cost or fair value. Estimated fair value is based upon quoted market prices, if available. For preferred stock without quoted market prices, fair value is estimated using independent pricing services or internally developed pricing models. B-23 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- Mortgage Loans Mortgage loans are reported in the financial statements at unpaid principal balance, less any valuation allowance or unamortized commitment or origination fee. Such fees are generally deferred upon receipt and amortized into investment income using the interest method. Mortgage loans are collateralized by properties located throughout the United States and Canada. The Company attempts to minimize mortgage loan investment risk by diversification of borrowers, geographic locations and types of collateral properties. The maximum and minimum interest rates for mortgage loans originated during 2003 were 8.5% and 3.6%, respectively, while these rates during 2002 were 8.2% and 5.0%, respectively. The aggregate average ratio of amounts loaned to the value of collateral for mortgage loans originated during 2003 and 2002 were 66% and 65%, respectively, with a maximum of 100% for any single loan during each of 2003 and 2002. Mortgage loans are considered impaired when, based on current information, management considers it probable that the Company will be unable to collect all principal and interest due according to the contractual terms of the loan. If necessary, a valuation adjustment is made to reduce the carrying value of an impaired loan to the lower of unpaid principal balance or estimated net realizable value based on appraisal of the collateral property. If the impairment is considered to be temporary, the valuation adjustment is reported as an unrealized loss. Valuation adjustments for impairments considered to be other-than-temporary are reported as realized losses. At December 31, 2003 and 2002, the reported value of mortgage loans was reduced by $13 million and $44 million, respectively, in valuation adjustments. Real Estate Real estate investments are reported in the financial statements at cost, less any valuation adjustment, encumbrances and accumulated depreciation of buildings and other improvements using a straight-line method over the estimated useful lives of the improvements. An investment in real estate is considered impaired when, based on current information, the estimated fair value of the property is lower than depreciated cost. The estimated fair value is primarily based upon the present value of future cash flow (for commercial properties) or the capitalization of stabilized net operating income (for residential properties). When the Company determines that an investment in real estate is impaired, a valuation adjustment is made to reduce the carrying value to estimated fair value, net of encumbrances. Valuation adjustments are reported as a realized loss. At both December 31, 2003 and 2002 there was no valuation adjustment in determining the reported value of real estate investments. At December 31, 2003 and 2002, the reported value of real estate included $180 million and $124 million, respectively, of real estate properties occupied by the Company. Leveraged Leases Leveraged leases are reported in the financial statements at the present value of future minimum lease payments, plus the residual value of the leased asset. At December 31, 2003 and 2002, the reported value of leveraged leases was $513 million and $532 million, respectively. The reported value of leveraged leases at December 31, 2003 and 2002 was reduced by $0 and $108 million, respectively, to reflect a decline in value of certain aircraft leases that management considered to be other-than-temporary. The decline in value was charged against an existing valuation allowance and was not reported as a realized capital loss during 2002. Leveraged leases are included in other investments and primarily represent investments in commercial aircraft or real estate property that are leased to third parties and serve as collateral for non-recourse borrowings. B-24 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- Capital Gains and Losses Realized investment gains and losses for the years ended December 31, 2003, 2002 and 2001 were as follows:
For the year ended For the year ended For the year ended December 31, 2003 December 31, 2002 December 31, 2001 -------------------------------- ------------------------------------ ---------------------------------- Net Net Net Realized Realized Realized Realized Realized Gains Realized Realized Gains Realized Realized Gains Gains Losses (Losses) Gains Losses (Losses) Gains Losses (Losses) --------- --------- ---------- ---------- ------------ ---------- ---------- ---------- ---------- (in millions) Bonds $ 1,369 $ (861) $ 508 $ 950 $ (1,237) $ (287) $ 537 $ (674) $ (137) Common and preferred stocks 397 (402) (5) 356 (619) (263) 863 (569) 294 Mortgage loans 12 -- 12 -- (4) (4) -- (10) (10) Real estate 198 -- 198 121 (3) 118 85 (11) 74 Other invested assets 145 (286) (141) 158 (258) (100) 296 (149) 147 --------- --------- ---------- ---------- ------------ ---------- ---------- ---------- ---------- $ 2,121 $ (1,549) 572 $ 1,585 $ (2,121) (536) $ 1,781 $ (1,413) 368 ========= ========= ========== ============ ========== ========== Less: IMR gains (losses) 538 264 11 Less: Capital gains taxes (benefit) (105) (194) 98 ---------- ---------- ---------- Net realized capital gains (losses) $ 139 $ (606) $ 259 ========== ========== ==========
Proceeds from the sale of bond investments totaled $83 billion, $53 billion and $30 billion for the years ended December 31, 2003, 2002, and 2001, respectively. Realized losses (before capital gains taxes) included $405 million, $588 million, and $457 million for the years ended December 31, 2003, 2002, and 2001, respectively, of valuation adjustments for declines in fair value of investments that were considered to be other-than-temporary. The amortized cost and estimated fair value of bonds and common and preferred stocks for which the estimated fair value had temporarily declined and remained below cost as of December 31, 2003, were as follows:
December 31, 2003 ---------------------------------------------------------------------- Decline For Less Than 12 Months Decline For Greater Than 12 Months ---------------------------------- ---------------------------------- Fair Fair Cost Value Difference Cost Value Difference ---------- ---------- ---------- ---------- ---------- ---------- (in millions) Bonds $ 9,051 $ 8,804 $ (247) $ 1,559 $ 1,448 $ (111) Common and preferred stocks 587 536 (51) 613 520 (93) ---------- ---------- ---------- ---------- ---------- ---------- Total $ 9,638 $ 9,340 $ (298) $ 2,172 $ 1,968 $ (204) ========== ========== ========== ========== ========== ==========
B-25 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- Changes in net unrealized investment gains and losses for the years ended December 31, 2003, 2002, and 2001 were as follows: For the year ended December 31, -------------------------------------- 2003 2002 2001 ----------- ------------- ---------- (in millions) Bonds $ 188 $ (150) $ (15) Common and preferred stocks 1,372 (436) (699) Other investments 163 (172) (193) ----------- ------------- ---------- 1,723 (758) (907) Change in deferred taxes (552) 241 352 ----------- ------------- ---------- $ 1,171 $ (517) $ (555) =========== ============= ========== Securities Lending The Company has entered into securities lending agreements whereby certain investment securities are loaned to third parties, primarily major brokerage firms. The Company's policy requires a minimum of 102% of the fair value of the loaned securities, calculated on a daily basis, as collateral in the form of either cash or securities held by the Company or a trustee. At December 31, 2003 and 2002, unrestricted cash collateral held by the Company of $2.5 billion and $1.6 billion, respectively, is reported in cash and invested assets and the offsetting collateral liability of $2.5 billion and $1.6 billion, respectively, is reported in other liabilities in the consolidated statement of financial position. Additional non-cash collateral of $482 million and $389 million is held on the Company's behalf by a trustee at December 31, 2003 and 2002, respectively, and is not included in the consolidated statement of financial position. Repurchase Agreements The Company has entered into agreements whereby the Company sells and agrees to repurchase certain mortgage-backed securities. At December 31, 2002, the book value of securities subject to these agreements and included in the reported value of bonds was $1.0 billion, while the repurchase obligation liability of $1.0 billion was reported in other liabilities in the consolidated statement of financial position. Securities subject to these agreements had contractual maturities of 30 years at December 31, 2002 and a weighted average interest rate of 5.8%. There were no outstanding repurchase commitments at December 31, 2003. 4. Derivative Financial Instruments In the normal course of business, the Company enters into derivative transactions, generally to mitigate the risk to Company assets and surplus of fluctuations in interest rates, foreign currency exchange rates and other market risks. Derivative investments are reported as other investments in the consolidated statement of financial position. Cash flow and fair value hedges that qualify for hedge accounting are accounted for in a manner consistent with the hedged item (e.g. amortized cost or fair value) whereas cash flow and fair value hedges that do not qualify for hedge accounting are accounted for at fair value. Fair value is estimated as the amount that the Company would expect to receive or pay upon termination of the contract at the reporting date. In addition to cash flow and fair value hedges, the Company entered into replication transactions during 2003 and 2002. A replication transaction is a derivative transaction entered into in B-26 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- conjunction with other investment transactions in order to replicate the investment characteristics of otherwise permissible investments. The Company does not take positions in derivatives for income generation purposes. The Company implemented Statement of Statutory Accounting Principles ("SSAP") No. 86, Accounting for Derivative Instruments and Hedging Activities, which superceded SSAP 31, effective January 1, 2003. Upon implementation the Company had the option of applying the new guidance to all derivatives to which the Company was a party to as of January 1, 2003 or continuing to use the existing guidance of SSAP 31 for all derivatives held as of December 31, 2002. The Company chose to apply SSAP 86 guidance retroactively to derivatives held prior to January 1, 2003. The impact on surplus from the adoption of SSAP 86 was considered to be immaterial. The Company held the following derivative positions at December 31, 2003 and 2002:
December 31, 2003 December 31, 2002 ---------------------------------- ---------------------------------- Carrying Notional Fair Carrying Notional Fair Derivative Instrument Value Amount Value Value Amount Value - --------------------------------- ---------- ---------- ---------- ---------- ---------- ---------- (in millions) Cash Flow Hedges: - ----------------- Foreign currency swaps $ -- $ 36 $ (2) $ -- $ 68 $ 7 Interest rate swaps -- 473 6 (3) 442 (8) Swaptions 23 521 25 12 358 12 Interest rate floors 13 775 38 8 625 41 Fair Value Hedges: - ------------------ Short equity futures -- -- -- -- -- -- Fixed income futures -- -- -- -- 365 -- Foreign currency forward contracts (43) 1,029 (43) (19) 567 (17) Credit default swaps -- 203 (1) -- 67 -- Commodity swaps -- -- -- -- 5 (1) Replications: - ------------- Credit default swaps -- 230 (2) -- 65 -- Long fixed income futures -- -- -- -- -- -- Long equity futures -- 28 -- -- 9 --
The notional or contractual amounts of derivative financial instruments are used to denominate the transactions and do not represent the amounts exchanged between the parties. Foreign currency swaps are cash flow hedges used to mitigate exposure to variable U.S. dollar cash flows from certain bonds denominated in foreign currencies. A foreign currency swap is a contractual agreement to exchange the currencies of two different countries at a specified rate of exchange in the future. Interest rate swaps are cash flow hedges used to mitigate exposure to variable interest payments B-27 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- on certain floating rate bonds. An interest rate swap is a contractual agreement to pay a floating rate of interest, based upon a reference index, in exchange for a fixed rate of interest established at the origination of the contract. Swaptions are cash flow hedges used to mitigate the asset/liability risks of a significant and sustained increase or decrease in interest rates for certain of the Company's insurance products. Swaptions are a contractual agreement whereby one party holds an option to enter into an interest rate swap with another party on predefined terms. Interest rate floors are cash flow hedges used to mitigate the asset/liability risks of a significant and sustained decrease in interest rates. Floors entitle the Company to receive settlement payments from the counterparties if interest rates decline below a specified level. Short equity index futures contracts are fair value hedges that are used to mitigate exposure to market fluctuations for the Company's portfolio of common stocks. Futures contracts obligate the Company to buy or sell a financial instrument at a specified future date for a specified price. Fixed income futures contracts are fair value hedges used to mitigate interest rate risk for a portion of its fixed maturity investment portfolio. These futures contracts obligate the Company to buy or sell a financial instrument at a specified future date for a specified price. Foreign currency forward contracts are fair value hedges used to mitigate the foreign exchange risk for portfolios of investments denominated in foreign currencies. Foreign currency forward contracts obligate the Company to deliver a specified amount of foreign currency at a future date at a specified exchange rate. Credit default swaps are fair value hedges used to protect against a decrease in bond prices due to credit concerns for certain bond issuers. A credit default swap allows the Company to put the bond to a counterparty at par upon a "credit event" sustained by the bond issuer. A credit event is defined as bankruptcy, failure to pay, or obligation acceleration. Commodity swaps are fair value hedges used to mitigate exposure to market fluctuations for the forward sale of crude oil and natural gas production. Commodity swaps are agreements whereby one party pays a floating commodity price in exchange for a specified fixed commodity price. Credit default swap replication transactions are used by the Company to create a fixed income investment through the use of derivatives and cash market instruments. These replication transactions, including the derivative component, are reported at amortized cost. During 2003 and 2002, the average fair value of such contracts was $0 and ($1) million, respectively. No realized gains or losses were recognized during 2003 or 2002 on the termination of such contracts. Long fixed income futures replication contracts are used by the Company to manage the duration of the fixed income portfolio and mitigate exposure to interest rate changes. These replication transactions are reported at fair value, with changes in fair value reflected as a component of unrealized gains and losses until such time as the contracts are terminated. During 2003 and 2002, the average fair value of such contracts was $0. Realized gains of $29 million and $5 million were recognized during 2003 and 2002 on the termination of such contracts. Long equity futures replication contracts are used by the Company to gain equity market investment exposure. These replication transactions are reported at fair value, with changes in fair value reflected as a component of unrealized gains and losses until such time as the contracts B-28 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- are terminated. During 2003 and 2002, the average fair value of such contracts was $0 and $73 million, respectively. Realized gains of $28 million and $10 million were recognized during 2003 and 2002, respectively, on the termination of such contracts. 5. Reserves for Policy Benefits Reserves for policy benefits represent the net present value of future policy benefits, less future policy premiums, estimated using actuarial methods based on mortality and morbidity experience tables and valuation interest rates prescribed or permitted by the Office of the Commissioner of Insurance of the State of Wisconsin ("OCI"). Use of these actuarial tables and methods involved assumptions regarding future mortality and morbidity. Actual future experience could differ from the assumptions used to make these estimates. General account reserves for policy benefits at December 31, 2003 and 2002 are summarized below: December 31, ------------------- 2003 2002 -------- -------- (in millions) Life insurance reserves $ 71,441 $ 65,605 Annuity reserves and deposit liabilities 4,940 4,607 Disability income and long-term care unpaid claims and claim reserves 3,083 2,907 Disability income active life reserves 1,801 1,757 Long-term care active life reserves 15 4 -------- -------- Total reserves for policy benefits $ 81,280 $ 74,880 -------- -------- Life insurance reserves on substantially all policies issued since 1978 are based on the Commissioner's Reserve Valuation Method ("CRVM") with interest rates ranging from 3 1/2% to 5 1/2% and the 1958 or 1980 CSO mortality tables. Other life insurance reserves are primarily based on the net level premium method, using various mortality tables at interest rates ranging from 2% to 4 1/2%. As of December 31, 2003, the Company has $810 billion of total life insurance in-force, including $8.7 billion of life insurance in-force for which gross premiums are less than net premiums according to the standard valuation methods and assumptions prescribed by the OCI. As of January 1, 2001, the Company changed the valuation basis for reserves on certain term life insurance policies. The impact of this change increased policy benefit reserves by $61 million, and was reported as a direct reduction of surplus for the year ended December 31, 2001. Tabular cost has been determined from the basic data for the calculation of policy reserves. Tabular cost less actual reserves released has been determined from the basic data for the calculation of reserves and reserves released. Tabular interest has been determined from the basic data for the calculation of policy reserves. Tabular interest on funds not involving life contingencies is calculated as the product of the valuation rate of interest times the mean of the amount of funds subject to such rate held at the beginning and end of the year of valuation. Additional premiums are charged for substandard lives for policies issued after January 1, 1956. Net level premium or CRVM mean reserves are based on multiple mortality tables or one-half the net flat or other extra mortality charge. The Company waives deduction of fractional premiums B-29 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- upon death of an insured and returns any portion of the final premium beyond the date of death. Cash values are not promised in excess of the legally computed reserves. Deferred annuity reserves on contracts issued since 1985 are primarily based on the Commissioner's Annuity Reserve Valuation Method with interest rates ranging from 3 1/2% to 6 1/4%. Other deferred annuity reserves are based on contract value. Immediate annuity reserves are based on present value of expected benefit payments at interest rates ranging from 3 1/2% to 7 1/2%. Changes in future policy benefits on supplementary contracts without life contingencies are classified as deposit-type transactions and thereby excluded from net additions to policy benefit reserves in the consolidated statement of operations, see Note 2. At December 31, 2003 and 2002, the withdrawal characteristics of the Company's general account annuity reserves and deposit liabilities were as follows: December 31, ------------------- 2003 2002 -------- -------- Subject to discretionary withdrawal - with market value adjustment $ 1,354 $ 1,386 - without market value adjustment 2,340 2,032 Not subject to discretionary withdrawal 1,246 1,189 -------- -------- Total $ 4,940 $ 4,607 ======== ======== Unpaid claims and claim reserves for DI policies are based on the present value of expected benefit payments, primarily using the 1985 CIDA (modified for Company experience in the first four years of disability) and interest rates ranging from 3% to 5 1/2%. Unpaid claims and claim reserves for long-term care policies are based on the present values of expected benefit payments using industry-based long-term care experience with a 4.5% interest rate. Reserves for unpaid claims, losses, and loss adjustment expenses on disability income and long-term care insurance were $3.1 billion and $2.9 billion at December 31, 2003 and December 31, 2002, respectively. The table below provides a summary of the changes in these reserves for the years ended December 31, 2003 and 2002. For the year ended December 31, ------------------- 2003 2002 -------- -------- (in millions) Balance at January 1 $ 2,907 $ 2,701 Incurred related to: Current year 466 466 Prior year 50 59 -------- -------- Total incurred 516 525 Paid related to: Current year 17 17 Prior year 323 302 -------- -------- Total paid 340 319 -------- -------- Balance at December 31 $ 3,083 $ 2,907 ======== ======== B-30 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- The changes in reserves for incurred claims related to prior years are generally the result of ongoing analysis of recent loss development trends. Active life reserves for disability income ("DI") policies issued since 1987 are primarily based on the two-year preliminary term method using a 4% interest rate and the 1985 Commissioner's Individual Disability Table A ("CIDA") for morbidity. Active life reserves for prior DI policies are based on the net level premium method, with interest rates ranging from 3% to 4% and the 1964 Commissioner's Disability Table for morbidity. Active life reserves for long-term care policies consist of mid-terminal reserves and unearned premium. Mid-terminal reserves are based on the one-year preliminary term method, industry-based experience morbidity, total terminations based on the 1983 Individual Annuity Mortality table without lapses or the 1983 Group Annuity Mortality table with lapses, and an interest rate of either 4% or the minimum rate allowable for tax purposes. When the tax interest rate is used, lapses are not included in total terminations and reserves are compared in the aggregate to the statutory minimum and the greater of the two is held. 6. Premium and Annuity Considerations Deferred and Uncollected Gross deferred and uncollected insurance premiums represent life insurance premiums due to be received from policyowners through the next respective policy anniversary dates. Net deferred and uncollected premiums represent only the portion of gross premiums related to mortality charges and interest. Deferred and uncollected premiums at December 31, 2003 and 2002 were as follows: December 31, 2003 December 31, 2002 ------------------ ------------------ Type of Business Gross Net Gross Net - --------------------- -------- ------- -------- ------- (in millions) Ordinary new business $ 171 $ 76 $ 149 $ 69 Ordinary renewal 1,461 1,191 1,409 1,145 -------- ------- -------- ------- $ 1,632 $ 1,267 $ 1,558 $ 1,214 ======== ======= ======== ======= 7. Separate Accounts Separate account assets and related policy liabilities represent the segregation of balances attributable to variable life insurance and variable annuity policies. Policyowners bear the investment performance risk associated with variable products. Separate account assets are invested at the direction of the policyowner in a variety of mutual fund options. Variable annuity policyowners also have the option to invest in a fixed interest rate annuity issued by the general account of the Company. Separate account assets are reported at fair value based primarily on quoted market prices. B-31 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- Following is a summary of separate account liabilities by withdrawal characteristic at December 31, 2003 and 2002: December 31, ------------------- 2003 2002 -------- -------- Subject to discretionary withdrawal - with market value adjustment $ 10,524 $ 8,442 - without market value adjustment -- -- Not subject to discretionary withdrawal 1,886 1,550 Non-policy liabilities 252 254 -------- -------- Total $ 12,662 $ 10,246 ======== ======== While separate account liability values are not guaranteed by the Company, the variable annuity and variable life insurance products represented in the separate accounts do include guaranteed minimum death benefits underwritten by the Company. At both December 31, 2003 and 2002, general account reserves for policy benefits included $11 million attributable to these benefits. Premiums and other considerations received from variable life and variable annuity policyowners during the years ended December 31, 2003 and 2002 were $1.2 billion and $1.3 billion, respectively. These amounts are reported as premiums in the consolidated statement of operations. The subsequent transfer of these receipts to the Separate Accounts is reported in net transfers to separate accounts in the consolidated statement of operations, net of amounts received from the Separate Accounts to provide for policy benefit payments to variable product policyowners. Following is a summary reconciliation of amounts reported as transfers to and from separate accounts in the summary of operations of the Company's NAIC Separate Account Annual Statement with the amount reported as net transfers to separate accounts in the accompanying consolidated statement of operations for the years ended December 31, 2003, 2002 and 2001: For the year ended December 31, ------------------------------- 2003 2002 2001 ------------------------------- (in millions) From Separate Account Annual Statement: Transfers to Separate Accounts $ 1,224 $ 1,341 $ 1,419 Transfers from Separate Accounts (1,125) (1,300) (1,128) ------------------------------- 99 41 291 Reconciling adjustments: Investment management and administrative charges 73 65 72 Mortality, breakage and taxes 116 136 139 ------------------------------- Net transfers to separate accounts $ 288 $ 242 $ 502 =============================== 8. Employee and Representative Benefit Plans The Company sponsors noncontributory defined benefit retirement plans for all eligible employees and financial representatives. These include tax-qualified plans, as well as nonqualified plans that provide benefits to certain participants in excess of ERISA limits for qualified plans. The Company's policy is to fully fund the obligations of qualified plans in accordance with ERISA requirements. In 2003, the Company contributed $28 million to the qualified employee retirement plan. No contributions were required during 2002 or 2001. B-32 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- In addition to pension benefits, the Company provides certain health care and life insurance benefits ("postretirement benefits") to retired employees, field representatives and eligible dependents. Substantially all employees and field representatives will become eligible for these benefits if they reach retirement age while working for the Company. Aggregate assets and projected benefit obligations of the defined benefit plans and for postretirement benefits at December 31, 2003 and 2002, and changes in assets and obligations for the years then ended, were as follows:
Defined Benefit Plans Postretirement Benefits ----------------------- ----------------------- 2003 2002 2003 2002 ---------- ---------- ---------- ---------- (in millions) Fair value of plan assets at January 1 $ 1,420 $ 1,612 $ 17 $ 20 Changes in plan assets: Actual return on plan assets 323 (161) 5 (2) Company contributions 28 -- -- -- Actual plan benefits paid (33) (31) (2) (1) ---------- ---------- ---------- ---------- Fair value of plan assets at December 31 $ 1,738 $ 1,420 $ 20 $ 17 ========== ========== ========== ========== Projected benefit obligation at January 1 $ 1,499 $ 1,367 $ 131 $ 96 Changes in benefit obligation: Service cost of benefits earned 64 54 15 11 Interest cost on projected obligations 103 95 10 8 Projected plan benefits paid (38) (34) (9) (8) Experience losses 101 17 19 24 ---------- ---------- ---------- ---------- Projected benefit obligation at December 31 $ 1,729 $ 1,499 $ 166 $ 131 ========== ========== ========== ==========
Plan assets are invested primarily in common stocks and corporate debt securities through a separate account of the Company. Asset mix is re-balanced regularly to maintain ratios of approximately 60% equities, 35% fixed income investments, and 5% cash equivalents. Fair value of plan assets is based primarily on quoted market values. The projected benefit obligation represents the actuarial net present value of future benefit obligations, which is estimated annually by the Company. The following table summarizes assumptions used in estimating the projected benefit obligations at December 31, 2003, 2002, and 2001:
Defined Benefit Plans Postretirement Benefits --------------------- ----------------------- 2003 2002 2001 2003 2002 2001 --------------------- ----------------------- Discount rate 6.5% 7.0% 7.0% 6.5% 7.0% 7.0% Long-term rate of return on plan assets 8.0% 8.5% 9.0% 8.0% 8.5% 9.0% Annual increase in compensation 4.5% 5.0% 5.0% 4.5% 5.0% 5.0%
The projected benefit obligations for post-retirement benefits at December 31, 2003 and 2002 also assumed an annual increase in future retiree medical costs of 10%, grading down to 5% over 5 years and remaining level thereafter. A further increase in the assumed healthcare cost trend of 1% in each year would increase the accumulated postretirement benefit obligation as of December 31, 2003 by $18 million and net periodic postretirement benefit expense during 2003 by $3 million. A decrease in the assumed healthcare cost trend of 1% in each year would reduce the accumulated postretirement benefit obligation as of December 31, 2003 by $18 million and net periodic postretirement benefit expense during 2003 by $3 million. B-33 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- Projected benefit obligations included $28 million and $12 million for non-vested employees at December 31, 2003 and 2002, respectively. Following is an aggregate reconciliation of the funded status of the plans to the net liability reported by the Company at December 31, 2003 and 2002:
Defined Benefit Plans Postretirement Benefits ----------------------- ----------------------- 2003 2002 2003 2002 ---------- ---------- ---------- ---------- (in millions) Fair value of plan assets at December 31 $ 1,738 $ 1,420 $ 20 $ 17 Projected benefit obligation at December 31 1,729 1,499 166 131 Funded status 9 (79) (146) (114) ---------- ---------- ---------- ---------- Unrecognized net experience losses 368 516 43 29 Unrecognized initial net asset (598) (644) -- -- Nonadmitted asset (76) (58) -- -- ---------- ---------- ---------- ---------- Net pension liability $ (297) $ (265) $ (103) $ (85) ========== ========== ========== ==========
Unrecognized net experience gains or losses represent cumulative amounts by which plan experience for return on plan assets or benefit costs has been more or less favorable than assumed. These net differences accumulate without recognition in the Company's financial statements unless they exceed 10% of plan assets or projected benefit obligation, whichever is greater. If they exceed this limit, they are amortized into net periodic benefit costs over the remaining average years of service until retirement of the plan participants, which is currently fourteen years. Unrecognized initial net assets represent the amount by which the fair value of plan assets exceeded the projected benefit obligation for funded pension plans upon the adoption of new statutory accounting principles at January 1, 2001. The Company has elected not to record an initial asset for this excess, electing instead to utilize the excess through amortization of this initial asset as a credit to net periodic benefit cost in a systematic manner until exhausted. Any pension assets for funded plans are nonadmitted under statutory accounting and are thereby excluded from reported assets and surplus in the consolidated statement of financial position. The components of net periodic benefit costs for the years ended December 31, 2003, 2002, and 2001, were as follows:
Defined Benefit Plans Postretirement Benefits --------------------------- --------------------------- 2003 2002 2001 2003 2002 2001 --------------------------- --------------------------- (in millions) Components of net periodic benefit cost: Service cost of benefits earned $ 64 $ 54 $ 50 $ 15 $ 11 $ 7 Interest cost on projected obligations 103 95 86 10 9 6 Amortization of experience gains and losses 34 5 -- 2 1 -- Amortization of initial net asset (46) (13) -- -- -- -- Expected return on plan assets (113) (136) (151) (1) (2) (2) --------------------------- --------------------------- Net periodic expense (benefit) $ 42 $ 5 ($ 15) $ 26 $ 19 $ 11 =========================== ===========================
The Company also sponsors a contributory 401(k) plan for eligible employees and a noncontributory defined contribution plan for financial representatives. For the years ended B-34 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- December 31, 2003, 2002 and 2001 the Company expensed total contributions to these plans of $23 million, $22 million and $20 million, respectively. 9. Reinsurance The Company limits its exposure to life insurance death benefits on any single insured by ceding insurance coverage to various reinsurers under excess and coinsurance contracts. The Company retains a maximum of $25 million of coverage per individual life policy and a maximum of $35 million of coverage per joint life policy. The Company also participates in catastrophic risk sharing pools and has an excess reinsurance contract for certain disability income policies issued prior to 1999 with retention limits varying based upon coverage type. Amounts shown in the consolidated financial statements are reported net of the impact of reinsurance. Reserves for policy benefits at December 31, 2003 and 2002 were reported net of ceded reserves of $1.0 billion and $877 million, respectively. The effect of reinsurance on premium revenue and benefits expense for the years ended December 31, 2003, 2002 and 2001 was as follows: For the year ended December 31, ------------------------------------ 2003 2002 2001 ---------- ---------- ---------- (in millions) Direct premium revenue $ 10,959 $ 10,706 $ 9,995 Premiums ceded (652) (598) (548) ---------- ---------- ---------- Net premium revenue $ 10,307 $ 10,108 $ 9,447 ========== ========== ========== Direct benefit expense 11,110 10,770 10,119 Benefits ceded (483) (440) (442) ---------- ---------- ---------- Net benefit expense $ 10,627 $ 10,330 $ 9,677 ========== ========== ========== In addition, the Company earned $184 million, $172 million and $161 million for the years ended December 31, 2003, 2002 and 2001, respectively, in allowances from reinsurers for reimbursement of commissions and other expenses on ceded business. These amounts are reported in other income in the consolidated statement of operations. Reinsurance contracts do not relieve the Company from its obligations to policyowners. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company attempts to minimize this risk by diversifying its reinsurance coverage among a number of reinsurers that meet its standards for strong financial condition. There were no reinsurance recoverables at December 31, 2003 and 2002, which were considered by management to be uncollectible. B-35 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- 10. Income Taxes The Company files a consolidated federal income tax return including the following entities: Northwestern Mutual Investment Services, LLC Baird Holding Company Northwestern International Holdings, Inc. Frank Russell Company NML Real Estate Holdings, LLC and subsidiaries Bradford, Inc. NML Securities Holdings, LLC and subsidiaries Network Planning Advisors, LLC Northwestern Investment Management Company, LLC Mason Street Advisors, LLC Northwestern Securities Holdings, LLC NML - CBO, LLC Northwestern Mutual Trust Company JYD, LLC Chateau, LLC The Company collects from or refunds to these subsidiaries their share of consolidated income taxes determined under written tax-sharing agreements. Federal income tax returns for years through 1999 are closed as to further assessment of tax. The liability for income taxes payable in the financial statements includes a provision for additional taxes that may become due with respect to the open tax years. The Company accounts for deferred tax assets and liabilities, which reflect the financial statement impact of cumulative temporary differences between the tax and financial statement bases of assets and liabilities. The components of the net deferred tax asset at December 31, 2003 and 2002 were as follows: December 31, ----------------------- 2003 2002 Change ---------- ---------- --------- (in millions) Deferred tax assets: Policy acquisition costs $ 715 $ 673 $ 42 Investment assets 189 664 (475) Policy benefit liabilities 1,751 1,769 (18) Benefit plan obligations 252 223 29 Guaranty fund assessments 12 14 (2) Nonadmitted assets 54 67 (13) Other 58 61 (3) ----------------------------------- Gross deferred tax assets $ 3,031 $ 3,471 $ (440) ----------------------------------- Deferred tax liabilities: Premium and other receivables $ 453 $ 425 $ 28 Investment assets 1,375 1,156 219 Other 5 3 2 ----------------------------------- Gross deferred tax liabilities $ 1,833 $ 1,584 $ 249 ----------------------------------- Net deferred tax asset $ 1,198 $ 1,887 $ (689) =================================== The statutory basis of accounting limits the amount of gross deferred tax assets that can be included in Company surplus. This limit is based on a formula that takes into consideration available loss carryback capacity, expected timing of reversal for existing temporary differences, gross deferred tax liabilities and the level of Company surplus. At December 31, 2003 and 2002, the Company's gross deferred tax assets did not exceed this limitation. B-36 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- Changes in deferred tax assets and liabilities related to unrealized gains and losses on investments are reported as a component of changes in unrealized capital gains and losses in the consolidated statement of changes in surplus. Other net changes in deferred tax assets and liabilities are direct adjustments to surplus and separately reported in the consolidated statement of changes in surplus. The major components of current income tax expense (benefit) were as follows: For the Year Ended December 31, ----------------------------------- 2003 2002 2001 ---------- ---------- --------- (in millions) Current year income tax $ (65) $ 26 $ 170 Tax credits (25) (15) (11) Equity tax expense (benefit) -- (453) 14 ---------- ---------- --------- Total current tax expense (benefit) $ (90) $ (442) $ 173 ========== ========== ========= The Company's taxable income can vary significantly from gain from operations before taxes due to temporary timing and permanent differences in revenue recognition and expense deduction between book and tax. The Company is subject to an "equity tax" that is assessed only on mutual life insurance companies. At December 31, 2001, the liability for income taxes payable included $453 million related to the Company's estimated liability for equity tax, primarily with respect to the 2001 tax year. In March 2002, Congress passed legislation that suspended assessments of equity tax for tax years 2001 through 2003. As a result, this liability was released as a current tax benefit during 2002. Barring any additional action by Congress, the equity tax is scheduled to be reinstated for the 2004 tax year. The Company's effective tax rates were 13%, 299%, and 21% for the years ended December 31, 2003, 2002, and 2001, respectively. The effective rate is not the statutory rate applied to the Company's taxable income or loss by the Internal Revenue Service. It is a financial statement relationship that represents the ratio between the sum of total taxes, including those that affect net income and changes in deferred taxes not related to unrealized gains and losses on investments, to the sum of gain from operations before taxes and pretax net realized gains or losses. These financial statement effective rates were different than the applicable federal tax rate of 35% due primarily to differences between book and tax recognition of net investment income and realized capital gains and losses, prior year adjustments and the impact the of equity tax in 2002. Income taxes incurred in the current and prior years of $1.2 billion are available at December 31, 2003 for recoupment in the event of future net losses. B-37 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- 11. Frank Russell Company Acquisition and Goodwill The Company acquired Frank Russell Company ("Russell") effective January 1, 1999 for a purchase price of approximately $955 million plus contingent consideration based upon the financial performance of Russell from the date of acquisition through the five year period ended December 31, 2003. Through December 31, 2003 that contingent consideration had aggregated to approximately $143 million. Russell, a global leader in multi-manager investment services, provides investment products and services in more than 35 countries. This acquisition was accounted for using the statutory purchase method, and the investment is accounted for using the equity method, adjusted for the charge-off of acquisition goodwill, and is reported in common stocks in the consolidated statement of financial position. Since the date of acquisition, the Company charged-off directly from surplus approximately $958 million, representing the goodwill associated with the acquisition, including the impact on goodwill of contingent consideration. The Company has received permission from the OCI for this statutory accounting treatment, which is different than that required by the NAIC "Accounting Practices and Procedures Manual", which prescribes amortization of goodwill over the period in which the purchasing entity benefits economically, not to exceed 10 years. 12. Contingencies and Guarantees The Company has unconditionally guaranteed certain debt obligations of Russell, including $350 million of senior notes and up to $150 million of other credit facilities. In the normal course of business, the Company has guaranteed certain obligations of other affiliates. The maximum exposure under these agreements totaled approximately $62 million at December 31, 2003 and was generally mitigated by the underlying net asset values of the affiliates. The Company believes that the likelihood is remote that payments will be required under these guarantees and therefore has not accrued a contingent liability in the consolidated statement of financial position. In addition, the Company routinely makes commitments to fund mortgage loans or other investments in the normal course of business. These commitments aggregated to $2.3 billion at December 31, 2003 and were extended at market interest rates and terms. The Company is engaged in various legal actions in the normal course of its investment and insurance operations. In the opinion of management, losses that may ultimately result from such actions would not have a material effect on the Company's financial position at December 31, 2003. 13. Related Party Transactions During 2003, the Company transferred investments to a majority-owned investment subsidiary as a capital contribution. Realized capital gains (losses) of ($7) million were recognized in 2003 on the transfer of these assets. During 2001, the Company transferred appreciated equity investments to wholly-owned subsidiaries as a capital contribution to the subsidiaries. Realized capital gains of $244 million for 2001 were reported based on the fair value of the assets at transfer. B-38 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- 14. Fair Value of Financial Instruments The fair value of investment assets, including derivatives, and certain policy liabilities at December 31, 2003 and 2002 were as follows: December 31, 2003 December 31, 2002 ------------------- ------------------- Statement Fair Statement Fair Value Value Value Value --------- -------- --------- -------- (in millions) Assets: Bonds $ 55,571 $ 58,596 $ 50,597 $ 53,311 Common and preferred stocks 6,577 8,488 4,902 6,373 Mortgage loans 16,426 18,086 15,692 17,485 Real estate 1,481 2,122 1,503 2,181 Policy loans 9,546 9,839 9,292 9,628 Other investments 4,851 5,373 4,242 4,802 Cash and short-term investments 2,594 2,594 1,814 1,814 Liabilities: Investment-type insurance reserves $ 3,989 $ 3,759 $ 3,737 $ 3,562 Fair value of bonds, common and preferred stocks and derivative financial instruments are based upon quoted market prices, when available. For those not actively traded, fair values are estimated using independent pricing services or internally developed pricing models. The fair value of mortgage loans is estimated by discounting estimated future cash flows using market interest rates for debt with comparable credit risk and maturities. Real estate fair value is determined by discounting estimated future cash flows using market interest rates. Policy loan fair value is estimated based on discounted projected cash flows using market interest rates and assumptions regarding future loan repayments based on Company experience. Other investments primarily represent joint ventures and partnerships, for which the equity method approximates fair value. The fair value of investment-type insurance reserves is estimated by discounting estimated future cash flows at market interest rates for similar instruments with comparable maturities. 15. Codification of Statutory Accounting Principles Beginning January 1, 2001, insurance companies domiciled in Wisconsin were required to prepare statutory basis financial statements in accordance with the new NAIC "Accounting Practices and Procedures Manual," subject to any variations prescribed or permitted by the OCI. These new requirements differed from those used prior to January 1, 2001, primarily because under the new statutory accounting principles: (1) deferred tax balances were established for temporary differences between book and tax bases of certain assets and liabilities, (2) investment valuation adjustments on impaired assets were measured differently and were reported as realized losses, (3) pension and other employee benefit obligations were accounted for based on the funded status of the related plans, (4) recognition of earnings from unconsolidated subsidiaries and affiliates as net investment income was limited to dividends received, (5) certain software costs were capitalized and amortized to expense over a maximum of five years, and (6) premiums, benefits and reserve changes for policies without significant mortality or morbidity B-39 FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL The Northwestern Mutual Life Insurance Company Notes to Consolidated Statutory Financial Statements December 31, 2003, 2002, 2001 - -------------------------------------------------------------------------------- risks ("deposit-type contracts") were not included in revenue or benefits as reported in the consolidated statement of operations. The cumulative effect of adoption of these new accounting principles was reported in the consolidated statement of changes in surplus as of January 1, 2001, with no restatement of prior periods permitted. This cumulative effect was the difference in the amount of surplus that would have been reported at that date if the new accounting principles had been retroactively applied to all prior periods. The cumulative effect of these accounting changes increased surplus by $749 million at that date, and included the following (in millions): Deferred tax accounting $ 850 Pension plan liabilities (74) Investment valuation changes, net (27) ----------- $ 749 =========== B-40 [Letterhead of PricewaterhouseCoopers] - -------------------------------------------------------------------------------- PricewaterhouseCoopers LLP 100 East Wisconsin Ave., Suite 1500 Report of Independent Auditors Milwaukee, WI 53202 Telephone: (414) 212 1600 To the Board of Trustees and Policyowners of The Northwestern Mutual Life Insurance Company We have audited the accompanying consolidated statement of financial position of The Northwestern Mutual Life Insurance Company and its subsidiary ("the Company") as of December 31, 2003 and 2002, and the related consolidated statements of operations, of changes in surplus and of cash flows for each of the three years in the period ended December 31, 2003. 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. As described in Note 1 to the financial statements, the Company prepared these consolidated financial statements using accounting practices prescribed or permitted by the Office of the Commissioner of Insurance of the State of Wisconsin (statutory basis of accounting), which practices differ from accounting principles generally accepted in the United States of America. Accordingly, the consolidated financial statements are not intended to represent a presentation in accordance with accounting principles generally accepted in the United States of America. The effects on the consolidated financial statements of the variances between the statutory basis of accounting and accounting principles generally accepted in the United States of America, although not reasonably determinable, are presumed to be material. In our opinion, the consolidated financial statements audited by us (1) do not present fairly in conformity with generally accepted accounting principles, the financial position of The Northwestern Mutual Life Insurance Company and its subsidiary as of December 31, 2003 and 2002, or the results of their operations or their cash flows for each of the three years in the period ended December 31, 2003 because of the effects of the variances between the statutory basis of accounting and accounting principles generally accepted in the United States of America referred to in the preceding paragraph, and (2) do present fairly, in all material respects, the financial position of The Northwestern Mutual Life Insurance Company and its subsidiary as of December 31, 2003 and 2002 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, on the basis of accounting described in Note 1. As discussed in Note 15 to the financial statements, the Company adopted the accounting policies in the revised National Association of Insurance Commissioners "Accounting Practices and Procedures Manual" - Effective January 1, 2001, as required by the Office of the Commissioner of Insurance of the State of Wisconsin. The effect of adoption is recorded as an adjustment to surplus as of January 1, 2001. /s/ PRICEWATERHOUSECOOPERS LLP January 26, 2004 B-41 TABLE OF CONTENTS Page ---- DISTRIBUTION OF THE POLICIES.................................................B-2 EXPERTS......................................................................B-2 FINANCIAL STATEMENTS OF THE ACCOUNT..........................................B-3 (as of December 31, 2003 and for each of the two years in the period ended December 31, 2003) Report of Independent Accountants........................................B-14 (as of December 31, 2003 and for each of the two years in the period ended December 31, 2003) FINANCIAL STATEMENTS OF NORTHWESTERN MUTUAL.................................B-15 (as of December 31, 2003 and 2002 and for each of the three years in the period ended December 31, 2003) Report of Independent Accountants........................................B-41 (as of December 31, 2003 and 2002 and for each of the three years in the period ended December 31, 2003) B-42 -----END PRIVACY-ENHANCED MESSAGE-----