- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
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 MARCH 31, 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 MAY 1, 1998
------------------------------ --------------------------
Common Stock, Par value $50.00 50,000
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION
I(1) (A) AND (B) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM 10-Q WITH THE
REDUCED DISCLOSURE FORMAT.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Page 1 of 19
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
- ------ --------------------- --------
CONDENSED FINANCIAL STATEMENTS:
BALANCE SHEET
MARCH 31, 1998 (Unaudited) AND DECEMBER 31, 1997.......... 3
STATEMENT OF OPERATIONS (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1997........ 4
STATEMENT OF STOCKHOLDER'S EQUITY (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1997........ 5
STATEMENT OF CASH FLOWS (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1997........ 6
NOTES TO CONDENSED FINANCIAL
STATEMENTS (Unaudited) MARCH 31, 1998..................... 7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS....................... 10
PART II. OTHER INFORMATION
- ------- -----------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.......................... 17
SIGNATURES .......................................................... 18
EXHIBIT 27 FINANCIAL DATA SCHEDULE................................... 19
2
<PAGE>
<TABLE>
<CAPTION>
VALLEY FORGE LIFE INSURANCE COMPANY
BALANCE SHEET
- ------------------------------------------------------------------------------------------------------
MARCH 31 DECEMBER 31
1998 1997
(Unaudited)
- ------------------------------------------------------------------------------------------------------
(In thousands of dollars)
ASSETS:
Investments:
<S> <C> <C>
Fixed maturities available-for-sale (cost: $473,493 and $466,267) $ 478,275 $ 471,707
Equity securities available-for-sale (cost: $981 and $981) 2,515 2,260
Policy loans 68,808 66,971
Other invested assets 180 433
Short-term investments 38,891 4,597
--------- ----------
TOTAL INVESTMENTS 588,669 545,968
Cash 4,328 24,565
Receivables:
Reinsurance 1,876,871 1,586,471
Premium and other insurance 71,681 65,196
Less allowance for doubtful accounts (208) (285)
Deferred acquisition costs 99,264 95,354
Accrued investment income 9,531 5,245
Receivables for securities sold 1,970 744
Due from affiliates - 35,999
Other 1,055 228
Separate Account business 22,907 8,941
- ----------------------------------------------------------------------------------------------------
TOTAL ASSETS $2,676,068 $2,368,426
====================================================================================================
LIABILITIES AND STOCKHOLDER'S EQUITY:
Liabilities:
Insurance reserves:
Future policy benefits $2,203,067 $1,906,899
Claims 92,743 81,242
Policyholders' funds 39,868 39,928
Payables for securities purchased 3,259 497
Federal income taxes payable 9,657 5,975
Deferred income taxes 2,418 4,098
Due to affiliates 3,117 -
Commissions and other payables 30,213 19,787
Other 49,037 84,799
Separate Account business 22,907 8,941
---------- ----------
TOTAL LIABILITIES 2,456,286 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 174,149 170,230
Accumulated other comprehensive income 3,983 4,380
---------- ----------
TOTAL STOCKHOLDER'S EQUITY 219,782 216,260
- ----------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $2,676,068 $2,368,426
====================================================================================================
<FN>
See accompanying Notes to Condensed Financial Statements (Unaudited).
</FN>
3
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
VALLEY FORGE LIFE INSURANCE COMPANY
STATEMENT OF OPERATIONS
(Unaudited)
- --------------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31 1998 1997
- --------------------------------------------------------------------------------------
(In thousands of dollars)
Revenues:
<S> <C> <C>
Premiums $81,555 $86,083
Net investment income 8,591 7,305
Realized investment gains 1,993 29
Other 1,561 1,275
------- -------
93,700 94,692
------- -------
Benefits and expenses:
Insurance claims and policyholders' benefits 75,153 81,756
Amortization of deferred acquisition costs 2,552 1,531
Other operating expenses 9,858 7,279
------- -------
87,563 90,566
------- -------
Income before income tax 6,137 4,126
Income tax expense 2,218 1,464
- --------------------------------------------------------------------------------------
NET INCOME $ 3,919 $ 2,662
======================================================================================
<FN>
See accompanying Notes to Condensed Financial Statements (Unaudited).
</FN>
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
VALLEY FORGE LIFE INSURANCE COMPANY
STATEMENT OF STOCKHOLDER'S EQUITY
(Unaudited)
- ------------------------------------------------------------------------------------------------------------------
Accumulated
Additional Comprehensive Other Total
Three Months Ended Common Paid-in Income Retained Comprehensive Stockholder's
March 31, 1998 and 1997 Stock Capital (Loss) Earnings Income (Loss) 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 - - $2,662 2,662 - 2,662
Other comprehensive income (loss):
Unrealized investment losses net of
reclassification adjustment and taxes - - (4,929) - (4,929) (4,929)
-------
Total comprehensive income $(2,267)
=======
- -------------------------------------------------------------- ------------------------------------
Balance, March 31, 1997 $2,500 $39,150 $159,562 $(3,939) $197,273
============================================================== ====================================
Balance, December 31, 1997 $2,500 $39,150 $170,230 $4,380 $216,260
Comprehensive income:
Net income - - $3,919 3,919 - 3,919
Other comprehensive income (loss):
Unrealized investment losses net of
reclassification adjustment and taxes - - (397) - (397) (397)
-------
Total comprehensive income $3,522
=======
- -------------------------------------------------------------- -----------------------------------
Balance, March 31, 1998 $2,500 $39,150 $174,149 $3,983 $219,782
============================================================== ===================================
<FN>
See accompanying Notes to Condensed Financial Statements (Unaudited).
</FN>
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
VALLEY FORGE LIFE INSURANCE COMPANY
STATEMENT OF CASH FLOWS
(Unaudited)
- -----------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31 1998 1997
- -----------------------------------------------------------------------------------------------------------------------
(In thousands of dollars)
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C> <C>
Net income $ 3,919 $ 2,662
-------- --------
Adjustments to reconcile net income to net cash flows from operating
activities:
Net realized investment gains, pre-tax (1,993) (29)
Amortization of bond discount (160) (1,178)
Changes in:
Insurance receivables, net (296,962) (94,536)
Deferred acquisition costs (4,036) (6,383)
Accrued investment income (4,286) (1,732)
Due from affiliates 39,116 40,896
Federal income taxes 3,682 2,437
Deferred income taxes (1,534) 1,665
Insurance reserves 299,265 57,931
Commissions and other payables 10,426 6,298
Other, net (36,604) 6,530
-------- ---------
Total adjustments 6,914 11,899
-------- ---------
NET CASH FLOWS FROM OPERATING ACTIVITIES 10,833 14,561
-------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of fixed maturities (124,149) (36,839)
Proceeds from fixed maturities:
Sales 95,940 39,435
Maturities, calls and redemptions 24,926 6,636
Change in short-term investments (34,294) (69,461)
Change in policy loans (1,837) (2,021)
-------- ---------
NET CASH FLOWS FROM INVESTING ACTIVITIES (39,414) (62,250)
-------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Receipts from investment contracts credited to policyholder account balances 13,813 27,366
Return of policyholder account balances on investment contracts (5,469) (2,690)
-------- ---------
NET CASH FLOWS FROM FINANCING ACTIVITIES 8,344 24,676
-------- ---------
NET CASH FLOWS (20,237) (23,013)
Cash at beginning of period 24,565 24,759
- ---------------------------------------------------------------------------------------------------------------------
CASH AT END OF PERIOD $ 4,328 $ 1,746
=====================================================================================================================
Supplemental disclosures of cash flow information:
Federal income taxes paid $ - $ -
=====================================================================================================================
<FN>
See accompanying Notes to Condensed Financial Statements (Unaudited).
</FN>
</TABLE>
6
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS
MARCH 31, 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 84% 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.
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 in
the accompanying condensed financial statements.
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 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
---------------------------------------------------------
THREE MONTHS ENDED MARCH 31 DIRECT ASSUMED CEDED NET %
- ------------------------------------------------------------------------------------------------------------
(In thousands of dollars)
1998
<S> <C> <C> <C> <C> <C>
Life $165,569 $21,371 $165,791 $21,149 101%
Accident and Health 749 60,406 749 60,406 100
- ------------------------------------------------------------------------------------------------------------
TOTAL PREMIUMS $166,318 $81,777 $166,540 $81,555 100%
============================================================================================================
1997
Life $127,691 $21,951 $128,736 $20,906 105%
Accident and Health 705 65,177 705 65,177 100
- ------------------------------------------------------------------------------------------------------------
TOTAL PREMIUMS $128,396 $87,128 $129,441 $86,083 101%
============================================================================================================
</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 $45.2 million for the first quarter in 1998, and
$20.2 million for the first quarter in 1997, respectively. Additionally,
insurance claims and policyholders' benefits are net of reinsurance recoveries
from non-affiliated companies of $34.1 million for the first quarter of 1998,
and $0 million for the same period in 1997.
Reinsurance receivables reflected on the balance sheet are recoverables from
reinsurers related to insurance reserves. These balances, which were
approximately $1.9 billion and $1.4 billion at March 31, 1998 and 1997,
respectively, are principally due from Assurance pursuant the Reinsurance
Pooling Agreement.
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.
8
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS - CONCLUDED
NOTE 4. OTHER COMPREHENSIVE INCOME:
VFL adopted Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income," which established standards for reporting and display of
comprehensive income and its components in the financial statements.
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. The change in the components of other comprehensive
income (loss) are reported net of income tax as shown below:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
PERIOD ENDED MARCH 31, 1998 PRE-TAX TAX (EXPENSE) NET
AMOUNT BENEFIT AMOUNT
- --------------------------------------------------------------------------------------------------------------
(In thousands of dollars)
Net unrealized gains (losses) on investment securities:
<S> <C> <C> <C>
Net unrealized holding gains (losses) arising during the period $1,856 $ (650) $1,206
Reclassification adjustment for (gains) losses
included in net income (2,466) 863 (1,603)
==============================================================================================================
TOTAL OTHER COMPREHENSIVE INCOME $ (610) $ 213 $ (397)
==============================================================================================================
- --------------------------------------------------------------------------------------------------------------
PERIOD ENDED MARCH 31, 1997 PRE-TAX TAX (EXPENSE) NET
AMOUNT BENEFIT AMOUNT
- --------------------------------------------------------------------------------------------------------------
(In thousands of dollars)
Net unrealized gains (losses) on investment securities:
Net unrealized holding gains (losses) arising during the period $(6,634) $2,322 $(4,312)
Reclassification adjustment for (gains) losses
included in net income (949) 332 (617)
==============================================================================================================
TOTAL OTHER COMPREHENSIVE INCOME $(7,583) $2,654 $(4,929)
==============================================================================================================
</TABLE>
9
<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 9, which
contain additional information helpful in evaluating operating results and
financial condition.
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.
10
<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 months ended March 31, 1998 and 1997.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31 1998 1997
- ------------------------------------------------------------------------------------------------
(In thousands of dollars)
OPERATING SUMMARY (excluding realized investment gains/losses):
Revenues:
<S> <C> <C>
Individual premium $16,451 $15,609
Group premium 65,104 70,474
------- ---------
Total premiums 81,555 86,083
Net investment income 8,591 7,305
Other 1,561 1,275
------- ---------
Total revenues 91,707 94,663
Benefits and expenses 87,563 90,566
------- ---------
Operating income before income tax 4,144 4,097
Income tax expense (1,520) (1,454)
------- ---------
Net operating income
(excluding realized investment gains/losses) $ 2,624 $ 2,643
======= =========
SUPPLEMENTAL FINANCIAL DATA:
Net operating income:
Individual $ 1,942 $ 1,591
Group 682 1,052
------- ---------
Net operating income 2,624 2,643
Net realized investment gains 1,295 19
------- ---------
=================================================================================================
NET INCOME $ 3,919 $ 2,662
=================================================================================================
</TABLE>
VFL's revenues, excluding net realized investment gains/losses, were $91.7
million for the first three months of 1998, compared to $94.7 million for the
same period in 1997. Premiums were $81.6 million for the three months ended
March 31, 1998, compared to $86.1 million for the same period in 1997. For the
three month period of 1998, individual premiums increased by 5% to $16.5
million, compared to $15.6 million for the same period in 1997. This increase is
primarily due to a slight increase in sales of ViaTerm, a term life insurance
product. Individual annuity premiums continue to decrease as marketing efforts
have shifted to more profitable products. Group premiums were $65.1 million for
the first three months of 1998, compared to $70.5 million for the same period in
1997. Decreases primarily in group health premiums and Federal Employee Health
Benefit Plan (FEHBP) premiums contributed to the change in group premiums. The
decrease in FEHBP premiums is due to improved claim experience upon which
premiums are based during the first three months of 1998, as compared to the
same period in 1997.
VFL's investment income for the three months ended March 31, 1998 was $8.6
million, an approximate increase of $1.3 million or 18% from the same period for
1997 when investment income was $7.3 million. The increase is attributable to a
larger asset base of VFL's investment portfolio generated from increased cash
flows from premium growth in 1997. The increase was offset by a slightly lower
average yield on VFL's portfolio during 1998, as compared to 1997.
11
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -CONTINUED
Higher losses in group business during the first three months of 1998 as
compared to the same period in 1997 offset the increase in net investment income
and led to relatively no change in pre-tax operating income between the first
quarter of 1998 and the same period for 1997.
FINANCIAL CONDITION:
Assets increased approximately $307.6 million from December 31, 1997 to
$2,676.1 million as of March 31, 1998. VFL's cash and invested assets increased
by $22.5 million from December 31, 1997 to $593.0 million.
During the first three months of 1998, VFL's stockholder's equity increased
by $3.5 million, or 2%, to approximately $219.8 million. The increase in
stockholder's equity in 1998 is due to net income of approximately $3.9 million
and approximately $0.4 million of losses in accumulated other comprehensive
income.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
FINANCIAL POSITION MARCH 31 DECEMBER 31
1998 1997
- --------------------------------------------------------------------------------------------------------
(In thousands of dollars)
<S> <C> <C>
Assets $2,676,068 $2,368,426
Stockholder's Equity 219,782 216,260
Accumulated Other Comprehensive Income (Included in Stockholder's Equity) 3,983 4,380
- --------------------------------------------------------------------------------------------------------
</TABLE>
INVESTMENTS:
The following table summarizes VFL's investments shown at cost or amortized
cost and carrying value at March 31, 1998 and December 31, 1997:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------
DISTRIBUTION OF INVESTMENTS MARCH 31 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 $309,332 53.1% $299,066 55.4%
Asset backed securities 66,893 11.5 68,612 12.7
Corporate debt securities 73,121 12.6 51,355 9.5
Other debt securities 24,147 4.1 47,234 8.8
- ---------------------------------------------------------------------------------------------------
Total fixed maturity securities 473,493 81.3 466,267 86.4
Common stocks 981 0.2 981 0.2
Policy loans 68,808 11.8 66,971 12.4
Other invested assets 545 0.1 579 0.1
Short-term investments 38,891 6.6 4,597 0.9
- ---------------------------------------------------------------------------------------------------
INVESTMENTS AT AMORTIZED COST $582,718 100.0% $539,395 100.0%
===================================================================================================
INVESTMENTS AT CARRYING VALUE* $588,669 $545,968
===================================================================================================
<FN>
* As reported in the Balance Sheet
</FN>
</TABLE>
12
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -CONTINUED
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 $478.3 million at March 31, 1998, compared with $471.7 million at December
31, 1997. At March 31, 1998, net unrealized gains on fixed maturity securities
amounted to approximately $4.8 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 March 31, 1998 were $6.1
million and $1.3 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 a fair value of $2.5
million and $2.3 million at March 31, 1998 and December 31, 1997, respectively.
At March 31, 1998, unrealized gains on equity securities amounted to
approximately $1.5 million. This compares with unrealized gains of approximately
$1.3 million at December 31, 1997. There were no unrealized losses on equity
securities at March 31, 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.
The following table summarizes the ratings of VFL's fixed maturity portfolio
at carrying value (market):
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------
MARCH 31 % DECEMBER 31 %
1998 1997
- -------------------------------------------------------------------------------------------------
(In thousands of dollars)
<S> <C> <C> <C> <C>
U.S. government and affiliated securities $310,141 64.8% $300,676 63.8%
Other AAA rated 73,807 15.4 75,531 16.0
AA and A rated 66,274 13.9 61,404 13.0
BBB rated 24,927 5.2 27,292 5.8
Below investment grade 3,126 0.7 6,804 1.4
- -------------------------------------------------------------------------------------------------
TOTAL $478,275 100.0% $471,707 100.0%
=================================================================================================
</TABLE>
Included in VFL's fixed maturity securities at March 31, 1998 are $67.5
million of asset-backed securities, consisting of approximately 43.5% in
corporate mortgage-backed pass-through certificates, 34.0% in collateralized
mortgage obligations (CMOs), 22.1% in corporate asset-backed obligations and
0.4% in U.S. government agency issued pass-through certificates. The majority of
CMOs held are U.S. government agency issues, which are actively traded in liquid
markets and are priced by broker-dealers.
13
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -CONTINUED
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 $0.6 million and $0.1 million at
March 31, 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 March 31,
1998. The gross notional or contractual amounts of derivative financial
instruments in the general account totaled $50.0 million at both March 31, 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 March 31, 1998 and December 31, 1997, respectively. The fair
value of derivative financial instruments in the general account and Separate
Accounts at March 31, 1998 totaled $0.2 million 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 $0.2 million for the period ended March 31, 1998,
while net realized gains/losses on derivatives in the Separate Accounts were $0
million for the same period. There were no investments in derivative securities
at March 31, 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
expected 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 0.1% and 0.3% of total
assets as of March 31, 1998 and December 31, 1997, respectively.
14
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -CONTINUED
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 replacing many of its legacy systems and is upgrading its
systems to accommodate business for the year 2000 and beyond. VFL believes that
it will be able to resolve the year 2000 issue in a timely manner. 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. 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 to $70
million. VFL will be allocated its proportionate share of this cost upon
completion of the upgrade; however, a reasonable estimate of this cost is not
currently available. 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, CNAF is communicating with its vendors
and business partners to coordinate year 2000 conversion. At this time,
management is unable to determine whether the adverse impact, if any, in
connection with the foregoing circumstances would be material to VFL.
LIQUIDITY AND CAPITAL RESOURCES:
The liquidity requirements of VFL have been met primarily by funds generated
from operating, investing and financing activities. 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 and
operating expenses.
For the three months of 1998, VFL's operating activities generated net
positive cash flows of approximately $10.8 million, compared with net positive
cash flows of $14.6 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.
15
<PAGE>
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -CONCLUDED
Accounting Standards:
In June 1997, the FASB issued 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.
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 Casualty
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 Statement of Position (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.
16
<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 19
(b) REPORTS ON FORM 8-K:
There were no reports on Form 8-K for the three months ended
March 31,1998.
17
<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: May 15, 1998
18
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