<PAGE> 1
================================================================================
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 JUNE 30, 1999 COMMISSION FILE NUMBER 333-1083
--------------------------
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, 1999
----- --------------------------
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> 2
VALLEY FORGE LIFE INSURANCE COMPANY
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE NO.
CONDENSED FINANCIAL STATEMENTS:
<S> <C>
BALANCE SHEETS
JUNE 30, 1999 (Unaudited) AND DECEMBER 31, 1998 ................... 3
STATEMENTS OF OPERATIONS (Unaudited)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1999 AND 1998 ......... 4
STATEMENTS OF STOCKHOLDER'S EQUITY (Unaudited)
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 ................... 5
STATEMENTS OF CASH FLOWS (Unaudited)
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 ................... 6
NOTES TO CONDENSED FINANCIAL
STATEMENTS (Unaudited) JUNE 30, 1999 .............................. 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 .......................................... 23
SIGNATURES .......................................................................... 24
EXHIBIT 10(k) FINANCIAL SUPPORT AGREEMENT ........................................... 25
EXHIBIT 27 FINANCIAL DATA SCHEDULE .................................................. 27
</TABLE>
2
<PAGE> 3
VALLEY FORGE LIFE INSURANCE COMPANY
BALANCE SHEETS
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
JUNE 30 DECEMBER 31
1999 1998
(Unaudited)
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
(In thousands of dollars, except per share amounts)
ASSETS:
Investments:
Fixed maturities available-for-sale (amortized cost: $481,347 and $454,635) $ 476,265 $ 460,516
Equity securities available-for-sale (cost: $981 and $981) 2,558 2,218
Policy loans 74,213 74,150
Other invested assets 351 485
Short-term investments 33,500 81,418
----------- -----------
TOTAL INVESTMENTS 586,887 618,787
Cash 4,515 3,750
Receivables:
Reinsurance 2,215,669 2,119,897
Premium and other insurance 53,088 54,664
Deferred acquisition costs 119,845 111,963
Receivables for securities sold 17,309 --
Accrued investment income 8,229 7,721
Due from affiliates 39,165 --
Deferred income taxes 2,804 --
Other 1,836 902
Separate Account business 128,691 73,745
- --------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 3,178,038 $ 2,991,429
==============================================================================================================
LIABILITIES AND STOCKHOLDER'S EQUITY:
Liabilities:
Insurance reserves:
Future policy benefits $ 2,540,154 $ 2,438,305
Claims 142,776 93,001
Policyholders' funds 48,003 42,746
Payables for securities purchased 17,106 370
Federal income taxes payable 8,260 6,468
Deferred income taxes -- 6,213
Due to affiliates -- 1,946
Commissions and other payables 38,783 64,815
Separate Account business 128,691 73,745
----------- -----------
TOTAL LIABILITIES 2,923,773 2,727,609
----------- -----------
Commitments and contingent liabilities - Note 3 -- --
Stockholder's Equity:
Common stock ($50 par value; Authorized-200,000 shares;
Issued-50,000 shares) 2,500 2,500
Additional paid-in capital 69,150 69,150
Retained earnings 183,453 187,683
Accumulated other comprehensive income (838) 4,487
----------- -----------
TOTAL STOCKHOLDER'S EQUITY 254,265 263,820
- --------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $ 3,178,038 $ 2,991,429
==============================================================================================================
</TABLE>
See accompanying Notes to Condensed Financial Statements (Unaudited).
3
<PAGE> 4
VALLEY FORGE LIFE INSURANCE COMPANY
STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
THREE MONTHS SIX MONTHS
PERIOD ENDED JUNE 30 1999 1998 1999 1998
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(In thousands of dollars)
Revenues:
Premiums $ 83,651 $ 73,025 $158,324 $154,580
Net investment income 9,004 9,032 18,108 17,623
Realized investment gains (losses) (13,213) 1,520 (17,902) 3,513
Other 3,597 2,595 5,262 4,156
-------- -------- -------- --------
83,039 86,172 163,792 179,872
-------- -------- -------- --------
Benefits and expenses:
Insurance claims and policyholders' benefits 80,891 70,228 151,002 145,381
Amortization of deferred acquisition costs 3,068 2,615 6,065 5,167
Other operating expenses 7,415 6,713 13,714 16,571
-------- -------- -------- --------
91,374 79,556 170,781 167,119
-------- -------- -------- --------
Income (loss) before income tax and cumulative
effect of change in accounting principle (8,335) 6,616 (6,989) 12,753
Income tax expense (benefit) (3,485) 2,336 (2,993) 4,554
-------- -------- -------- --------
Income (loss) before cumulative effect of change
in accounting principle (4,850) 4,280 (3,996) 8,199
Cumulative effect of change in accounting
principle, net of taxes - Note 5 - - (234) -
- ------------------------------------------------------------- ------- -------- -------
NET INCOME (LOSS) $ (4,850) $ 4,280 $ (4,230) $ 8,199
============================================================= ======= ======== =======
</TABLE>
See accompanying Notes to Condensed Financial Statements (Unaudited).
4
<PAGE> 5
VALLEY FORGE LIFE INSURANCE COMPANY
STATEMENTS OF STOCKHOLDER'S EQUITY
(Unaudited)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
Accumulated
Additional Other Total
Six Months Ended Common Paid-in Comprehensive Retained Comprehensive Stockholder's
June 30, 1999 and 1998 Stock Capital Income (Loss) Earnings Income (Loss) Equity
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
(In thousands of dollars)
Balance, December 31, 1997 $ 2,500 $ 39,150 $ 170,230 $ 4,380 $ 216,260
Comprehensive income (loss):
Net income - - $ 8,199 8,199 - 8,199
Other comprehensive income - - 788 - 788 788
---------
Total comprehensive income $ 8,987
=========
- ----------------------------------------------------------- ------------------------------------------
Balance, June 30, 1998 $ 2,500 $ 39,150 $ 178,429 $ 5,168 $ 225,247
=========================================================== ==========================================
Balance, December 31, 1998 $ 2,500 $ 69,150 $ 187,683 $ 4,487 $ 263,820
Comprehensive income (loss):
Net loss - - $ (4,230) (4,230) - (4,230)
Other comprehensive loss - - (5,325) - (5,325) (5,325)
---------
Total comprehensive loss $ (9,555)
=========
- ----------------------------------------------------------- -------------------------------------------
Balance, June 30, 1999 $ 2,500 $ 69,150 $ 183,453 $ (838) $ 254,265
=========================================================== ===========================================
</TABLE>
See accompanying Notes to Condensed Financial Statements (Unaudited).
5
<PAGE> 6
VALLEY FORGE LIFE INSURANCE COMPANY
STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30 1999 1998
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C>
(In thousands of dollars)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (4,230) $ 8,199
Adjustments to reconcile net income to net cash flows from
operating activities:
Deferred income provision (6,277) 4,292
Net realized investment (gains) losses, pre-tax 17,902 (3,513)
Amortization of bond discount (1,237) (1,955)
Changes in:
Insurance receivables, net (94,196) (491,676)
Deferred acquisition costs (5,657) (8,873)
Accrued investment income (508) (514)
Due from affiliates (41,111) 29,566
Federal income taxes 1,792 102
Insurance reserves 171,590 495,132
Commissions and other payables and other (26,631) (39,109)
--------- ---------
Total adjustments 15,667 (16,548)
--------- ---------
NET CASH FLOWS FROM OPERATING ACTIVITIES 11,437 (8,349)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of fixed maturities (989,428) (190,742)
Proceeds from fixed maturities:
Sales 898,060 173,683
Maturities, calls and redemptions 46,529 28,186
Change in policy loans (63) (3,329)
Change in other invested assets (214) --
Change in short-term investments 49,153 (29,854)
--------- ---------
NET CASH FLOWS FROM INVESTING ACTIVITIES 4,037 (22,056)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Receipts for investment contracts credited to policyholder account balances 5,982 27,111
Return of policyholder account balances on investment contracts (20,691) (19,836)
--------- ---------
NET CASH FLOWS FROM FINANCING ACTIVITIES (14,709) 7,275
--------- ---------
NET CASH FLOWS 765 (23,130)
Cash at beginning of period 3,750 24,565
- -------------------------------------------------------------------------------------------------------
CASH AT END OF PERIOD $ 4,515 $ 1,435
=======================================================================================================
Supplemental disclosures of cash flow information:
Federal income taxes paid $ -- $ --
=======================================================================================================
</TABLE>
See accompanying Notes to Condensed Financial Statements (Unaudited).
6
<PAGE> 7
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS - CONTINUED
JUNE 30, 1999
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION:
Valley Forge Life Insurance Company (VFL) is a wholly-owned subsidiary of
Continental Assurance Company (CAC). CAC is a wholly-owned subsidiary of
Continental Casualty Company (Casualty) which is wholly-owned by CNA Financial
Corporation (CNA Financial). CNA Financial is a holding company whose primary
subsidiaries consist of property/casualty and life insurance companies,
collectively CNA. Loews Corporation owns approximately 86% of the outstanding
common stock of CNA Financial.
VFL markets and underwrites insurance products designed to satisfy the life,
health and retirement needs of individuals and groups. Products available in
individual policy form include annuities as well as term and universal life
insurance. Products available in group policy form include life, pension,
accident and health.
The operations, assets and liabilities of VFL and its parent, CAC, are
managed on a combined basis pursuant to a Reinsurance Pooling Agreement. Under
this Reinsurance Pooling Agreement, VFL cedes all of its business, excluding its
Separate Account business, to its parent, CAC. This business is then pooled with
the business of CAC, which excludes CAC'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, 1998, filed with the Securities and
Exchange Commission.
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 1999.
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> 8
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS - CONTINUED
NOTE 2. REINSURANCE:
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/
SIX MONTHS ENDED JUNE 30 DIRECT ASSUMED CEDED NET NET %
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
(In thousands of dollars)
1999
Life $312,515 $ 38,004 $319,682 $ 30,837 123%
Accident and health 2,945 127,487 2,945 127,487 100
- --------------------------------------------------------------------------------------------
TOTAL PREMIUMS $315,460 $165,491 $322,627 $158,324 105%
============================================================================================
1998
Life $255,982 $ 41,293 $258,973 $ 38,302 108%
Accident and health 1,827 116,278 1,827 116,278 100%
- --------------------------------------------------------------------------------------------
Total premiums $257,809 $157,571 $260,800 $154,580 102%
============================================================================================
</TABLE>
Transactions with CAC, as part of the pooling agreement described in Note 1,
are reflected in the above table. Premium revenues ceded to non-affiliated
companies were $187.4 million for the six months ended June 30, 1999, and $111.0
million for the six months ended June 30, 1998. Additionally, benefits and
expenses for insurance claims and policyholders' benefits are net of reinsurance
recoveries from non-affiliated companies of $139.2 million for the period ended
June 30, 1999, and $77.5 million for the same period in 1998.
Reinsurance receivables reflected on the balance sheets are amounts
recoverable from reinsurers who have assumed a portion of VFL's insurance
reserves. These balances are principally due from CAC pursuant to 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> 9
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS - CONTINUED
NOTE 4. OTHER COMPREHENSIVE INCOME:
Comprehensive income is comprised of all changes to stockholder's equity,
including net income, except those changes resulting from investments by, and
distributions to, the stockholder. Other comprehensive income (loss) is
comprehensive income exclusive of net income. The change in the components of
other comprehensive income (loss) are presented in the following table:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------
PRE-TAX TAX (EXPENSE) NET
THREE MONTHS ENDED JUNE 30, 1999 AMOUNT BENEFIT AMOUNT
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(In thousands of dollars)
Net unrealized gains (losses) on investments securities:
Net unrealized gains (losses) arising during the period $(1,304) $ 354 (950)
Reclassification adjustment for (gains) losses included in net income (566) 198 (368)
- --------------------------------------------------------------------------------------------------------------------------
TOTAL OTHER COMPREHENSIVE LOSS $(1,870) $ 552 $(1,318)
==========================================================================================================================
Pre-tax Tax (Expense) Net
Three Months Ended June 30, 1998 Amount Benefit Amount
- --------------------------------------------------------------------------------------------------------------------------
(In thousands of dollars)
Net unrealized gains (losses) on investments securities:
Net unrealized gains (losses) arising during the period $(3,606) $ 1,263 $(2,343)
Reclassification adjustment for (gains) losses included in net income 5,428 (1,900) 3,528
- --------------------------------------------------------------------------------------------------------------------------
Total Other Comprehensive Income $ 1,822 $ (637) $ 1,185
==========================================================================================================================
- --------------------------------------------------------------------------------------------------------------------------
PRE-TAX TAX (EXPENSE) NET
SIX MONTHS ENDED JUNE 30, 1999 AMOUNT BENEFIT AMOUNT
- --------------------------------------------------------------------------------------------------------------------------
(In thousands of dollars)
Net unrealized gains (losses) on investments securities:
Net unrealized gains (losses) arising during the period $(5,323) $ 1,851 $(3,472)
Reclassification adjustment for (gains) losses included in net income (2,851) 998 (1,853)
- --------------------------------------------------------------------------------------------------------------------------
TOTAL OTHER COMPREHENSIVE LOSS $(8,174) $ 2,849 $(5,325)
==========================================================================================================================
Pre-tax Tax (Expense) Net
Six Months Ended June 30, 1998 Amount Benefit Amount
- --------------------------------------------------------------------------------------------------------------------------
(In thousands of dollars)
Net unrealized gains (losses) on investments securities:
Net unrealized gains (losses) arising during the period $(1,750) $ 613 $(1,137)
Reclassification adjustment for (gains) losses included in net income 2,962 (1,037) 1,925
- --------------------------------------------------------------------------------------------------------------------------
Total Other Comprehensive Income $ 1,212 $ (424) $ 788
==========================================================================================================================
</TABLE>
9
<PAGE> 10
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS - CONCLUDED
NOTE 5. CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE:
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." SOP 97-3 requires that entities recognize liabilities for
insurance-related assessments when all of the following criteria have been met:
an assessment has been imposed or it is probable that an 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.
Accordingly, VFL adopted SOP 97-3 effective January 1, 1999 and an after-tax
charge of $234,000 ($360,000 pre-tax) was recorded during 1999 to reflect the
cumulative effect of a change in accounting principle.
10
<PAGE> 11
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 (unaudited) and notes thereto found on pages 3 to
10, which contain additional information helpful in evaluating operating results
and financial condition.
VFL, along with its parent CAC, markets and underwrites insurance products
designed to satisfy the life, health and retirement needs of individuals and
groups. The individual insurance products consist primarily of term and
universal life insurance policies and individual annuities. Group insurance
products include life, accident and health, consisting primarily of major
medical and hospitalization and pension products. VFL also market a portfolio of
variable products, including annuity and universal life products. These variable
products offer policyholders the option of allocating payments to one or more
variable accounts or to a guaranteed income account or both. Payments allocated
to the variable accounts are invested in corresponding investment portfolios
where the investment risk is borne by the policyholder while payments allocated
to the guaranteed income account earn a minimum guaranteed rate of interest for
a specified period of time for annuity contracts and one year for life products.
The operations, assets and liabilities of VFL and its parent, CAC, are
managed on a combined basis pursuant to a Reinsurance Pooling Agreement. Under
this Reinsurance Pooling Agreement, VFL cedes all of its business, excluding its
Separate Account business, to its parent, CAC. This ceded business is then
pooled with the business of CAC, which excludes CAC's participating contracts
and separate account business, and 10% of the combined pool is assumed by VFL.
11
<PAGE> 12
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 and six months ended June 30, 1999 and 1998.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
THREE MONTHS SIX MONTHS
PERIOD ENDED JUNE 30 1999 1998 1999 1998
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(In thousands of dollars)
OPERATING SUMMARY
Revenues (excluding realized investment gains/losses):
Premiums $ 83,651 $ 73,025 $ 158,324 $ 154,580
Net investment income 9,004 9,032 18,108 17,623
Other 3,597 2,595 5,262 4,156
--------- --------- -------- --------
Total revenues 96,252 84,652 181,694 176,359
Benefits and expenses 91,374 79,556 170,781 167,119
--------- --------- -------- --------
Operating income before income tax 4,878 5,096 10,913 9,240
Income tax (expense) (1,737) (1,805) (4,146) (3,325)
--------- --------- -------- --------
Net operating income
(excluding realized investment gains/losses) 3,141 3,291 6,767 5,915
Net realized investment gains (losses), net of income tax (7,991) 989 (10,763) 2,284
--------- --------- -------- --------
Income before cumulative effect of change in accounting principle (4,850) 4,280 (3,996) 8,199
Cumulative effect of change in accounting principle, net of taxes -- -- (234) --
- -----------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ (4,850) $ 4,280 $ (4,230) $ 8,199
=======================================================================================================================
</TABLE>
VFL's revenues, excluding net realized investment gains (losses), were
$181.7 million for the first six months of 1999, compared to $176.4 million for
the same period in 1998. Premiums for the six months ended June 30, 1999
increased approximately 2.4% to $158.3 million compared to $154.6 million for
the same period in 1998. The increase in premiums is due to an increase in the
premiums earned for the Federal Employees Health Benefits Plan. This positive
effect was offset somewhat by the decision to exit the insured comprehensive
medical market, and by lower sales of single premium fixed annuity products.
Premiums for the three months ended June 30, 1999 increased approximately
14.6% to $83.7 million compared to $73.0 million for the same period in 1998.
This increase in premiums can be attributed to the same factors that accounted
for the increase in premiums for the six month reporting period, more fully
discussed above.
VFL's investment income for the six months ended June 30, 1999 was $18.1
million, an increase of 2.8% from the comparable 1998 period when investment
income was $17.6 million. The increase is attributable to a larger portfolio of
fixed maturity investments, funded by premiums received during the twelve months
ended June 30, 1999.
12
<PAGE> 13
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -CONTINUED
VFL's realized investment losses, net of tax for the six months ended June
30, 1999 of $10.8 million, compares unfavorably to $2.3 million of investment
gains, net of tax, realized during the comparable period in 1998. Sales of fixed
maturity securities accounted for virtually all of the net realized gains and
(losses) in both reporting periods. Accordingly, the interest rate environment
during all 1999 and 1998 reporting periods was an important factor underlying
the comparative realized investment results. VFL's realized investment gains
(losses), net of tax for the three months ended June 30, 1999 and 1998 were
$(8.0) million and $1.0 million, respectively. This decline in investment gains
can be attributed to the same factors underlying realized investment performance
for the six month reporting periods, more fully discussed above.
FINANCIAL CONDITION:
Assets increased approximately $187 million from December 31, 1998 to $3,178
million as of June 30, 1999. VFL's cash and invested assets decreased by $31
million from December 31, 1998 to $591 million.
During the first six months of 1999, VFL's stockholder's equity decreased by
$9.5 million, or 3.6%, to approximately $254.3 million. The decrease in
stockholder's equity in 1999 is due primarily to a net loss of $4.2 million and
other comprehensive loss of $5.3 million during the six months ended June 30,
1999.
13
<PAGE> 14
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 June 30, 1999 and December 31, 1998:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
DISTRIBUTION OF INVESTMENTS JUNE 30, December 31,
1999 % 1998 %
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(In thousands of dollars)
Fixed maturity securities:
U.S. Treasury Securities and
obligations of government agencies $ 240,729 40.8% 223,743 36.6%
Asset backed securities 99,393 16.8 109,207 17.8
Other debt securities 141,225 23.9 121,685 19.9
- ----------------------------------------------------------------------------------------------------------
Total fixed maturity securities 481,347 81.5 454,635 74.3
Common stocks 981 0.1 981 0.2
Policy loans 74,213 12.6 74,150 12.1
Other invested assets 446 0.1 485 0.1
Short-term investments 33,500 5.7 81,418 13.3
- ----------------------------------------------------------------------------------------------------------
INVESTMENTS AT AMORTIZED COST $ 590,487 100.0% $ 611,669 100.0%
==========================================================================================================
INVESTMENTS AT CARRYING VALUE* $ 586,887 $ 618,787
==========================================================================================================
* As reported on the Balance Sheet
</TABLE>
The operations, assets and liabilities of VFL and CAC are managed on a
combined basis. The investment portfolios of VFL and CAC are 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 $476.3 million at June 30, 1999, compared with $460.5 million at December 31,
1998. At June 30, 1999, net unrealized losses on fixed maturity securities
amounted to approximately $5.1 million. This compares with net unrealized gains
of approximately $5.9 million at December 31, 1998. The gross unrealized gains
and (losses) for the fixed maturities portfolio at June 30, 1999 were $3.0
million and $(8.1) million, respectively, compared to $6.9 million and $(1.0)
million, respectively, at December 31, 1998.
VFL's investments in equity securities are carried at a fair value of $2.6
million and $2.2 million at June 30, 1999 and December 31, 1998, respectively.
At June 30, 1999, unrealized gains on equity securities amounted to
approximately $1.6 million. This compares with unrealized gains of approximately
$1.2 million at December 31, 1998. There were no unrealized losses on equity
securities at June 30, 1999 and December 31, 1998.
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> 15
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>
- ------------------------------------------------------------------------------------------------------
JUNE 30, December 31,
1999 % 1998 %
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(In thousands of dollars)
U.S. government and affiliated securities $ 279,846 58.8 $ 270,600 58.8
Other AAA rated 64,547 13.5 76,258 16.5
AA and A rated 37,263 7.8 53,528 11.6
BBB rated 91,312 19.2 54,241 11.8
Below investment grade 3,297 0.7 5,889 1.3
- ------------------------------------------------------------------------------------------------------
TOTAL $ 476,265 100.0 $ 460,516 100.0
======================================================================================================
</TABLE>
Included in the carrying value of fixed maturity securities at June 30, 1999
are $97.6 million of asset-backed securities, consisting of approximately 46% in
collateralized mortgage obligations (CMOs), 40% in U.S. government agency issued
pass-through certificates, 8% in corporate mortgage-backed pass-through
certificates and 6% 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. Net unrealized gains (losses) on
CMOs is $(0.8) million and $1.0 million at June 30, 1999 and December 31, 1998,
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
general account derivatives are classified as other invested assets and its
Separate Accounts' derivatives are classified as Separate Account business.
Derivative financial instruments consist of interest rate caps in the
general account and purchased options in the Separate Accounts at June 30, 1999.
The gross notional or contractual amounts of derivative financial instruments in
the general account totaled $50 million at June 30, 1999 and December 31, 1998.
The gross notional principal or contractual amounts of derivative financial
instruments in the Separate Accounts totaled $1.5 million at June 30, 1999 and
December 31, 1998. The fair value of derivative financial instruments in the
general account and Separate Accounts at June 30, 1999 totaled $0.4 million and
$0.5 million, respectively. The fair value of derivative financial instruments
in the general account and Separate Accounts at December 31, 1998 totaled $0.1
million and $0.5 million, respectively. Net realized gains on derivative
financial instruments held in the general account and Separate Accounts were
$0.2 million, while net realized gains on derivatives in the Separate Accounts
were not material for the period ended June 30, 1999. Net realized losses on
derivative financial instruments held in the
15
<PAGE> 16
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -CONTINUED
general account totaled $0.3 million while net realized gains (losses) on
derivatives in the Separate Accounts were not material for the 1998 reporting
period.
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 0.2% of total
assets as of June 30, 1999 and December 31, 1998, respectively. At June 30,
1999 and December 31, 1998, net unrealized gains on high yield securities were
approximately $0.3 million.
16
<PAGE> 17
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 after 1999. Such malfunctions could lead
to business delays and disruptions. VFL does not maintain any systems. Instead,
it relies on the systems of CNA Financial, third party vendors and other
business partners. CNA Financial, on behalf of VFL, has a plan under which it
reviews periodically the progress that these parties are making on this issue.
As of December 1, 1998, CNA Financial had certified internally as Year
2000-ready all of the internal systems used by VFL. However, as business
conditions change, CNA may respond by revising previous Year 2000 strategies or
solutions affecting specific systems. In limited cases, a system that was to
have been replaced, instead, may be renovated to become Year 2000 ready prior to
January 1, 2000. VFL does not believe these changes will have a material impact
on the Company.
CNA Financial has also received statements of Year 2000 compliance from
certain key business partners. VFL management believes that the systems on which
it relies do not have any significant remaining exposure to the Year 2000 issue
and, therefore VFL does not have a material exposure to the Year 2000 issue.
However, due to the interdependent nature of computer systems, there may be an
adverse impact on VFL if its business partners fail to address the Year 2000
issue successfully. To mitigate this impact, if any, CNA Financial on behalf of
itself and VFL is communicating with its business partners to coordinate Year
2000 conversion. In addition, CNA Financial has developed business resumption
plans to ensure that it and VFL are able to continue critical processes through
other means in the event that it becomes necessary to do so. Formal strategies
have been developed to include appropriate recovery processes and use of
alternative vendors.
Based on its current assessment, CNA Financial estimates that the total cost
to replace and upgrade its systems to accommodate Year 2000 processing will be
approximately $70 million. As of June 30, 1999, CNA Financial has spent
approximately $60 million on Year 2000 readiness matters. VFL is allocated its
proportionate share of this cost.
17
<PAGE> 18
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS-CONTINUED
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 investments. The primary cash flow uses are payments
for claims, policy benefits, payments on matured policyholder contracts and
operating expenses.
During the first six months of 1999, VFL's operating activities generated
net positive cash flows of approximately $11.4 million, compared with net
negative cash flows of $8.3 million for the same period in 1998.
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.
ACCOUNTING STANDARDS:
Accounting for Derivative Instruments and Hedging Activities
In June 1998, the Financial Accounting Standards Board issued SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities." This statement
requires that entities 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 fiscal
quarters of fiscal years beginning after June 15, 1999. VFL is currently
evaluating the effects of this Statement on its accounting and reporting for
derivative securities and hedging activities.
Accounting for Insurance and Reinsurance Contracts That Do Not Transfer
Insurance Risk
In October 1998, the American Institute of Certified Public Accountant's
Accounting Standards Executive Committee issued SOP 98-7, "Accounting for
Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." This
guidance excludes long-duration life and health insurance contracts from its
scope. This Statement is effective for financial statements in the year 2000,
with early adoption encouraged. VFL is currently evaluating the effects of this
SOP.
18
<PAGE> 19
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -CONTINUED
ITEM 7A. MARKET RISK
Market risk is a broad term related to economic losses due to adverse
changes in the fair value of a financial instrument. Market risk is inherent to
all financial instruments, and accordingly, VFL's risk management policies and
procedures include all market risk sensitive financial instruments.
According to the Securities and Exchange Commission (SEC) disclosure rules,
discussions regarding market risk focus on only one element of market
risk--change in price levels. Price levels can be affected by changes in
interest rates, equity prices, foreign exchange rates or other factors that
relate to volatility of the interest rates, index or price of the underlying
financial instrument. VFL's primary market risk exposures are due to changes in
interest rates, although VFL has certain exposures to changes in equity prices
and foreign currency exchange rates.
Active management of market risk is integral to VFL's operations. VFL may
use the following tools to manage its exposure to market risk within tolerable
ranges: 1) change the character of future investments purchased or sold, 2) use
derivatives to offset the market behavior of existing assets and liabilities or
assets expected to be purchased and liabilities to be incurred, or 3) rebalance
its existing asset and liability portfolios.
For purposes of this disclosure, market risk sensitive instruments are
divided into two categories: instruments entered into for trading purposes and
instruments entered into for purposes other than trading.
Interest Rate Risk: VFL has exposure to economic losses due to interest rate
risk arising from changes in the level or volatility of interest rates. VFL
attempts to mitigate its exposure to interest rate risk through active portfolio
management. VFL may also reduce this risk by utilizing instruments such as
interest rate swaps, interest rate caps, commitments to purchase securities,
options, futures and forwards. This exposure is also offset by VFL's
asset/liability duration matching strategy.
Equity Price Risk: VFL is exposed to equity price risk as a result of its
investment in equity securities and equity derivatives. Equity price risk
results from changes in the level or volatility of equity prices, which affect
the value of equity securities, or instruments which derive their value from
such securities or indexes. VFL attempts to mitigate its security specific risk
by limiting its investment in any one security or index.
Foreign Exchange Risk: Foreign exchange rate risk arises from the
possibility that changes in foreign currency exchange rates will impact the
value of financial instruments. VFL has foreign exchange exposure when it buys
or sells foreign currencies or financial instruments denominated in a foreign
currency. VFL's foreign transactions are primarily denominated in Canadian
Dollars. This exposure is mitigated by VFL's asset/liability matching strategy
and through the use of forwards for those instruments, which are not matched.
Sensitivity Analysis: VFL monitors its sensitivity to interest rate risks by
evaluating the change in its financial assets and liabilities relative to
fluctuations in interest rates. The evaluation is made using an instantaneous
parallel change in interest rates of varying magnitudes on a static balance
sheet to determine the effect such a change in rates
19
<PAGE> 20
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS-CONTINUED
MARKET RISK - (CONTINUED)
would have on VFL's market value at risk and the resulting effect on
stockholder's equity. The analysis presents the sensitivity of the market value
of VFL's financial instruments to selected changes in market rates and prices.
The range of changes selected reflects VFL's view of changes, which are
reasonably possible over a one-year period. The selection of the range of values
chosen to represent changes in interest rates should not be construed as VFL's
prediction of future market events, but rather an illustration of the impact of
such events. Accordingly, the analysis may not be indicative of, is not intended
to provide, and does not provide a precise forecast of the effect of changes of
market interest rates on VFL's income or stockholder's equity. Further, the
computations do not reflect any actions VFL would undertake in response to
changes in interest rates.
The sensitivity analysis modeled an instantaneous increase and decrease in
market interest rates of 100 and 150 basis points from their levels at June 30,
1999 with all other variables held constant. A 100 and 150 basis point increase
in market interest rates would result in a pre-tax decrease in the net financial
instrument position of $25.4 million and $36.8 million, respectively. Similarly,
a 100 and 150 basis point decrease in market interest rates would result in a
pre-tax increase in the net financial instrument position of $28.8 million and
$44.0 million, respectively.
Equity price risk was measured assuming an instantaneous 10% and 25% change
in the Standard & Poor's 500 Index (the Index) from its level of June 30, 1999
with all other variables held constant. VFL's equity holdings were assumed to be
perfectly positively correlated with the Index. A 10% and 25% decrease in the
Index would result in a $11.1 million and $27.8 million decrease, respectively,
in the market rate of VFL's equity investments. Of these amounts, $10.8 million
and $27.1 million, respectively, would be offset by decreases in liabilities to
customers under variable annuity contracts. Similarly, increases in the Index
would result in like increases in the market value of VFL's equity investments
and increases in liabilities to customers under variable annuity contracts.
The sensitivity analysis also assumes an instantaneous 10% and 20% change in
the foreign currency exchange rates versus the U.S. Dollar from their levels at
June 30, 1999, with all other variables held constant. A 10% and 20%
strengthening of the U.S. Dollar versus other currencies would result in
decreases of $0.6 million and $1.2 million in the market value of financial
instruments that are denominated in foreign currencies. Weakening of the U.S.
Dollar versus all other currencies would result in like increases in the market
value of financial instruments that are denominated in foreign currencies.
20
<PAGE> 21
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS-CONTINUED
MARKET RISK - (CONTINUED)
The following table reflects the estimated effects on the market value of
VFL's financial instruments due to an increase in interest rates of 100 basis
points, a 10% decline in the S&P 500 Index, and a decline of 10% in foreign
currency exchange rates.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
MARKET INTEREST CURRENCY EQUITY
JUNE 30, 1999 VALUE RATE RISK RISK RISK
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(In thousands of dollars)
Held for Trading Purposes
General Account:
Interest Rate Caps $ 351 $ 263 $ -- $ --
Separate Accounts:
Other derivative securities 514 -- -- (51)
- ---------------------------------------------------------------------------------------------------------
Total trading securities 865 263 -- (51)
- ---------------------------------------------------------------------------------------------------------
Held for Other Than Trading Purposes
General Account:
Fixed maturity securities 476,265 (25,665) (578) --
Equity securities 2,558 -- -- (256)
Short-term investments 33,500 (3) -- --
- ---------------------------------------------------------------------------------------------------------
Total general account 512,323 (25,668) (578) (256)
- ---------------------------------------------------------------------------------------------------------
Separate Account Business:
Fixed maturity securities 148 (8) -- --
Equity securities 108,312 -- -- (10,831)
Short-term investments 19,717 (11) -- --
- ---------------------------------------------------------------------------------------------------------
Total Separate Accounts business 128,177 (19) -- (10,831)
- ---------------------------------------------------------------------------------------------------------
Total securities held for other than
trading purposes 640,500 (25,687) (578) (11,087)
- ---------------------------------------------------------------------------------------------------------
TOTAL SECURITIES $641,365 $ (25,424) $ (578) $(11,138)
=========================================================================================================
</TABLE>
21
<PAGE> 22
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS-CONTINUED
MARKET RISK - (CONTINUED)
The following table reflects the estimated effects on the market value of
VFL's financial instruments due to an increase in interest rates of 150 basis
points, a 25% decline in the S&P 500 Index, and a decline of 20% in foreign
currency exchange rates.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
MARKET INTEREST CURRENCY EQUITY
JUNE 30, 1999 VALUE RATE RISK RISK RISK
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(In thousands of dollars)
Held for Trading Purposes
General Account:
Interest Rate Caps $ 351 $ 524 $ -- $ --
Separate Accounts:
Other derivative securities 514 -- -- (129)
- ---------------------------------------------------------------------------------------------------------
Total trading securities 865 524 -- (129)
- ---------------------------------------------------------------------------------------------------------
Held for Other Than Trading Purposes
General Account:
Fixed maturity securities 476,265 (37,278) (1,156) --
Equity securities 2,558 -- -- (639)
Short-term investments 33,500 (5) -- --
- ---------------------------------------------------------------------------------------------------------
Total general account 512,323 (37,283) (1,156) (639)
- ---------------------------------------------------------------------------------------------------------
Separate Account Business:
Fixed maturity securities 148 (10) -- --
Equity securities 108,312 -- -- (27,078)
Short-term investments 19,717 (17) -- -
- ---------------------------------------------------------------------------------------------------------
Total Separate Accounts business 128,177 (27) -- (27,078)
- ---------------------------------------------------------------------------------------------------------
Total securities held for other than
trading purposes 640,500 (37,310) (1,156) (27,717)
- ---------------------------------------------------------------------------------------------------------
TOTAL SECURITIES $641,365 $ (36,786) $ (1,156) $(27,846)
=========================================================================================================
</TABLE>
22
<PAGE> 23
VALLEY FORGE LIFE INSURANCE COMPANY
PART II OTHER INFORMATION
ITEM 5. OTHER INFORMATION
On August 16, 1999, CNA Financial Corporation issued a press release
announcing the appointment of Robert V. Deutsch as chief financial officer.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS:
Exhibit Page
Number Description Number
- ------ ----------- ------
10(k) Financial Support Agreement 25
27 Financial Data Schedule 28
(b) REPORTS ON FORM 8-K:
There were no reports on Form 8-K for the three months ended June 30, 1999.
23
<PAGE> 24
VALLEY FORGE LIFE INSURANCE COMPANY
PART II OTHER INFORMATION
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 W. JAMES MACGINNITIE
------------------------------------------
W. James MacGinnitie
Director, Senior Vice President
and Chief Financial Officer
Date: August 16, 1999
24
<PAGE> 1
EXHIBIT 10(K)
FINANCIAL SUPPORT AGREEMENT
THIS FINANCIAL SUPPORT AGREEMENT is entered into as of the 25th day of
February, 1999, between CONTINENTAL ASSURANCE COMPANY, a stock insurance company
incorporated under the laws of Illinois ("CAC") and VALLEY FORGE LIFE INSURANCE
COMPANY, a stock insurance company incorporated under the laws of Pennsylvania
("VFL")
1. Status of VFL. All of the capital stock of VFL is currently owned by
CAC. During the term of this Agreement, CAC agrees that it will not transfer
more than 49% of the issued and outstanding voting stock of VFL or any of the
business of VFL to an entity with a financial strength rating from Moodys
Investors Services (a "Financial Strength Rating") that is lower than the
Financial Strength Rating of CAC.
2. Capital and Surplus. CAC agrees that during the term of this
Agreement VFL shall have not less than the amount of capital and surplus
necessary to maintain the capital and surplus of VFL at a level of not less than
150% of the Company Action level under the Risk Based Capitalization Model as in
effect in the Commonwealth of Pennsylvania for domiciliary life insurance
companies.
3. Liquidity. CAC agrees that it will cause VFL to be sufficiently
funded at all times to meet VFL's contractual obligations on a timely basis,
including but not limited to obligations to pay policy benefits and to provide
policyholder services.
4. Term of Agreement. CAC retains the absolute right to terminate this
Agreement upon not less than thirty days' prior written notice, provided,
however, that CAC agrees that it will not terminate this Agreement until one of
the following events occurs:
(a) The earlier of the tenth anniversary hereof or VFL's
attainment of capital and surplus of not less than
$250,000,000 as of the end of a fiscal year;
(b) VFL attains a Financial Strength Rating without giving weight
to the support of this Agreement that is the same or better
than its Financial Strength Rating with such support;
(c) There is a change of control of VFL to the extent that VFL is
no longer a subsidiary, direct or indirect, of CNA Financial
Corporation provided that control of VFL will not be
transferred to an entity with a Financial Strength Rating that
is less than the Financial Strength Rating of CAC or VFL; or
(d) Substantially all of VFL's business is transferred to an
entity with a Financial Strength Rating at least equal to the
Financial Strength Rating of CAC, or to VFL's current
Financial Strength Rating as supported by this Agreement,
whichever is lower.
5. Not a Guarantee. This Agreement is not, and nothing herein contained
and nothing done pursuant hereto by either party shall constitute or be
construed or deemed to constitute an evidence of indebtedness or an obligation
or liability of guarantor, endorser, surety or otherwise in respect of any
obligation, indebtedness or liability, of any kind whatsoever, of VFL and this
Agreement does not provide, and is not intended to be construed or deemed to
provide, any creditor of VFL with recourse to or against any of the assets of
CAC.
25
<PAGE> 2
6. Applicable Laws. This Agreement shall be governed by the laws of the
State of Illinois applicable to agreements made and entered into therein without
regard to principles of conflicts of laws.
7. Publicity. No party hereto may, directly or indirectly, disclose
this Agreement or the terms hereof other than to any regulatory agency or rating
agency, except with the permission of the other party hereto and then only as
permitted by law. Each party disclosing this Agreement agrees to take
commercially reasonable efforts to require that any recipient of this Agreement
shall be bound to maintain the confidentiality of this Agreement.
8. Modifications. This Agreement may be modified only by an agreement
in writing signed by each party hereto.
9. Entire Agreement. This Agreement constitutes the entire agreement of
the parties hereto with respect to capital support (except such support as
exists under any reinsurance, pooling or expense sharing or other similar
agreements) of one another, and supersedes all prior and contemporaneous
agreements, understandings, negotiations and discussions, whether oral or
written of the parties.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed by their respective duly authorized representatives as of the day and
year first written above.
CONTINENTAL ASSURANCE COMPANY
By: Peter E. Jokiel
-----------------------------
Name: Peter E. Jokiel
Title: Senior Vice President
May 10, 1999
VALLEY FORGE LIFE INSURANCE COMPANY
By: W. James MacGinnitie
-----------------------------
Name: W. James MacGinnitie
Title: Senior Vice President,
Chief Financial Officer
May 10, 1999
26
<TABLE> <S> <C>
<ARTICLE> 7
<CIK> 0001007008
<NAME> VALLEY FORGE LIFE INSURANCE COMPANY
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<DEBT-HELD-FOR-SALE> 476,265
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 2,558
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 586,887
<CASH> 4,515
<RECOVER-REINSURE> 2,215,669
<DEFERRED-ACQUISITION> 119,845
<TOTAL-ASSETS> 3,178,038
<POLICY-LOSSES> 2,540,154
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 142,776
<POLICY-HOLDER-FUNDS> 48,003
<NOTES-PAYABLE> 0
0
0
<COMMON> 2,500
<OTHER-SE> 251,765
<TOTAL-LIABILITY-AND-EQUITY> 3,178,038
158,324
<INVESTMENT-INCOME> 18,108
<INVESTMENT-GAINS> (17,902)
<OTHER-INCOME> 5,262
<BENEFITS> 151,002
<UNDERWRITING-AMORTIZATION> 6,065
<UNDERWRITING-OTHER> 13,714
<INCOME-PRETAX> (6,989)
<INCOME-TAX> (2,993)
<INCOME-CONTINUING> (3,996)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> (234)
<NET-INCOME> (4,230)
<EPS-BASIC> (84.60)
<EPS-DILUTED> (84.60)
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
