<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 MARCH 31, 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 1 of 24
<PAGE> 2
VALLEY FORGE LIFE INSURANCE COMPANY
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE NO.
- ------- --------------------- --------
<S> <C> <C>
CONDENSED FINANCIAL STATEMENTS:
BALANCE SHEETS
MARCH 31, 1999 (Unaudited) AND DECEMBER 31, 1998............ 3
STATEMENTS OF OPERATIONS (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998.......... 4
STATEMENTS OF STOCKHOLDER'S EQUITY (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998.......... 5
STATEMENTS OF CASH FLOWS (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998.......... 6
NOTES TO CONDENSED FINANCIAL
STATEMENTS (Unaudited) MARCH 31, 1999....................... 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............................ 22
SIGNATURES ................................................................... 23
EXHIBIT 27 FINANCIAL DATA SCHEDULE....................................... 24
</TABLE>
2
<PAGE> 3
VALLEY FORGE LIFE INSURANCE COMPANY
BALANCE SHEETS
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
MARCH 31 DECEMBER 31
1999 1998
(Unaudited)
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
(In thousands of dollars)
ASSETS:
Investments:
Fixed maturities available-for-sale (amortized cost: $502,211 and $454,635) $ 500,084 $ 460,516
Equity securities available-for-sale (cost: $981 and $981) 2,347 2,218
Policy loans 75,603 74,150
Other invested assets 161 485
Short-term investments 26,258 81,418
----------- ------------
TOTAL INVESTMENTS 604,453 618,787
Cash 7,155 3,750
Receivables:
Reinsurance 2,422,150 2,119,897
Premium and other insurance 56,045 54,664
Deferred acquisition costs 117,675 111,963
Accrued investment income 7,255 7,721
Due from affiliates 12,237 -
Other 1,670 902
Separate Account business 95,808 73,745
- ------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $3,324,448 $2,991,429
==================================================================================================================
LIABILITIES AND STOCKHOLDER'S EQUITY:
Liabilities:
Insurance reserves:
Future policy benefits $2,735,495 $2,438,305
Claims 97,601 93,001
Policyholders' funds 41,981 42,746
Payables for securities purchased - 370
Federal income taxes payable 7,462 6,468
Deferred income taxes 3,249 6,213
Due to affiliates - 1,946
Commissions and other payables 82,420 64,815
Separate Account business 95,808 73,745
----------- ------------
TOTAL LIABILITIES 3,064,016 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 188,302 187,683
Accumulated other comprehensive income 480 4,487
----------- ------------
TOTAL STOCKHOLDER'S EQUITY 260,432 263,820
- ------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $3,324,448 $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 ENDED MARCH 31 1999 1998
- ----------------------------------------------------------------------------------------------
<S> <C> <C>
(In thousands of dollars)
Revenues:
Premiums $ 74,673 $ 81,555
Net investment income 9,104 8,591
Realized investment gains/(losses) (4,689) 1,993
Other 1,665 1,561
------------ ------------
80,753 93,700
------------ ------------
Benefits and expenses:
Insurance claims and policyholders' benefits 70,111 75,153
Amortization of deferred acquisition costs 2,997 2,552
Other operating expenses 6,300 9,858
------------ ------------
79,408 87,563
------------ ------------
Income before income tax and cumulative effect
of change in accounting principle 1,345 6,137
Income tax expense 492 2,218
------------ ------------
Income before cumulative effect of change
in accounting principle 853 3,919
Cumulative effect of change in accounting
principle, net of taxes - Note 5 (234) -
- ----------------------------------------------------------------------------------------------
NET INCOME $ 619 $ 3,919
==============================================================================================
</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
Three Months Ended Common Paid-in Comprehensive Retained Comprehensive Stockholder's
March 31, 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 - - $ 3,919 3,919 - 3,919
Other comprehensive loss - - (397) - (397) (397)
------------
Total comprehensive income $ 3,522
============
- ----------------------------------------------------------- ----------------------------------------------
Balance, March 31, 1998 $ 2,500 $ 39,150 $ 174,149 $ 3,983 $ 219,782
=========================================================== ==============================================
Balance, December 31, 1998 $ 2,500 $ 69,150 $ 187,683 $ 4,487 $ 263,820
Comprehensive income (loss):
Net income - - $ 619 619 - 619
Other comprehensive loss - - (4,007) - (4,007) (4,007)
------------
Total comprehensive loss $ (3,388)
============
- ----------------------------------------------------------- ----------------------------------------------
Balance, March 31, 1999 $ 2,500 $ 69,150 $ 188,302 $ 480 $ 260,432
=========================================================== ==============================================
</TABLE>
See accompanying Notes to Condensed Financial Statements (Unaudited).
5
<PAGE> 6
VALLEY FORGE LIFE INSURANCE COMPANY
STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31 1999 1998
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
(In thousands of dollars)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 619 $ 3,919
Adjustments to reconcile net income to net cash flows from
operating activities:
Deferred income tax provision (804) (1,534)
Net realized investment (gains) losses, pre-tax 4,689 (1,993)
Amortization of bond discount (897) (160)
Changes in:
Insurance receivables, net (303,893) (296,962)
Deferred acquisition costs (3,752) (4,036)
Accrued investment income 466 (4,286)
Due from affiliates (14,183) 39,116
Federal income taxes 994 3,682
Insurance reserves 306,318 299,265
Commissions and other payables and other 16,849 (26,178)
------------------------------
Total adjustments 5,787 6,914
---------- ---------------
NET CASH FLOWS FROM OPERATING ACTIVITIES 6,406 10,833
---------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of fixed maturities (523,810) (124,149)
Proceeds from fixed maturities:
Sales 458,825 95,940
Maturities, calls and redemptions 12,192 24,926
Change in policy loans (1,453) (1,837)
Change in other invested assets 416 -
Change in short-term investments 56,122 (34,294)
---------- ---------------
NET CASH FLOWS FROM INVESTING ACTIVITIES 2,292 (39,414)
---------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES
Receipts for investment contracts credited to policyholder account balances 4,389 13,813
Return of policyholder account balances on investment contracts (9,682) (5,469)
---------- ---------------
NET CASH FLOWS FROM FINANCING ACTIVITIES (5,293) 8,344
---------- ---------------
NET CASH FLOWS 3,405 (20,237)
Cash at beginning of period 3,750 24,565
- -------------------------------------------------------------------------------------------------------------------
CASH AT END OF PERIOD $ 7,155 $ 4,328
===================================================================================================================
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
MARCH 31, 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 85% 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/NET
THREE MONTHS ENDED MARCH 31 DIRECT ASSUMED CEDED NET %
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
(In thousands of dollars)
1999
Life $185,524 $20,429 $188,290 $17,663 116 %
Accident and Health 1,124 57,010 1,124 57,010 100
- --------------------------------------------------------------------------------------------------------------
TOTAL PREMIUMS $186,648 $77,439 $189,414 $74,673 104 %
==============================================================================================================
1998
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 %
==============================================================================================================
</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 $93.4 million for the first quarter in 1999, and $45.2 million
for the first quarter in 1998. Additionally, benefits and expenses for insurance
claims and policyholders' benefits are net of reinsurance recoveries from
non-affiliated companies of $73.7 million for the first quarter of 1999, and
$34.1 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 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 - CONCLUDED
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 March 31, 1999 Amount Benefit Amount
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(In thousands of dollars)
Net unrealized gains (losses) on investment securities:
Net unrealized holding losses arising during the period $ (4,019) $ 1,497 $ (2,522)
Reclassification adjustment for gains included in net income (2,285) 800 (1,485)
- ----------------------------------------------------------------------------------------------------------------
TOTAL OTHER COMPREHENSIVE LOSS $ (6,304) $ 2,297 $ (4,007)
================================================================================================================
- ----------------------------------------------------------------------------------------------------------------
Pre-tax Tax (expense) Net
Three months ended March 31, 1998 Amount Benefit Amount
- ----------------------------------------------------------------------------------------------------------------
(In thousands of dollars)
Net unrealized gains (losses) on investment securities:
Net unrealized holding gains arising during the period $ 1,856 $ (650) $ 1,206
Reclassification adjustment for gains included in net income (2,466) 863 (1,603)
- ----------------------------------------------------------------------------------------------------------------
TOTAL OTHER COMPREHENSIVE LOSS $ (610) $ 213 $ (397)
================================================================================================================
</TABLE>
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 to reflect the cumulative
effect of a change in accounting principle.
9
<PAGE> 10
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, 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 and CAC 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 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.
10
<PAGE> 11
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, 1999 and 1998.
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31 1999 1998
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C>
(In thousands of dollars)
OPERATING SUMMARY
Revenues (excluding realized investment gains/losses):
Premiums $ 74,673 $ 81,555
Net investment income 9,104 8,591
Other 1,665 1,561
--------- ---------
Total revenues 85,442 91,707
Benefits and expenses 79,408 87,563
--------- ---------
Operating income before income tax 6,034 4,144
Income tax expense (2,134) (1,520)
--------- ---------
Net operating income
(excluding realized investment gains/losses) 3,900 2,624
Net realized investment (losses) gains, net of income tax (3,047) 1,295
--------- ---------
Income before cumulative effect of
change in accounting principle 853 3,919
Cumulative effect of change in accounting principle, net of taxes (234) -
- ---------------------------------------------------------------------------------------------------------
NET INCOME $ 619 $ 3,919
=========================================================================================================
</TABLE>
VFL's revenues, excluding net realized investment gains (losses), were
$85.4 million for the first three months of 1999, compared to $91.7 million for
the same period in 1998. Premiums the three months ended March 31, 1999 declined
approximately 8.4% to $74.7 million compared to $81.6 million for the same
period in 1998. The decline in premiums is due in part to the decision to exit
the insured comprehensive medical market. Individual fixed annuity premiums also
declined, as a result of suspending marketing efforts beginning in the third
quarter of 1998. This action was taken as a result of the current unfavorable
market pricing environment for individual deferred fixed annuity products.
VFL's investment income for the three months ended March 31, 1999 was $9.1
million, an increase of 6% from the comparable 1998 period when investment
income was $8.6 million. The increase is attributable to a larger investment
portfolio, funded by premiums received during the twelve months ended March 31,
1999. The positive effect of a larger investment portfolio was offset somewhat
by lower average yield on VFL's portfolio during 1999 compared to 1998. VFL's
realized investment losses, net of tax for the three months ended March 31, 1999
of $3.0 million, compare unfavorably to $1.3 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 the
1999 and 1998 reporting periods was an important factor underlying realized
investment gains and (losses).
11
<PAGE> 12
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -CONTINUED
FINANCIAL CONDITION:
Assets increased approximately $333 million from December 31, 1998 to $3,324
million as of March 31, 1999. VFL's cash and invested assets decreased by $11
million from December 31, 1998 to $612 million.
During the first three months of 1999, VFL's stockholder's equity decreased
by $3.4 million, or 1.3%, to approximately $260.4 million. The decrease in
stockholder's equity in 1999 is due primarily to $ 4.0 million of losses in
accumulated other comprehensive income.
INVESTMENTS:
The following table summarizes VFL's investments shown at cost or amortized
cost and carrying value at March 31, 1999 and December 31, 1998:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
DISTRIBUTION OF INVESTMENTS MARCH 31 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 $ 261,425 43.2% $ 223,743 36.6%
Asset backed securities 103,076 17.0 109,207 17.8
Other debt securities 137,710 22.7 121,685 19.9
- ---------------------------------------------------------------------------------------------------------------
Total fixed maturity securities 502,211 82.9 454,635 74.3
Common stocks 981 0.2 981 0.2
Policy loans 75,603 12.5 74,150 12.1
Other invested assets 466 0.1 485 0.1
Short-term investments 26,258 4.3 81,418 13.3
- ---------------------------------------------------------------------------------------------------------------
INVESTMENTS AT AMORTIZED COST $ 605,519 100.0% $ 611,669 100.0%
===============================================================================================================
INVESTMENTS AT CARRYING VALUE* $ 604,453 $ 618,787
===============================================================================================================
</TABLE>
* As reported in the Balance Sheet
12
<PAGE> 13
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 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 $500.1 million at March 31, 1999, compared with $460.5 million at December
31, 1998. At March 31, 1999, net unrealized losses on fixed maturity securities
amounted to approximately $2.1 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 March 31, 1999 were $2.8
million and $(4.9) 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 $2.3
million and $2.2 million at March 31, 1999 and December 31, 1998, respectively.
At March 31, 1999, unrealized gains on equity securities amounted to
approximately $1.4 million. This compares with unrealized gains of approximately
$1.2 million at December 31, 1998. There were no unrealized losses on equity
securities at March 31, 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.
The following table summarizes the ratings of VFL's fixed maturity portfolio
at carrying value (market):
<TABLE>
<CAPTION>
MARCH 31 % DECEMBER 31 %
1999 1998
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(In thousands of dollars)
U.S. government and affiliated securities $301,001 60.2% $ 270,600 58.8%
Other AAA rated 71,722 14.3 76,258 16.5
AA and A rated 69,534 13.9 53,528 11.6
BBB rated 52,257 10.5 54,241 11.8
Below investment grade 5,570 1.1 5,889 1.3
- -------------------------------------------------------------------------------------------------------
TOTAL $500,084 100.0% $ 460,516 100.0%
=======================================================================================================
</TABLE>
Included in VFL's fixed maturity securities at March 31, 1999 are $103.2
million of asset-backed securities, consisting of approximately 44.3% in
collateralized mortgage obligations (CMOs), 41.4% in U.S. government agency
issued pass-through certificates, 8.8% in corporate mortgage-backed pass-through
certificates and 5.5% 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.
13
<PAGE> 14
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 CMOs exceeds
amortized cost by $0.3 million and $1.0 million at March 31, 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. 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,
1999. The gross notional or contractual amounts of derivative financial
instruments in the general account totaled $50.0 million at both March 31, 1999
and December 31, 1998. 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, 1999 and December 31, 1998, respectively. The fair
value of derivative financial instruments in the general account and Separate
Accounts at March 31, 1999 totaled $0.2 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 not material for the period ended
March 31, 1999. 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 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 0.2% of total assets as of
March 31, 1999 and December 31, 1998.
14
<PAGE> 15
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 March 31, 1999, CNA Financial has spent
approximately $60 million on Year 2000 readiness matters. VFL is allocated its
proportionate share of this cost.
15
<PAGE> 16
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 investment. The primary cash flow
uses are payments for claims, policy benefits, payments on matured policyholder
contracts and operating expenses.
During the first three months of 1999, VFL's operating activities generated
net positive cash flows of approximately $6.4 million, compared with net
positive cash flows of $10.8 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.
16
<PAGE> 17
VALLEY FORGE LIFE INSURANCE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -CONTINUED
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.
17
<PAGE> 18
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
18
<PAGE> 19
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 March 31,
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 $28.4 million and $42.2 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 $29.4 million and
$44.4 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 March 31, 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 $8.7 million and $21.8 million decrease, respectively,
in the market rate of VFL's equity investments. Of these amounts, $8.4 million
and $21.0 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
March 31, 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 $1.1 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.
19
<PAGE> 20
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>
------------------------------------------------------------------------------------------------------------------------------
March 31, 1999 Market Interest Currency Equity
Value Rate Risk Risk Risk
------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(In thousands of dollars)
Held for Trading Purposes
General Account:
Interest Rate Caps $ 161 $ 92 $ - $ -
Separate Accounts:
Other derivative securities 519 - - (52)
------------------------------------------------------------------------------------------------------------------------------
Total trading securities 680 92 - (52)
------------------------------------------------------------------------------------------------------------------------------
Held for Other Than Trading Purposes
General Account:
Fixed maturity securities 500,084 (28,484) (557) -
Equity securities 2,347 - - (235)
Short term investments 26,258 (5) - -
------------------------------------------------------------------------------------------------------------------------------
Total general account 528,689 (28,489) (557) (235)
------------------------------------------------------------------------------------------------------------------------------
Separate Accounts Business:
Fixed maturity securities 241 (8) - -
Equity securities 84,185 - - (8,418)
Short term investments 10,913 1 - -
------------------------------------------------------------------------------------------------------------------------------
Total separate accounts business 95,339 (7) - (8,418)
------------------------------------------------------------------------------------------------------------------------------
Total securities held for other than
trading purposes 624,028 (28,496) (557) (8,653)
------------------------------------------------------------------------------------------------------------------------------
Total all securities $ 624,708 $ (28,404) $ (557) $ (8,705)
==============================================================================================================================
</TABLE>
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 affects 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>
- ----------------------------------------------------------------------------------------------------------------------
March 31, 1999 Market Interest Currency Equity
Value Rate Risk Risk Risk
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(In thousands of dollars)
Held for Trading Purposes
General Account:
Interest Rate Caps $ 161 $ 172 $ - $ -
Separate Accounts:
Other derivative securities 519 - - (130)
- ----------------------------------------------------------------------------------------------------------------------
Total trading securities 680 172 - (130)
- ----------------------------------------------------------------------------------------------------------------------
Held for Other Than Trading Purposes
General Account:
Fixed maturity securities 500,084 (42,384) (1,114) -
Equity securities 2,347 - - (587)
Short term investments 26,258 (7) - -
- ----------------------------------------------------------------------------------------------------------------------
Total general account 528,689 (42,391) (1,114) (587)
- ----------------------------------------------------------------------------------------------------------------------
Separate Accounts Business:
Fixed maturity securities 241 (12) - -
Equity securities 84,185 - - (21,046)
Short term investments 10,913 5 - -
- ----------------------------------------------------------------------------------------------------------------------
Total separate accounts business 95,339 (7) - (21,046)
- ----------------------------------------------------------------------------------------------------------------------
Total securities held for other than
trading purposes 624,028 (42,398) (1,114) (21,633)
- ----------------------------------------------------------------------------------------------------------------------
Total all securities $ 624,708 $ (42,226) $ (1,114) $ (21,763)
======================================================================================================================
</TABLE>
21
<PAGE> 22
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 24
(b) REPORTS ON FORM 8-K:
There were no reports on Form 8-K for the three months ended March 31,
1999.
22
<PAGE> 23
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 W. JAMES MACGINNITIE
--------------------------------------
W. James MacGinnitie
Director, Senior Vice President
and Chief Financial Officer
Date: May 13, 1999
23
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<EXCHANGE-RATE> 1
<DEBT-HELD-FOR-SALE> 500,084
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 2,347
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 604,453
<CASH> 7,155
<RECOVER-REINSURE> 2,422,150
<DEFERRED-ACQUISITION> 117,675
<TOTAL-ASSETS> 3,324,448
<POLICY-LOSSES> 2,735,495
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 97,601
<POLICY-HOLDER-FUNDS> 41,981
<NOTES-PAYABLE> 0
0
0
<COMMON> 2,500
<OTHER-SE> 257,932
<TOTAL-LIABILITY-AND-EQUITY> 3,324,448
74,673
<INVESTMENT-INCOME> 9,104
<INVESTMENT-GAINS> (4,689)
<OTHER-INCOME> 1,665
<BENEFITS> 70,111
<UNDERWRITING-AMORTIZATION> 2,997
<UNDERWRITING-OTHER> 6,300
<INCOME-PRETAX> 1,345
<INCOME-TAX> 492
<INCOME-CONTINUING> 853
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> (234)
<NET-INCOME> 619
<EPS-PRIMARY> 12.38
<EPS-DILUTED> 12.38
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
