- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30,1998 COMMISSION FILE NUMBER 333-1087
--------------------------
VALLEY FORGE LIFE INSURANCE COMPANY
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-6200031
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
CNA PLAZA
CHICAGO, ILLINOIS 60685
(Address of principal executive offices) (Zip Code)
(312) 822-5000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter periods that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
- -
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
CLASS OUTSTANDING AT NOVEMBER 1, 1998
- ------------------------------ -------------------------------
Common Stock, Par value $50.00 50,000
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION
H(1) (A) AND (B) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM 10-Q WITH THE
REDUCED DISCLOSURE FORMAT.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Page 1 of 22
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
- ------------------------------- --------
CONDENSED FINANCIAL STATEMENTS:
BALANCE SHEETS
SEPTEMBER 30, 1998 (Unaudited) AND DECEMBER 31, 1997................... 3
STATEMENTS OF OPERATIONS (Unaudited)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997........ 4
STATEMENTS OF STOCKHOLDER'S EQUITY (Unaudited)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997.................. 5
STATEMENTS OF CASH FLOWS (Unaudited)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997.................. 6
NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited)
SEPTEMBER 30, 1998..................................................... 7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.................................... 11
PART II. OTHER INFORMATION
- ---------------------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................. 20
SIGNATURES ................................................................. 21
EXHIBIT 27. FINANCIAL DATA SCHEDULE....................................... 22
2
<PAGE>
<TABLE>
<CAPTION>
VALLEY FORGE LIFE INSURANCE COMPANY
BALANCE SHEETS
- ---------------------------------------------------------------------------------------------------
SEPTEMBER 30 DECEMBER 31
1998 1997
(Unaudited)
- ---------------------------------------------------------------------------------------------------
(In thousands of dollars)
ASSETS:
Investments:
<S> <C> <C>
Fixed maturities available-for-sale (cost: $416,288 and $466,267) $ 436,541 $ 471,707
Equity securities available-for-sale (cost: $981 and $981) 2,573 2,260
Policy loans 70,630 66,971
Other invested assets 25 433
Short-term investments 81,854 4,597
---------- ----------
Total investments 591,623 545,968
Cash 1,588 24,565
Receivables:
Reinsurance 2,187,784 1,586,471
Premium and other insurance 58,769 65,196
Less allowance for doubtful accounts (285) (285)
Deferred acquisition costs 105,304 95,354
Accrued investment income 7,712 5,245
Receivables for securities sold 1,567 744
Due from affiliates - 35,999
Other 3,060 228
Separate Account business 53,505 8,941
- ---------------------------------------------------------------------------------------------------
TOTAL ASSETS $3,010,627 $2,368,426
===================================================================================================
LIABILITIES AND STOCKHOLDER'S EQUITY:
Liabilities:
Insurance reserves:
Future policy benefits $2,486,965 $1,906,899
Claims 116,281 81,242
Policyholders' funds 41,305 39,928
Payables for securities purchased 408 497
Federal income taxes payable 6,651 5,975
Deferred income taxes 12,674 4,098
Due to affiliates 2,081 -
Commissions and other payables 57,259 104,586
Separate Account business 53,505 8,941
---------- ----------
TOTAL LIABILITIES 2,777,129 2,152,166
---------- ----------
Stockholder's Equity
Common stock ($50 par value; Authorized-200,000 shares;
Issued-50,000 shares) 2,500 2,500
Additional paid-in capital 39,150 39,150
Retained earnings 178,748 170,230
Accumulated other comprehensive income 13,100 4,380
---------- ----------
TOTAL STOCKHOLDER'S EQUITY 233,498 216,260
- ---------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $3,010,627 $2,368,426
===================================================================================================
<FN>
See accompanying Notes to Condensed Financial Statements (Unaudited).
</FN>
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
VALLEY FORGE LIFE INSURANCE COMPANY
STATEMENTS OF OPERATIONS
(Unaudited)
- ----------------------------------------------------------------------------------------------------
THIRD QUARTER NINE MONTHS
PERIOD ENDED SEPTEMBER 30 1998 1997 1998 1997
- ----------------------------------------------------------------------------------------------------
(In thousands of dollars)
Revenues:
<S> <C> <C> <C> <C>
Premiums $76,936 $82,622 $231,516 $247,397
Net investment income 8,879 7,676 26,502 22,937
Realized investment gains 967 1,282 4,480 1,149
Other 1,113 2,151 5,269 4,902
------- ------- -------- --------
87,895 93,731 267,767 276,385
------- ------- -------- --------
Benefits and expenses:
Insurance claims and policyholders' benefits 74,163 78,528 219,544 233,364
Amortization of deferred acquisition costs 3,465 3,997 8,632 6,817
Other operating expenses 9,825 5,164 26,396 22,778
------- ------- -------- --------
87,453 87,689 254,572 262,959
------- ------- -------- --------
Income before income tax 442 6,042 13,195 13,426
Income tax expense 123 2,188 4,677 4,836
- -----------------------------------------------------------------------------------------------------
NET INCOME $ 319 $ 3,854 $ 8,518 $ 8,590
=====================================================================================================
<FN>
See accompanying Notes to Condensed Financial Statements (Unaudited).
</FN>
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
VALLEY FORGE LIFE INSURANCE COMPANY
STATEMENTS OF STOCKHOLDER'S EQUITY
(Unaudited)
- --------------------------------------------------------------------------------------------------------------------
Accumulated
Additional Other Total
Common Paid-in Comprehensive Retained Comprehensive Stockholder's
Stock Capital Income Earnings Income Equity
- --------------------------------------------------------------------------------------------------------------------
(In thousands of dollars)
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1997 $2,500 $39,150 $156,900 $ 990 $199,540
Comprehensive income:
Net income - - $ 8,590 8,590 - 8,590
Other comprehensive income:
Change in other comprehensive income - - 1,891 - 1,891 1,891
-------
Total comprehensive income $10,481
=======
- ---------------------------------------------------------- -----------------------------------------
BALANCE, SEPTEMBER 30, 1997 $2,500 $39,150 $165,490 $ 2,881 $210,021
========================================================== =========================================
Balance, January 1, 1998 $2,500 $39,150 $170,230 $ 4,380 $216,260
Comprehensive income:
Net income - - $ 8,518 8,518 - 8,518
Other comprehensive income:
Change in other comprehensive income - - 8,720 - 8,720 8,720
-------
Total comprehensive income $17,238
=======
- ---------------------------------------------------------- -----------------------------------------
BALANCE, SEPTEMBER 30, 1998 $2,500 $39,150 $178,748 $13,100 $233,498
========================================================== =========================================
<FN>
See accompanying Notes to Condensed Financial Statements (Unaudited).
</FN>
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
VALLEY FORGE LIFE INSURANCE COMPANY
STATEMENTS OF CASH FLOWS
(Unaudited)
- --------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30 1998 1997
- --------------------------------------------------------------------------------------------------------------
(In thousands of dollars)
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C> <C>
Net income $ 8,518 $ 8,590
-------- --------
Adjustments to reconcile net income to net cash flows from operating
activities:
Net realized investment (gains) losses, pre-tax (4,480) (1,149)
Amortization of bond discount (3,684) (4,676)
Changes in:
Insurance receivables, net (594,886) (178,867)
Deferred acquisition costs (11,832) (19,175)
Accrued investment income (2,467) (1,392)
Due from affiliates 38,080 (90,384)
Federal income taxes 676 2,137
Deferred income taxes 3,880 3,129
Insurance reserves 686,506 127,464
Commissions and other payables (49,988) 6,852
-------- --------
Total adjustments 61,805 (156,061)
-------- --------
NET CASH FLOWS FROM OPERATING ACTIVITIES 70,323 (147,471)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of fixed maturities (253,512) (170,107)
Proceeds from fixed maturities:
Sales 278,402 186,958
Maturities, calls and redemptions 30,757 19,659
Change in short-term investments (75,428) 22,013
Change in policy loans (3,659) (5,599)
Change in other invested assets 165 -
-------- --------
NET CASH FLOWS FROM INVESTING ACTIVITIES (23,275) 52,924
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Receipts from investment contracts credited to policyholder account balances 47,914 84,121
Return of policyholder account balances on investment contracts (117,939) (8,850)
-------- --------
NET CASH FLOWS FROM FINANCING ACTIVITIES (70,025) 75,271
-------- --------
NET CASH FLOWS (22,977) (19,276)
Cash at beginning of period 24,565 24,759
- --------------------------------------------------------------------------------------------------------------
CASH AT END OF PERIOD $ 1,588 $ 5,483
==============================================================================================================
Supplemental disclosures of cash flow information:
Federal income taxes received $ - $ 506
==============================================================================================================
<FN>
See accompanying Notes to Condensed Financial Statements (Unaudited).
</FN>
</TABLE>
6
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(Unaudited)
NOTE 1. BASIS OF PRESENTATION:
Valley Forge Life Insurance Company (VFL) is a wholly-owned subsidiary of
Continental Assurance Company (Assurance). Assurance is a wholly-owned
subsidiary of Continental Casualty Company (Casualty) which is wholly-owned by
CNA Financial Corporation (CNAF). Loews Corporation owns approximately 85% of
the outstanding common stock of CNAF.
VFL sells a variety of individual and group insurance products. The
individual insurance products consist primarily of term, universal life,
annuity, variable annuity and variable universal life. Group insurance products
include life, accident and health consisting primarily of major medical and
hospitalization, variable annuities and pension products, such as guaranteed
investment contracts and annuities.
The operations, assets and liabilities of VFL and its parent, Assurance, are
managed, to a large extent, on a combined basis. Pursuant to a Reinsurance
Pooling Agreement, VFL cedes all of its business, excluding its Separate Account
business, to its parent, Assurance. This business is then pooled with the
business of Assurance, which excludes Assurance's participating contracts and
Separate Account business, and 10% of the combined pool is assumed by VFL.
The operating results for the interim periods are not necessarily indicative
of the results to be expected for the full year. These statements should be read
in conjunction with the financial statements and notes thereto included in VFL's
Form 10-K for the year ended December 31, 1997, filed with the Securities and
Exchange Commission on March 31, 1998, and the information shown below.
The accompanying condensed financial statements have been prepared in
conformity with generally accepted accounting principles. Certain amounts
applicable to prior years have been reclassified to conform to classifications
followed in 1998.
The preparation of financial statements in conformity with generally
accepted accounting principles 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. In the
opinion of VFL's management, these statements include all adjustments,
consisting of normal recurring accruals, which are necessary for the fair
presentation of the financial position, results of operations, and cash flows.
7
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS - CONTINUED
NOTE 2. REINSURANCE:
VFL assumes and cedes insurance with other insurers and reinsurers and
members of various reinsurance pools and associations. VFL utilizes reinsurance
arrangements to limit its maximum loss, to provide greater diversification of
risk and to minimize exposures on larger risks. The reinsurance coverages are
tailored to the specific risk characteristics of each product line with VFL's
retained amount varying by type of coverage. VFL's reinsurance includes
coinsurance, quota share, yearly renewable term and facultative programs.
Amounts recoverable from reinsurers are estimated in a manner consistent with
the future policy benefits reserves.
The ceding of insurance does not discharge the primary liability of the
original insurer. VFL places reinsurance with other carriers only after careful
review of the nature of the contract and a thorough assessment of the
reinsurers' credit quality and claim settlement performance. Further, for
carriers that are not authorized reinsurers in VFL's state of domicile, VFL
receives collateral, primarily in the form of bank letters of credit.
In the table below, the majority of life premium revenue is from long
duration type contracts, while the majority of accident and health earned
premiums is from short duration contracts. The effects of reinsurance on premium
revenues are shown in the following schedule:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------
PREMIUMS ASSUMED/NET
------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30 DIRECT ASSUMED CEDED NET %
- -----------------------------------------------------------------------------------------------
(In thousands of dollars)
1998
<S> <C> <C> <C> <C> <C>
Life $480,096 $ 57,725 $482,550 $ 55,271 104%
Accident and Health 2,747 176,245 2,747 176,245 100
- -----------------------------------------------------------------------------------------------
TOTAL PREMIUMS $482,843 $233,970 $485,297 $231,516 101%
===============================================================================================
1997
Life $411,979 $ 59,680 $413,443 $ 58,216 103%
Accident and Health 1,908 189,181 1,908 189,181 100
- -----------------------------------------------------------------------------------------------
TOTAL PREMIUMS $413,887 $248,861 $415,351 $247,397 101%
===============================================================================================
</TABLE>
Transactions with Assurance, as part of the pooling agreement described in
Note 1, are reflected in the above table. Premium revenues ceded to
non-affiliated companies were $176.7 million for the nine month period ended
September 30, 1998 and $77.7 million for the same period in 1997, respectively.
Additionally, insurance claims and policyholders' benefits are net of
reinsurance recoveries from non-affiliated companies of $132.4 million for the
period ended September 30, 1998, and $10.6 million for the same period in 1997.
Reinsurance receivables reflected on the balance sheet represent amounts
due from reinsurers in connection with the cessions of insurance reserves. These
balances, which were approximately $2.0 billion and $1.5 billion at September
30, 1998 and December 31, 1997, respectively, are principally due from Assurance
pursuant the Reinsurance Pooling Agreement.
8
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS - CONTINUED
NOTE 3. LEGAL PROCEEDINGS:
VFL is party to litigation in the ordinary course of business. The outcome of
this litigation will not, in the opinion of management, materially affect the
results of operations or equity of VFL.
NOTE 4. ACCUMULATED OTHER COMPREHENSIVE INCOME:
Comprehensive income is comprised of all changes to stockholder's equity,
including net income, except those changes resulting from investments by owners
and distributions to owners. Other comprehensive income is comprehensive income
exclusive of net income. The change in the components of accumulated other
comprehensive income (loss) are shown below:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
PRE-TAX TAX (EXPENSE) NET
THREE MONTHS ENDED SEPTEMBER 30 AMOUNT BENEFIT AMOUNT
- -------------------------------------------------------------------------------------------------------------
(In thousands of dollars)
1998
Net unrealized gains (losses) on investment securities:
<S> <C> <C> <C>
Net unrealized holding gains (losses) arising during the period $12,575 $(4,401) $8,174
Adjustment for (gains) losses included in net income (372) 130 (242)
=============================================================================================================
TOTAL OTHER COMPREHENSIVE INCOME $12,203 $(4,271) $7,932
=============================================================================================================
Net unrealized gains (losses) on investment securities:
Net unrealized holding gains (losses) arising during the period $ 4,076 $(1,427) $2,649
Adjustment for (gains) losses included in net income (813) 285 (528)
=============================================================================================================
TOTAL OTHER COMPREHENSIVE INCOME $ 3,263 $(1,142) $2,121
=============================================================================================================
- -------------------------------------------------------------------------------------------------------------
PRE-TAX TAX (EXPENSE) NET
NINE MONTHS ENDED SEPTEMBER 30 AMOUNT BENEFIT AMOUNT
- -------------------------------------------------------------------------------------------------------------
(In thousands of dollars)
1998
Net unrealized gains (losses) on investment securities:
Net unrealized holding gains (losses) arising during the period $10,825 $(3,789) $7,036
Adjustment for (gains) losses included in net income 2,590 (906) 1,684
=============================================================================================================
TOTAL OTHER COMPREHENSIVE INCOME $13,415 $(4,695) $8,720
=============================================================================================================
1997
Net unrealized gains (losses) on investment securities:
Net unrealized holding gains (losses) arising during the period $ 2,600 $ (910) $1,690
Adjustment for (gains) losses included in net income 309 (108) 201
=============================================================================================================
TOTAL OTHER COMPREHENSIVE INCOME $ 2,909 $(1,018) $1,891
=============================================================================================================
</TABLE>
9
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS - CONCLUDED
NOTE 5. RESTRUCTURING CHARGES:
In the third quarter of 1998, the Company's ultimate parent, CNAF, recorded
pre-tax restructuring and other related charges totaling $220 million. These
charges primarily related to a net reduction in the current workforce, the
consolidation of certain processing centers, the closing of various facilities,
the exiting of certain businesses and the write-off of assets related to these
activities. $37 million of these charges related to the Employer Health and
Affinity line of business which Assurance decided to exit. VFL's allocation of
these charges as a result of the reinsurance pooling agreement with Assurance
was $3.7 million.
10
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
condensed financial statements and notes thereto found on pages 3 to 10 which
contain additional information helpful in evaluating operating results and
financial condition.
Valley Forge Life Insurance Company (VFL) sells a variety of individual and
group insurance products. The individual insurance products consist primarily of
term, universal life, annuity, variable annuity and variable universal life.
Group insurance products include life, accident and health consisting primarily
of major medical and hospitalization, variable annuities and pension products,
such as guaranteed investment contracts and annuities.
The operations, assets and liabilities of VFL and its parent, Continental
Assurance Company (Assurance), are managed, to a large extent, on a combined
basis. Pursuant to a Reinsurance Pooling Agreement, VFL cedes all of its
business, excluding its separate account business, to its parent, Assurance.
This business is then pooled with the business of Assurance, which excludes
Assurance's participating contracts and separate account business, and 10% of
the combined pool is assumed by VFL.
CNA Financial Corporation (CNAF) is a holding company whose primary
subsidiaries consist of property/casualty and life insurance companies,
collectively CNA. CNAF is the ultimate parent of VFL. On August 5, 1998, CNA
announced estimates of the financial implications of its initiatives to achieve
world-class performance. "World-class performance", as defined by CNA, refers to
CNA's intention to position each of its strategic business units (SBUs) as a
market leader by sharpening its focus on customers and employing new technology
to work smarter and faster. As a result of these initiatives, CNA is
reorganizing a number of its SBUs and corporate support areas. Certain of these
initiatives will affect VFL.
In the third quarter of 1998 CNAF recorded a pre-tax restructuring charge and
other related charges totaling $220 million. These charges primarily related to
a net reduction in the current workforce, the consolidation of certain
processing centers, the closing of various facilities and the exiting of certain
businesses and the write-offs of assets related to the these activities. $37
million of these charges related to the Employer Health and Affinity line of
business which Assurance decided to exit. VFL's allocation of these charges as a
result of the reinsurance pooling agreement with Assurance was $3.7 million.
11
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -CONTINUED
RESULTS OF OPERATIONS:
The following table summarizes key components of VFL's operating results for
the three and nine months ended September 30, 1998 and 1997.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------
THIRD QUARTER NINE MONTHS
PERIOD ENDED SEPTEMBER 30 1998 1997 1998 1997
- --------------------------------------------------------------------------------------------------
(In thousands of dollars)
OPERATING SUMMARY
(excluding realized investment gains/losses):
Revenues:
<S> <C> <C> <C> <C>
Individual premium $12,346 $14,071 $ 39,273 $ 43,351
Group premium 64,590 68,551 192,243 204,046
------- ------- -------- --------
Total premiums 76,936 82,622 231,516 247,397
Net investment income 8,879 7,676 26,502 22,937
Other 1,113 2,151 5,269 4,902
------- ------- -------- --------
Total revenues 86,928 92,449 263,287 275,236
Benefits and expenses 87,453 87,689 254,572 262,959
------- ------- -------- --------
Operating income before income tax (525) 4,760 8,715 12,277
Income tax benefit (expense) 216 (1,766) (3,109) (4,434)
-------- ------- -------- --------
Net operating income (309) 2,994 5,606 7,843
Net realized investment gains 628 860 2,912 747
- --------------------------------------------------------------------------------------------------
NET INCOME $ 319 $3,854 $ 8,518 $ 8,590
==================================================================================================
</TABLE>
VFL's revenues, excluding net realized investment gains/losses, were $263.3
million for the first nine months of 1998, compared to $275.2 million for the
same period in 1997. Premiums were $231.5 million for the nine months ended
September 30, 1998, compared to $247.4 million for the same period in 1997. For
the nine month period of 1998, individual premiums decreased by 9.4% to $39.3
million, from $43.4 million for the same period in 1997. This decrease is due in
part to a decline in individual annuity premiums as CNA's marketing efforts have
shifted to more profitable products. Group premiums were $192.2 million for the
first nine months of 1998, compared to $204.0 million for the same period in
1997. The decrease in group premiums is primarily due to lower Federal Employee
Health Benefit Plan (FEHBP) premiums and a reduction in group health premiums.
The decrease in FEHBP premiums is a result of improved claim experience upon
which the premiums are based and continues the trend from the first two quarters
of this year.
Premiums for the three months ended September 30, 1998 were $76.9 million,
compared to $82.6 million for the same period in 1997. Individual premiums
decreased by 12.3% to $12.3 million for the three months ended September 30,
1998, from $14.1 million for the same period in 1997. For the three months ended
September 30, 1998, group premium decreased to $64.6 million from $68.6 million
for the same period in 1997. The decrease in net premiums for the three months
ended September 30, 1998 were primarily due to lower premiums for individual
annuity and FEHBP business.
12
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -CONTINUED
VFL's investment income for the nine months ended September 30, 1998 was
$26.5 million, an approximate increase of $3.6 million or 15.5% to $22.9 million
for the same period in 1997. The increase is primarily attributable to a larger
asset base of VFL's investment portfolio generated from increased cash flows
from premium growth in 1997. Investment income was $8.9 million and $7.7 million
for the three months ended September 30, 1998 and 1997, respectively.
Benefits and expenses were $254.6 million for the nine month period ended
September 30, 1998, as compared to $263.0 million for the same period in 1997.
Benefits and expenses for the three months and nine months ended September 30,
1998 include $3.7 million related to restructuring charges that were taken
during the quarter. The decrease in benefits and expenses was related to the
decrease in premiums, as noted above.
The decrease in pre-tax operating income of $3.6 million to $8.7 million for
the nine month period ended September 30, 1998 is primarily due to the charge
taken in the third quarter related to restructuring.
Realized investment gains, net of tax, for the first nine months ended
September 30, 1998 were $2.9 million, compared to net realized investment gains
for the same period in 1997 of $0.7 million. Realized investment gains, net of
tax, for the three months ended September 30, 1998 were $0.6 million, compared
to net realized investment gains of $0.9 million for the same period in 1997.
FINANCIAL CONDITION:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------
FINANCIAL POSITION SEPTEMBER 30 DECEMBER 31
1998 1997
- ---------------------------------------------------------------------------------------------------
(In thousands of dollars)
<S> <C> <C>
Assets $3,010,627 $2,368,426
Cash and invested assets 593,211 570,533
Stockholder's equity 233,498 216,260
Net unrealized investment gains included in stockholder's equity 13,100 4,380
- ---------------------------------------------------------------------------------------------------
</TABLE>
Assets increased approximately $642.2 million from December 31, 1997 to
$3,010.6 million as of September 30, 1998. VFL's cash and invested assets
increased by approximately $22.7 million from December 31, 1997 to $593.2
million. Ceded insurance reserves, included in reinsurance receivables, totaled
$2,187.8 million at September 30, 1998, an increase of $601.3 million from
December 31, 1997. This increase is caused by a change in some of VFL's
reinsurance contracts to coinsurance.
During the first nine months of 1998, VFL's stockholder's equity increased
by $17.2 million, or 8.0%, to approximately $233.5 million. The increase in
stockholder's equity in 1998 is due to net income of approximately $8.5 million
and an approximate $8.7 million increase in accumulated other comprehensive
income. Accumulated other comprehensive income is comprised primarily of
unrealized gains and losses.
13
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -CONTINUED
INVESTMENTS:
The following table summarizes VFL's investments shown at cost or amortized
cost and carrying value at September 30, 1998 and December 31, 1997:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------
DISTRIBUTION OF INVESTMENTS SEPTEMBER 30 DECEMBER 31
1998 % 1997 %
- ---------------------------------------------------------------------------------------------
(In thousands of dollars)
Fixed maturity securities:
U.S. Treasury Securities and
<S> <C> <C> <C> <C>
obligations of government agencies $247,298 43.3% $299,066 55.4%
Asset backed securities 83,343 14.6 68,612 12.7
Corporate debt securities 62,456 11.0 51,355 9.5
Other debt securities 23,191 4.1 47,234 8.8
- ---------------------------------------------------------------------------------------------
Total fixed maturity securities 416,288 73.0 466,267 86.4
Common stocks 981 0.2 981 0.2
Policy loans 70,630 12.4 66,971 12.4
Other invested assets 505 0.1 579 0.1
Short-term investments 81,854 14.3 4,597 0.9
- ---------------------------------------------------------------------------------------------
INVESTMENTS AT AMORTIZED COST $570,258 100.0% $539,395 100.0%
=============================================================================================
INVESTMENTS AT CARRYING VALUE* $591,623 $545,968
=============================================================================================
<FN>
* As reported in the Balance Sheet
</FN>
</TABLE>
The operations, assets and liabilities of VFL and Assurance are, to a large
extent, managed on a combined basis. The investment portfolio is managed to
maximize after-tax investment return, while minimizing credit risks, with
investments concentrated in high quality securities to support insurance
underwriting operations. The investment portfolios are segregated for the
purpose of supporting policy liabilities for universal life, annuities and other
interest sensitive products.
VFL's investments in fixed maturity securities are carried at a fair value
of $436.5 million at September 30, 1998, compared with $471.7 million at
December 31, 1997. At September 30, 1998, net unrealized gains on fixed maturity
securities amounted to approximately $20.3 million. This compares with net
unrealized gains of approximately $5.4 million at December 31, 1997. The gross
unrealized gains and losses for the fixed maturities portfolio at September 30,
1998 were $20.8 million and $0.5 million, respectively, compared to $6.2 million
and $0.8 million, respectively, at December 31, 1997.
VFL's investments in equity securities are carried at their fair value of
$2.6 million and $2.3 million at September 30, 1998 and December 31, 1997,
respectively. At September 30, 1998, unrealized gains on equity securities
amounted to approximately $1.6 million. This compares with unrealized gains of
approximately $1.3 million at December 31, 1997. There were no unrealized losses
on equity securities at September 30, 1998 and December 31, 1997.
VFL has the capacity to hold its fixed maturity portfolio to maturity.
However, securities may be sold as part of VFL's asset/liability management
strategies or to take advantage of investment opportunities generated by
changing interest rates, tax and credit considerations or other similar factors.
Accordingly, the fixed maturity securities are classified as available-for-sale.
14
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -CONTINUED
The following table summarizes the ratings of VFL's fixed maturity portfolio
at carrying value (market):
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
SEPTEMBER 30 % DECEMBER 31 %
1998 1997
- --------------------------------------------------------------------------------------
(In thousands of dollars)
<S> <C> <C> <C> <C>
U.S. government and affiliated securities $282,690 64.8% $300,676 63.8%
Other AAA rated 76,944 17.6 75,531 16.0
AA and A rated 52,744 12.1 61,404 13.0
BBB rated 24,163 5.5 27,292 5.8
Below investment grade 0 - 6,804 1.4
- --------------------------------------------------------------------------------------
TOTAL $436,541 100.0% $471,707 100.0%
======================================================================================
</TABLE>
Included in VFL's fixed maturity securities at September 30, 1998 are $86.1
million of asset-backed securities, consisting of approximately 56.2% in
collateralized mortgage obligations (CMOs), 26.4% in U.S. government agency
issued pass-through certificates 10.3% in corporate mortgage-backed pass-through
certificates and 7.1% in corporate asset-backed obligations. The majority of
CMOs held are U.S. government agency issues, which are actively traded in liquid
markets and are priced by broker-dealers.
CMOs are subject to prepayment risk that tends to vary with changes in
interest rates. During periods of declining interest rates, CMOs generally
prepay faster as the underlying mortgages are prepaid and refinanced by the
borrowers in order to take advantage of the lower rates. Conversely, during
periods of rising interest rates, prepayments are generally slow. VFL limits the
risks associated with interest rate fluctuations and prepayments by
concentrating its CMO investments in planned amortization classes with
relatively short principal repayment windows. The fair value of asset-backed
securities was more than the amortized cost by $2.8 million and $0.1 million at
September 30, 1998 and December 31, 1997, respectively. VFL avoids investments
in complex mortgage derivatives and does not have any investments in mortgage
loans or real estate.
VFL invests from time to time in derivative financial instruments primarily
to reduce its exposure to market risk. VFL also uses derivatives to mitigate the
risk associated with certain guaranteed annuity contracts by purchasing certain
options in a notional amount equal to the original customer deposit. VFL's
derivatives are classified as other invested assets and VFL generally does not
hold or issue these instruments for trading purposes.
Derivative financial instruments consist of interest rate caps in the
general account and purchased options in the Separate Accounts at September 30,
1998. The gross notional or contractual amounts of derivative financial
instruments in the general account totaled $50.0 million at both September 30,
1998 and December 31, 1997. The gross notional principal or contractual amounts
of derivative financial instruments in the Separate Accounts totaled $1.6
million and $1.5 million at September 30, 1998 and December 31, 1997,
respectively.
The fair value of derivative financial instruments in the general account
and Separate Accounts at September 30, 1998 totaled $25.0 thousand and $0.4
million, respectively. The fair value of derivative financial instruments in the
general account and Separate Accounts at December 31, 1997 totaled $0.4 million
and $0.3 million, respectively. Net realized losses on derivative financial
instruments held in the general account totaled $0.4 million for the period
15
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -CONTINUED
ended September 30, 1998, while net realized gains on derivatives in the
Separate Accounts were $0.1 million for the same period. There were no
investments in derivative securities at September 30, 1997.
High yield securities are bonds rated below investment grade by bond rating
agencies, and other unrated securities which, in the opinion of management, are
below investment grade (below BBB). High yield securities generally involve a
greater degree of risk than that of investment grade securities. Returns are
intended to compensate for the added risk. The risk is also considered in the
interest rate assumptions in the underlying insurance products. VFL's
concentration in high yield bonds was approximately 0.3% of total assets as of
December 31, 1997. At September 30, 1998, VFL did not hold any high yield bonds.
LIQUIDITY AND CAPITAL RESOURCES:
VFL's principal cash flow sources are premiums, investment income, receipts
for investment contracts sold and sales and maturities of investment. The
primary cash flow uses are payments for claims, policy benefits, payments on
matured policyholder contracts, purchases of investment securities and operating
expenses.
For the nine months of 1998, VFL's operating activities generated net
positive cash flows of $70.3 million, compared with net negative cash flows of
$147.5 million for the same period in 1997.
Management believes that future liquidity needs will be met primarily by
cash generated from operations. Net cash flows from operations are generally
invested in marketable securities. Investment strategies employed by VFL
consider the cash flow requirements of the insurance products sold and the tax
attributes of the various types of marketable investments.
IMPACT OF YEAR 2000 ON VFL:
The widespread use of computer programs, both in the United States and
internationally, that rely on two digit date fields to perform computations and
decision making functions may cause computer systems to malfunction when
processing information involving dates beginning in 1999. Such malfunctions
could lead to business delays and disruptions. All subsidiaries of CNAF,
including VFL, utilize the same systems in conducting day-to-day operations. VFL
is in the process of renovating or replacing many of its legacy systems and is
upgrading its systems to accommodate business for the year 2000 and beyond. In
addition, VFL is checking embedded systems in computer hardware and other
infrastructure such as elevators, heating and ventilating systems and security
systems. VFL's cost to upgrade and replace its systems will be included as part
of the total cost incurred by CNAF to replace and upgrade its systems. To date,
89% of CNAF's planned hours have been expended, and a similar percentage of
milestones have been completed.
Approximately 81% of CNA's internal systems have been internally tested
so far and will be running in a production environment by December 1, 1998. This
deadline allows a full year for shake-out of already tested and implemented Year
2000 remediated systems, as well as for detection of any previously
unidentified problems and for interacting with business partners and vendors
that are still working on making their programs Year 2000 ready.
16
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -CONTINUED
Based upon its current assessment, CNAF estimates that the total cost to
replace and upgrade its systems to accommodate year 2000 processing will be
approximately $60.0 to $70.0 million. VFL will be allocated its proportionate
share of this cost upon completion of the upgrade. As of September 30, 1998,
approximately $48.0 million has been spent. The historical costs include some
limited amounts for costs incurred prior to 1997. However, prior to 1997, VFL
did not specifically separate technology charges for Year 2000 from other
information technology charges. In addition, while some hardware charges are
included in the budget figures, VFL's hardware costs are typically included as
part of ongoing technology updates and not specifically as part of the Year 2000
project. All funds spent and to be spent will be financed from current operating
funds.
VFL believes that it will be able to resolve the year 2000 issue in a
timely manner. However, due to the interdependent nature of computer systems,
VFL may be adversely impacted depending upon whether it or other entities not
affiliated with VFL (vendors and business partners) address this issue
successfully. To mitigate this impact, VFL is communicating with its vendors and
business partners to coordinate year 2000 conversion. CNAF has already sent Year
2000 information packages to more than 12,000 independent agents to encourage
them to become Year 2000 ready in time. CNAF has also sent Year 2000 information
to almost 300,000 business policyholders to increase their awareness of the Year
2000 issue. Similar information packages have been sent to healthcare providers,
lawyers and others with whom we have business relationships. Because of the
interdependent nature of the issue, VFL cannot be sure that there will not be a
disruption in its business.
VFL has also developed business resumption plans to ensure that it is able
to continue critical processes through other means in the event that it becomes
necessary to do so. Formal strategies have been developed within each business
unit and support organization to include appropriate recovery processes and use
of alternative vendors. More than 200 strategies have been developed to address
recovery plans for approximately 400 processes. These plans are being updated
quarterly.
ACCOUNTING STANDARDS:
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 131, "Disclosures about
Segments of an Enterprise and Related Information," which establishes standards
for the way that public business enterprises report information about operating
segments in interim and annual financial statements. It requires that those
enterprises report a measure of segment profit or loss, certain specific revenue
and expense items and segment assets, and that the enterprises reconcile the
total of those amounts to the general-purpose financial statements. It also
establishes standards for related disclosures about products and services,
geographic areas and major customers. This Statement is effective for financial
statements for periods beginning after December 15, 1997. This Statement need
not be applied to interim financial statements in the initial year of its
application. This Statement will redefine VFL's business segment disclosure.
17
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -CONTINUED
In December 1997, the American Institute of Certified Public Accountants'
Accounting Standards Executive Committee issued Statement of Position (SOP)
97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related
Assessments," which provides guidance on accounting by entities that are subject
to insurance-related assessments. It requires that entities recognize
liabilities for insurance-related assessments when all of the following criteria
have been met: an assessment has been imposed or a probable assessment will be
imposed; the event obligating an entity to pay an imposed or probable assessment
has occurred on or before the date of the financial statements; and the amount
of the assessment can be reasonably estimated. This SOP is effective for
financial statements for fiscal years beginning after December 15, 1998. VFL is
currently evaluating the effects of this SOP on its accounting for
insurance-related assessments.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits," which standardizes disclosure
requirements for pension and other postretirement benefits to the extent
practicable, and requires additional information on changes in the benefit
obligations and fair values of plan assets that will facilitate financial
analysis. The Statement also suggests combined formats for presentation of
pension and other postretirement benefit disclosures. The Statement changes
disclosure only and does not address measurement or recognition. It is effective
for fiscal years beginning after December 15, 1997. VFL has no employees;
however, expenses are allocated to VFL for services provided by Continental
Casualty Company employees. VFL is currently evaluating the effects of this
Statement on its benefit plan disclosures.
In March 1998, the American Institute of Certified Public Accountants'
Accounting Standards Executive Committee issued SOP 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use," which
provides guidance on accounting for costs of computer software developed or
obtained for internal use and for determining whether computer software is for
internal use. For purposes of this SOP, internal-use software is software
acquired, internally developed or modified solely to meet the entity's internal
needs for which no substantive plan exists or is being developed to market the
software externally during the software's development or modification.
Accounting treatment for costs associated with software developed or obtained
for internal use, as defined by this SOP, is based upon a number of factors,
including the point in time during the project that costs are incurred as well
as the types of costs incurred. This SOP is effective for financial statements
for fiscal years beginning after December 15, 1998. VFL is currently evaluating
the effects of this SOP.
18
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -CONCLUDED
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes standards for the
accounting and reporting for derivative instruments and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a forecasted transaction, or (c) a hedge
of the foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available-for-sale security, or a
foreign-currency-denominated forecasted transaction. The accounting for changes
in the fair value of a derivative depends on the intended use of the derivative
and the resulting designation. This Statement is effective for all quarters of
fiscal years beginning after June 15, 1999. VFL is currently evaluating the
effects of this Statement on its accounting and reporting for derivatives and
hedges.
FORWARD-LOOKING STATEMENTS
When included in management's discussion and analysis, the words "believes,"
"expects," "intends," "anticipates," "estimates" and analogous expressions are
intended to identify forward-looking statements. Such statements inherently are
subject to a variety of risks and uncertainties that could cause actual results
to differ materially from those projected. Such risks and uncertainties include,
among others, general economic and business conditions, competition, changes in
financial markets (interest rate, credit, currency, commodities and stocks)
changes in foreign, political, social and economic conditions, regulatory
initiatives and compliance with governmental regulations, judicial decisions and
rulings, and various other matters, many of which are beyond VFL's control. See
the Company's discussions elsewhere in this report on how these risks may affect
VFL. These forward-looking statements speak only as of the date of this report.
VFL expressly disclaims any obligation or undertaking to release publicly any
updates or revisions to any forward-looking statement contained herein to
reflect any change in VFL's expectations with regard thereto or any change in
events, conditions or circumstances on which any statement is based.
19
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
PART II OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS:
Description of Exhibit
Exhibit Page
Number Number
(27) Financial Data Schedule 27 22
(b) REPORTS ON FORM 8-K:
There were no reports on Form 8-K for the three months ended September
30, 1998.
20
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
PART II OTHER INFORMATION - CONCLUDED
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Valley Forge Life Insurance Company
By S/W. James MacGinnitie
-------------------------------
W. James MacGinnitie
Director, Senior Vice President
and Chief Financial Officer
Date: November 12, 1998
21
<TABLE> <S> <C>
<ARTICLE> 7
<CIK> 0001007008
<NAME> VALLEY FORGE LIFE INSURANCE COMPANY
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<DEBT-HELD-FOR-SALE> 436,541
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 2,573
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 591,623
<CASH> 1,588
<RECOVER-REINSURE> 2,187,784
<DEFERRED-ACQUISITION> 105,304
<TOTAL-ASSETS> 3,010,627
<POLICY-LOSSES> 2,603,246
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 41,305
<NOTES-PAYABLE> 0
0
0
<COMMON> 2,500
<OTHER-SE> 230,998
<TOTAL-LIABILITY-AND-EQUITY> 3,010,627
231,516
<INVESTMENT-INCOME> 26,502
<INVESTMENT-GAINS> 4,480
<OTHER-INCOME> 5,269
<BENEFITS> 219,544
<UNDERWRITING-AMORTIZATION> 8,632
<UNDERWRITING-OTHER> 26,396
<INCOME-PRETAX> 13,195
<INCOME-TAX> 4,677
<INCOME-CONTINUING> 8,518
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,518
<EPS-PRIMARY> 170.36
<EPS-DILUTED> 170.36
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
<FN>
22
</FN>
</TABLE>
