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PROSPECTUS
FLEXIBLE PREMIUM DEFERRED VARIABLE ANNUITY CONTRACT
ISSUED BY
VALLEY FORGE LIFE INSURANCE COMPANY AND
VALLEY FORGE LIFE INSURANCE COMPANY VARIABLE ANNUITY
SEPARATE ACCOUNT
This prospectus describes a flexible premium deferred variable annuity
contract (the "Contract") issued by Valley Forge Life Insurance Company (the
"Company"). The Contract may be sold to or used in connection with retirement
plans, including plans that qualify for special federal income tax treatment
under the Internal Revenue Code.
The Owner of a Contract may allocate Net Purchase Payments and Contract
values to one or more of the Subaccounts of Valley Forge Life Insurance Company
Variable Annuity Separate Account (the "Variable Account"), or to the Guaranteed
Interest Option for one or more Guarantee Periods, or to both. Assets of each of
the 18 Subaccounts of the Variable Account are invested in a corresponding
investment portfolio (each, a "Fund") of Insurance Series, Variable Insurance
Products Fund, Variable Insurance Products Fund II, The Alger American Fund, MFS
Variable Insurance Trust, SoGen Variable Funds, Inc., and Van Eck Worldwide
Insurance Trust. The Guaranteed Interest Option guarantees a minimum fixed rate
of interest for specified periods of time, currently 1 year, 3 years, 5 years, 7
years, and 10 years.
The Contract Value will vary daily as a function of the investment
performance of the Subaccounts and any interest credited under the Guaranteed
Interest Option. The Company does not guarantee any minimum Variable Contract
Value for amounts allocated to the Variable Account. Annuity Payments and other
values provided by this Contract, when based on the Guaranteed Interest Option,
are subject to a Market Value Adjustment, the operation of which may result in
upward or downward adjustments in amounts withdrawn, surrendered, transferred,
paid on a Death Benefit, or applied to purchase Annuity Payments.
This prospectus sets forth the information regarding the Contract, the
Variable Account, and the Guaranteed Interest Option that a prospective investor
should know before purchasing a Contract. The prospectuses for the Funds, which
provide information regarding investment objectives and policies of each of the
Funds, should be read in conjunction with this prospectus. A Statement of
Additional Information having the same date as this prospectus and providing
additional information about the Contract and the Variable Account has been
filed with the Securities and Exchange Commission and is incorporated herein by
reference. To obtain a free copy of this document, call or write the Service
Center.
The Securities and Exchange Commission (the "SEC") maintains a website that
contains reports, proxy and information statements and other information
regarding registrants that file electronically with the SEC, including the
Company. The website address is http://www.sec.gov.
PLEASE READ THIS PROSPECTUS CAREFULLY AND KEEP IT FOR FUTURE REFERENCE.
THIS PROSPECTUS MUST BE ACCOMPANIED BY THE CURRENT PROSPECTUS FOR EACH OF THE
FUNDS.
AN INVESTMENT IN A CONTRACT IS NOT A DEPOSIT OR OBLIGATION OF, OR
GUARANTEED OR ENDORSED BY, ANY BANK, NOR IS THE CONTRACT INSURED BY THE FEDERAL
DEPOSIT INSURANCE CORPORATION OR ANY OTHER GOVERNMENT AGENCY. AN INVESTMENT IN
THE CONTRACT INVOLVES CERTAIN RISKS, INCLUDING THE RISK OF LOSS OF PURCHASE
PAYMENTS (PRINCIPAL).
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
May 1, 1998
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TABLE OF CONTENTS
<TABLE>
<S> <C>
DEFINITIONS................................................. 1
FEE TABLE................................................... 4
SUMMARY..................................................... 7
General Description....................................... 7
Purchasing a Contract..................................... 7
Canceling the Contract.................................... 8
Transfers................................................. 8
Withdrawals............................................... 8
Surrenders................................................ 8
Charges and Fees.......................................... 8
CONDENSED FINANCIAL INFORMATION............................. 9
THE COMPANY, THE VARIABLE ACCOUNT, THE FUNDS, AND THE
GUARANTEED INTEREST OPTION................................ 10
The Company............................................... 10
The Variable Account...................................... 10
The Funds................................................. 11
The Guaranteed Interest Option............................ 14
DESCRIPTION OF THE CONTRACT................................. 16
Purchasing a Contract..................................... 16
Canceling the Contract.................................... 16
Crediting and Allocating Purchase Payments................ 16
Variable Contract Value................................... 17
Transfers................................................. 18
Withdrawals............................................... 19
Surrenders................................................ 20
Death Benefits............................................ 20
Payments by the Company................................... 22
Telephone Transaction Privileges.......................... 22
CONTRACT CHARGES AND FEES................................... 23
Surrender Charge (Contingent Deferred Sales Charge)....... 23
Annual Administration Fee................................. 24
Transfer Processing Fee................................... 24
Taxes on Purchase Payments................................ 24
Mortality and Expense Risk Charge......................... 24
Administration Charge..................................... 25
Fund Expenses............................................. 25
Possible Charge for the Company's Taxes................... 25
SELECTING AN ANNUITY PAYMENT OPTION......................... 25
Annuity Date.............................................. 25
Annuity Payment Dates..................................... 25
Election and Changes of Annuity Payment Options........... 26
Annuity Payments.......................................... 26
Annuity Payment Options................................... 28
ADDITIONAL CONTRACT INFORMATION............................. 28
Ownership................................................. 28
Changing the Owner or Beneficiary......................... 29
Misstatement of Age or Sex................................ 29
Change of Contract Terms.................................. 29
</TABLE>
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<TABLE>
<S> <C>
Reports to Owners........................................................................................ 29
Miscellaneous............................................................................................ 30
YIELDS AND TOTAL RETURNS................................................................................... 30
FEDERAL TAX CONSIDERATIONS................................................................................. 32
Introduction............................................................................................. 32
Tax Status of the Contract............................................................................... 32
Taxation of Annuities.................................................................................... 33
Transfers, Assignments or Exchanges of a Contract........................................................ 35
Withholding.............................................................................................. 35
Multiple Contracts....................................................................................... 35
Taxation of Qualified Plans.............................................................................. 35
Other Tax Consequences................................................................................... 37
OTHER INFORMATION.......................................................................................... 37
Distribution of the Contracts............................................................................ 37
Administrative Services.................................................................................. 37
Voting Privileges........................................................................................ 38
Legal Proceedings........................................................................................ 38
Company Holidays......................................................................................... 38
Legal Matters............................................................................................ 38
Experts.................................................................................................. 39
ADDITIONAL INFORMATION ABOUT VALLEY FORGE LIFE INSURANCE COMPANY........................................... 39
History and Business..................................................................................... 39
Selected Financial Data.................................................................................. 39
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.................... 40
Results of Operations................................................................................. 40
Financial Condition................................................................................... 41
Investments........................................................................................... 41
Risks and Uncertainties............................................................................... 43
Liquidity and Capital Resources....................................................................... 43
Accounting Standards.................................................................................. 44
Forward-Looking Statements............................................................................ 45
Other Additional Information............................................................................. 45
Employees............................................................................................. 45
Properties............................................................................................ 45
Certain Agreements.................................................................................... 45
Regulation............................................................................................ 46
Directors and Executive Officers...................................................................... 47
Executive Compensation................................................................................ 48
Employment Contracts.................................................................................. 49
Retirement Plans...................................................................................... 50
INDEPENDENT AUDITORS' REPORT............................................................................... 52
FINANCIAL STATEMENTS OF VALLEY FORGE LIFE INSURANCE COMPANY................................................ 53
Table of Contents for the Statement of Additional Information............................................ 70
APPENDIX A................................................................................................. A-1
APPENDIX B................................................................................................. B-1
</TABLE>
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFERING IN ANY JURISDICTION IN
WHICH SUCH OFFERING MAY NOT LAWFULLY BE MADE. NO PERSON IS AUTHORIZED TO MAKE
ANY REPRESENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED
IN THIS PROSPECTUS.
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DEFINITIONS
ACCUMULATION UNIT: A unit of measure used to calculate Variable Contract
Value.
ADJUSTED CONTRACT VALUE: The Contract Value plus or minus any applicable
Market Value Adjustment less purchase payment tax charges not previously
deducted less the annual administration fee.
AGE: The age of any person on the birthday nearest the date for which Age
is determined.
ANNUITANT: The person or persons whose life (or lives) determines the
Annuity Payments payable under the Contract and whose death determines the death
benefit. With regard to joint and survivorship Annuity Payment Options, the
maximum number of joint Annuitants is two and provisions referring to the death
of an Annuitant mean the death of the last surviving Annuitant. Provisions
relating to an action by the Annuitant mean, in the case of joint Annuitants,
both Annuitants acting jointly.
ANNUITY DATE: The date on which Surrender Value or Adjusted Contract Value
is applied to purchase Annuity Units or a Fixed Annuity.
ANNUITY PAYMENT: One of several periodic payments made by the Company to
the Payee under an Annuity Payment Option.
ANNUITY PAYMENT DATE: The date each month, quarter, semi-annual period, or
year as of which the Company computes Annuity Payments. The Annuity Payment
Date(s) is shown on the Contract.
ANNUITY PAYMENT OPTION: The form of Annuity Payments selected by the Owner
under the Contract. The Annuity Payment Option is shown on the Contract.
ANNUITY UNIT: A unit of measure used to calculate Variable Annuity
Payments.
BENCHMARK RATE OF RETURN: An annual rate of return shown on the Contract
and used by the Company to determine the degree of fluctuation in the amount of
Variable Annuity Payments in response to fluctuations in the net investment
return of selected Subaccounts by assuming (among other things) that the assets
in the Variable Account supporting the Contract will have a net annual
investment return over the anticipated Annuity Payment period equal to that rate
of return.
BENEFICIARY: The person(s) to whom the death benefit will be paid on the
death of the Owner or Annuitant prior to the Annuity Date.
CANCELLATION PERIOD: The period described on the cover page of the Contract
during which the Owner may return the Contract for a refund.
THE CODE: The Internal Revenue Code of 1986, as amended.
THE COMPANY OR VFL: Valley Forge Life Insurance Company.
CONTINGENT ANNUITANT: The person designated by the Owner in the application
who becomes the Annuitant in the event that the Annuitant dies before the
Annuity Date while the Owner is still alive.
CONTINGENT BENEFICIARY: The person(s) to whom the death benefit will be
paid if the Beneficiary (or Beneficiaries) is not living.
CONTRACT ANNIVERSARY: The same date in each Contract Year as the Contract
Effective Date.
CONTRACT EFFECTIVE DATE: The date on which the Company issues the Contract
and upon which the Contract becomes effective. The Contract Effective Date is
shown on the Contract and is used to determine Contract Years and Contract
Anniversaries.
CONTRACT YEAR: A twelve-month period beginning on the Contract Effective
Date or on a Contract Anniversary.
CONTRACT VALUE: The total amount invested under the Contract. It is the sum
of Variable Contract Value and the Guaranteed Interest Option Value.
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DUE PROOF OF DEATH: Proof of death satisfactory to the Company. Due Proof
of Death may consist of the following if acceptable to the Company:
(a) a certified copy of the death record;
(b) a certified copy of a court decree reciting a finding of death; or
(c) any other proof satisfactory to the Company.
FIXED ANNUITY PAYMENT: An Annuity Payment that is supported by the General
Account and does not vary in amount as a function of the investment return of
the Variable Account from one Annuity Payment Date to the next.
FUND: Any open-end management investment company or investment portfolio
thereof or unit investment trust or series thereof, in which a Subaccount
invests.
GENERAL ACCOUNT: The assets of the Company other than those allocated to
the Variable Account or any other separate account of the Company.
GIO ACCOUNT: Valley Forge Life Insurance Company Guaranteed Interest Option
Separate Account.
GUARANTEE AMOUNT: Before the Annuity Date, the amount equal to that part of
any Net Purchase Payment allocated to or any amount transferred to the
Guaranteed Interest Option for a designated Guarantee Period with a particular
expiration date (including interest thereon) less any withdrawals (including any
applicable surrender charges and any applicable purchase payment tax charge) or
transfers therefrom.
GUARANTEE PERIOD: A specific number of years for which the Company agrees
to credit a particular effective annual rate of interest.
GUARANTEED INTEREST OPTION: An investment option under the Contract
supported by the GIO Account. It is not part of nor dependent upon the
investment performance of the Variable Account.
GUARANTEED INTEREST OPTION VALUE: The sum of all Guarantee Amounts.
GUARANTEED INTEREST RATE: Unless a Market Value Adjustment is made, an
effective annual rate of interest that the Company will pay on a Guarantee
Amount.
HOME OFFICE: The Company's office at 401 Penn St., Reading, Pennsylvania
19801. All inquiries should be directed to the Service Center.
MARKET VALUE ADJUSTMENT: A positive or negative adjustment made to any
portion of a Guarantee Amount upon the surrender, withdrawal, transfer or
application to an Annuity Payment Option of such portion of the Guarantee Amount
prior to 30 days before the expiration of the Guarantee Period applicable to
that Guarantee Amount.
NET ASSET VALUE PER SHARE: The value per share of any Fund on any Valuation
Day. The method of computing the Net Asset Value Per Share is described in the
prospectus for the Fund.
NET PURCHASE PAYMENT: A purchase payment less any purchase payment tax
charge deducted from the purchase payment.
NON-QUALIFIED CONTRACT: A Contract that is not a "qualified contract."
OWNER: The person or persons who owns (or own) the Contract and who is
(are) entitled to exercise all rights and privileges provided in the Contract.
The maximum number of joint Owners is two. Provisions relating to action by the
Owner mean, in the case of joint Owners, both Owners acting jointly. In the
context of a Contract issued on a group basis, Owners refers to holders of
certificates under a group Contract.
PAYEE: The person entitled to receive Annuity Payments under the Contract.
The Annuitant is the Payee unless the Owner designates a different person as
Payee.
QUALIFIED CONTRACT: A Contract that is issued in connection with a
retirement plan that qualifies for special federal income tax treatment under
Sections 401, 408, 408A or 457 of the Code.
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SEC: The U.S. Securities and Exchange Commission.
SERVICE CENTER: The offices of the Company's administrative department at
P.O. Box 305139, Nashville, Tennessee 37230-5139 (1-800-262-1755).
SUBACCOUNT: A subdivision of the Variable Account, the assets of which are
invested in a corresponding Fund.
SUBACCOUNT VALUE: Before the Annuity Date, the amount equal to that part of
any Purchase Payment allocated to the Subaccount and any amount transferred to
that Subaccount, adjusted by interest income, dividends, net capital gains or
losses, realized or unrealized, and decreased by withdrawals (including any
applicable surrender charges and any applicable purchase payment tax charge) and
any amounts transferred out of that Subaccount.
SURRENDER VALUE: The Adjusted Contract Value less any applicable surrender
charges.
VALUATION DAY: For each Subaccount, each day on which the New York Stock
Exchange is open for business except for certain holidays listed in the
prospectus and days that a Subaccount's corresponding Fund does not value its
shares.
VALUATION PERIOD: The period that starts at the close of regular trading on
the New York Stock Exchange on any Valuation Day and ends at the close of
regular trading on the next succeeding Valuation Day.
VARIABLE ACCOUNT: Valley Forge Life Insurance Company Variable Annuity
Separate Account.
VARIABLE CONTRACT VALUE: The sum of all Subaccount Values.
VARIABLE ANNUITY PAYMENT: An Annuity Payment that may vary in amount from
one Annuity Payment Date to the next as a function of the investment experience
of one or more Subaccounts selected by the Owner to support such payments.
WRITTEN NOTICE: A notice or request submitted in writing in a form
satisfactory to the Company that is signed by the Owner and received at the
Service Center.
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FEE TABLE
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<TABLE>
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CONTRACT OWNER TRANSACTION EXPENSES
Sales load imposed on purchase payments..................................................................... 0%
Maximum Surrender Charge (as a percentage of purchase payments surrendered or withdrawn).................... 7%
Transfer Processing Fee (each, after first 12 in a Contract Year)........................................... $25
Annual Administration Fee (waived if Contract Value exceeds $50,000)........................................ $30
VARIABLE ACCOUNT ANNUAL EXPENSES (AS A PERCENTAGE OF NET ASSETS)
Mortality and Expense Risk Charge........................................................................... 1.25%
Administration Charge....................................................................................... 0.15%
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Total Variable Account Expenses 1.40%
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</TABLE>
ANNUAL FUND EXPENSES
(AS A PERCENTAGE OF FUND AVERAGE NET ASSETS)
<TABLE>
<CAPTION>
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MANAGEMENT
(ADVISORY) OTHER TOTAL ANNUAL
FEES EXPENSES EXPENSES
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<S> <C> <C> <C>
INSURANCE SERIES:
Federated High Income Bond Fund II........................ 0.51% 0.29% 0.80%[1]
Federated Prime Money Fund II............................. 0.30% 0.50% 0.80%[1]
Federated Utility Fund II................................. 0.48% 0.37% 0.85%[1]
VARIABLE INSURANCE PRODUCTS FUND (VIP) AND
VARIABLE INSURANCE PRODUCTS FUND II (VIP II):
Fidelity VIP Equity-Income Portfolio...................... 0.50% 0.08% 0.58%[2]
Fidelity VIP II Asset Manager Portfolio................... 0.55% 0.10% 0.65%[2]
Fidelity VIP II Contrafund Portfolio...................... 0.60% 0.11% 0.71%[2]
Fidelity VIP II Index 500 Portfolio....................... 0.24% 0.04% 0.28%[3]
THE ALGER AMERICAN FUND:
Alger American Growth Portfolio........................... 0.75% 0.04% 0.79%
Alger American MidCap Growth Portfolio.................... 0.80% 0.04% 0.84%
Alger American Small Capitalization Portfolio............. 0.85% 0.03% 0.89%
MFS VARIABLE INSURANCE TRUST:
MFS Emerging Growth Series................................ 0.75% 0.15% 0.90%[4]
MFS Growth With Income Series............................. 0.75% 0.25% 1.00%[4][5]
MFS Limited Maturity Series............................... 0.55% 0.45% 1.00%[4][5]
MFS Research Series....................................... 0.75% 0.17% 0.92%[4]
MFS Total Return Series................................... 0.75% 0.60% 1.35%[4][5]
SOGEN VARIABLE FUNDS, INC.:
SoGen Overseas Variable Fund.............................. 0.75% 1.25% 2.00%[6]
VAN ECK WORLDWIDE INSURANCE TRUST:
Van Eck Worldwide Emerging Markets Fund................... 0.80% 0.00% 0.80%[7]
Van Eck Worldwide Hard Assets Fund........................ 1.00% 0.17% 1.17%[8]
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</TABLE>
[1] Federated Advisers has voluntarily agreed to waive a portion of its
management fee with respect to these funds. Absent this waiver, the
management fee would have been .60%, .50%, and .75% for the Federated High
Income Bond Fund II, Federated Prime Money Fund II and Federated Utility
Fund II, respectively and total annual expenses would have been 0.89%, 1.00%
and 1.12% for the Federated High Income Bond Fund II, Federated Prime Money
Fund II and Federated Utility Fund II, respectively.
[2] A portion of the brokerage commissions that these funds pay was used to
reduce fund expenses. In addition, these funds have entered into
arrangements with their custodian and transfer agent whereby interest earned
on uninvested cash balances was used to reduce custodian and transfer agent
expenses. Including these reductions, the total operating expenses presented
in the table would have been .57%, .64% and .68% for the Equity-Income,
Asset Manager and Contrafund portfolios, respectively.
[3] Fidelity Management and Research Company has agreed to reimburse a portion
of this fund's expenses during the period. Absent this reimbursement, the
fund's management fee would have been .27% and its total annual expenses
would have been .40%.
[4] Each of these funds has an expense offset arrangement which reduces its
custodian fee based upon the amount of cash it maintains with its custodian
and dividend disbursing agent, and may enter into such arrangements and
directed
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brokerage arrangements (which would also have the effect of reducing its
expenses). Any such fee reductions are not reflected under "Other Expenses".
[5] Massachusetts Financial Services Company has agreed to bear expenses for
these funds, subject to reimbursement by each fund, such that each fund's
"Other Expenses" shall not exceed the following percentages of the average
daily net assets of the series during the current fiscal year: .45% for the
Limited Maturity Series and .25% for each of the Emerging Growth Series and
Total Return Series. Absent this arrangement, actual other expenses would
have been .35%, 5.65%, and .27% and total operating expenses would have been
1.10%, 6.20% and 1.02% for the Growth With Income Series, Limited Maturity
Series, and Total Return Series, respectively.
[6] The annualized ratios of operating expenses to average net assets for the
period ended December 31, 1997 would have been 16.07% without the effect of
earnings credits, and the investment advisory fee waiver and expense
reimbursement provided by the advisor.
[7] For the period January 1, 1997 to January 10, 1997, Van Eck Associates
Corporation agreed to waive its management fees and assume all expenses of
the Fund except interest, taxes, brokerage commissions and extraordinary
expenses. For the period January 11, 1997 to February 4, 1997, the Adviser
agreed to waive expenses exceeding 1% of average daily net assets. Absent
this waiver and reimbursement, management fees, other expenses and total
annual expenses would have been 1.00%, 0.34%, and 1.34%, respectively. The
fund has a fee arrangement, based on cash balances left on deposit with the
custodian, which reduces the funds operating expenses.
[8] The fund directs certain portfolio trades to a broker that, in turn, pays a
portion of the Fund's operating expenses. Absent this arrangement,
management fees, other expenses, and total annual expenses would have been
1.00%, 0.18% and 1.18%, respectively.
Taxes on purchase payments, generally ranging from 0% to 3.5% of purchase
payments, may be applicable, depending upon the laws of various jurisdictions.
The above tables are intended to assist the Owner in understanding the
costs and expenses that he or she will bear directly or indirectly. The table
reflects the anticipated expenses of the Variable Account and reflect the actual
expenses for each Fund for the year ended December 31, 1997. Expenses for these
Funds are estimates and are not based on past experience. For a more complete
description of the various costs and expenses, see "CONTRACT CHARGES AND FEES"
and the prospectuses for each Fund.
EXAMPLES
If you surrender your Contract at the end of the applicable time period,
you would pay the following expenses on a $1,000 purchase payment, assuming a 5%
annual rate of return on assets:
<TABLE>
<CAPTION>
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ONE YEAR THREE YEARS FIVE YEARS TEN YEARS
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<S> <C> <C> <C> <C>
Federated High Income Bond Fund II Subaccount........ $ 96 $139 $169 $268
Federated Prime Money Fund II Subaccount............. $ 96 $139 $169 $268
Federated Utility Fund II Subaccount................. $ 96 $141 $172 $273
Fidelity VIP Equity-Income Subaccount................ $ 94 $132 $157 $243
Fidelity VIP II Asset Manager Subaccount............. $ 94 $134 $161 $251
Fidelity VIP II Contrafund Subaccount................ $ 95 $136 $164 $258
Fidelity VIP II Index 500 Subaccount................. $ 91 $123 $141 $209
Alger American Growth Subaccount..................... $ 96 $139 $168 $267
Alger American MidCap Growth Subaccount.............. $ 96 $140 $171 $272
Alger American Small Capitalization Subaccount....... $ 97 $142 $174 $278
MFS Emerging Growth Subaccount....................... $ 97 $142 $174 $279
MFS Growth With Income Subaccount.................... $ 98 $145 $179 $290
MFS Limited Maturity Subaccount...................... $ 98 $145 $179 $290
MFS Research Subaccount.............................. $ 97 $145 $175 $281
MFS Total Return Subaccount.......................... $ 98 $145 $179 $290
SoGen Overseas Subaccount............................ $108 $176 $231 $393
Van Eck Worldwide Emerging Markets Subaccount........ $ 96 $139 $169 $268
Van Eck Worldwide Hard Assets Subaccount............. $100 $150 $188 $380
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</TABLE>
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If you do not surrender your Contract or if you annuitize, you would pay
the following expenses on a $1,000 purchase payment, assuming a 5% annual rate
of return on assets:
<TABLE>
<CAPTION>
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ONE YEAR THREE YEARS FIVE YEARS TEN YEARS
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<S> <C> <C> <C> <C>
Federated High Income Bond Fund II Subaccount........ $ 26 $ 79 $129 $268
Federated Prime Money Fund II Subaccount............. $ 26 $ 79 $129 $268
Federated Utility Fund II Subaccount................. $ 26 $ 81 $132 $273
Fidelity VIP Equity-Income Subaccount................ $ 24 $ 72 $117 $243
Fidelity VIP II Asset Manager Subaccount............. $ 24 $ 74 $121 $251
Fidelity VIP II Contrafund Subaccount................ $ 25 $ 76 $124 $258
Fidelity VIP II Index 500 Subaccount................. $ 21 $ 63 $101 $209
Alger American Growth Subaccount..................... $ 26 $ 79 $128 $267
Alger American MidCap Growth Subaccount.............. $ 26 $ 80 $131 $272
Alger American Small Capitalization Subaccount....... $ 27 $ 82 $134 $278
MFS Emerging Growth Subaccount....................... $ 27 $ 82 $134 $279
MFS Growth With Income Subaccount.................... $ 28 $ 85 $139 $290
MFS Limited Maturity Subaccount...................... $ 28 $ 85 $139 $290
MFS Research Subaccount.............................. $ 27 $ 83 $135 $281
MFS Total Return Subaccount.......................... $ 28 $ 85 $139 $290
SoGen Overseas Subaccount............................ $ 38 $116 $191 $393
Van Eck Worldwide Emerging Markets Subaccount........ $ 26 $ 79 $129 $268
Van Eck Worldwide Hard Assets Subaccount............. $ 30 $ 90 $148 $308
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</TABLE>
The examples provided above assume that no transfer processing fees or
purchase payment taxes have been assessed. The examples also assume that the
annual administration fee is $30 and that the Contract Value per Contract is
$10,000, which translates the annual administration fee into an assumed .30%
charge for purposes of the examples based on a $1,000 investment.
THESE EXAMPLES SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE
EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN. THE 5% ANNUAL
RETURN ASSUMED IS HYPOTHETICAL AND SHOULD NOT BE CONSIDERED A REPRESENTATION OF
PAST OR FUTURE ANNUAL RETURNS, WHICH MAY BE GREATER OR LESS THAN THE ASSUMED
RATE.
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SUMMARY
GENERAL DESCRIPTION
This prospectus has been designed to provide prospective Owners with the
information necessary to decide whether or not to purchase a Contract. This
summary provides a concise description of the more significant aspects of the
Contract. Further detail is provided in this prospectus, the related Statement
of Additional Information, the Contract and the prospectuses of the Funds. For
further information, contact the Service Center.
In many jurisdictions, the Contract is issued directly to individuals. In
certain jurisdictions, however, the Contract is only available as a group
contract. Group Contracts are issued to or on behalf of groups such as employers
for their employees. Individuals who are part of groups for which a Contract is
issued receive a certificate that recites substantially all of the provisions of
the Group Contract. Throughout this prospectus, the term "Contract" refers to
individual Contracts, Group Contracts and certificates for Group Contracts.
Owners may allocate all or a portion of Purchase Payments or transfer
Contract Value among several Subaccounts of the Variable Account. The Contract
also offers a Guaranteed Interest Option under which Owners may allocate all or
a portion of Purchase Payments and transfer Contract Value among several
Guarantee Periods selected by the Owner. The Company currently offers Guarantee
Periods with durations of 1, 3, 5, 7, and 10 years. If the amount allocated or
transferred remains in a Guarantee Period until the expiration date of a
Guarantee Period, its value will be equal to the amount originally allocated or
transferred, multiplied on an annually compounded basis, by its Guaranteed
Interest Rate. Any surrender, withdrawal, transfer, or annuitization made prior
to 30 days before the expiration of a Guarantee Period will be subject to a
Market Value Adjustment that may increase or decrease the Guarantee Amount (or
portion thereof) being surrendered, withdrawn, transferred, or annuitized.
Depending on the size of the Market Value Adjustment, such an adjustment may
reduce the Guarantee Amount (or portion thereof) to less than the Purchase
Payment allocated to or Contract Value transferred to a Guarantee Period. (See
"THE COMPANY, THE VARIABLE ACCOUNT, THE FUNDS AND THE GUARANTEED INTEREST
OPTION--The Guaranteed Interest Option - Market Value Adjustment.")
The Company makes no promise that the Contract Value will increase.
Depending on the investment experience of the Subaccounts and interest credited
to various Guarantee Amounts, the Contract Value, Adjusted Contract Value,
Surrender Value and the death benefit may increase or decrease on any Valuation
Day. Owners bear the investment risk for amounts invested in the Subaccounts and
for Guarantee Amounts surrendered, withdrawn, transferred or applied to an
Annuity Payment Option before the 30-day period prior to the expiration of a
Guarantee Period.
The Contract also offers a choice of Annuity Payment Options to which
Owners may apply the Adjusted Contract Value as of the Annuity Date.
Beneficiaries may also apply the death benefit to certain Annuity Payment
Options. An Owner may change the Annuity Date within certain limits.
PURCHASING A CONTRACT
The minimum initial purchase payment for a Contract is $2,000. The minimum
additional purchase payment the Company will accept is $100. The Company may
refuse to accept additional purchase payments at any time for any reason.
The initial Purchase Payment is allocated to each Subaccount or to
Guarantee Periods of the Guaranteed Interest Option, or to both, as specified on
the application, unless the Contract is issued in a state that requires the
return of purchase payments during the Cancellation Period. In those states,
that portion of an Owner's initial Purchase Payment allocated to a Subaccount is
allocated to the Prime Money Subaccount (the "Money Market Subaccount") for a
period equal to the number of days in the Cancellation Period. At the expiration
of this period, such portion of the Purchase Payment, as adjusted to reflect the
investment performance of the Money Market Subaccount during this period, is
then allocated to the Subaccounts based on the proportion that the Owner's
allocation percentage shown in the application bears to the Variable Contract
Value. (See "DESCRIPTION OF THE CONTRACT--Canceling the Contract.")
If an Owner elects to invest in a particular Subaccount or Guarantee
Period, at least 1% of the Purchase Payment must be allocated to that Subaccount
or Guarantee Period. All percentage allocations must be in
7
<PAGE> 12
whole numbers. In addition, allocations to a Guarantee Period must be at least
$500. The Company allocates any additional Purchase Payments among the
Subaccounts and the Guarantee Periods in accordance with the allocation schedule
in effect when such Purchase Payment is received at the Service Center unless it
is accompanied by Written Notice directing a different allocation. (See
"DESCRIPTION OF THE CONTRACT--Crediting and Allocating Purchase Payments.")
CANCELING THE CONTRACT
At any time during the Cancellation Period, an Owner may cancel the
Contract and receive a refund equal to the Contract Value plus fees or charges
deducted except for the mortality and expense risk charge and the administration
charge. However, if required by state law, the Company will return the purchase
payments made. The Cancellation Period is a 10-day period of time beginning when
the Contract is received by an Owner. Some states may require that the Company
provide a longer Cancellation Period. (See "DESCRIPTION OF THE
CONTRACT--Canceling the Contract.")
TRANSFERS
Prior to the Annuity Date, an Owner may transfer all or part of any
Subaccount Value to another available Subaccount(s) or to one or more Guarantee
Periods, or transfer all or part of any Guarantee Amount to any available
Subaccount(s) or other available Guarantee Periods, subject to certain
restrictions. (See "DESCRIPTION OF THE CONTRACT--Transfers.")
WITHDRAWALS
Upon Written Notice prior to the Annuity Date, an Owner may, subject to
certain restrictions, withdraw part of the Surrender Value. Withdrawals of
Surrender Value may result in the Company deducting from the remaining Contract
Value a Market Value Adjustment, any applicable surrender charge and any
applicable purchase payment tax charge. (See "DESCRIPTION OF THE
CONTRACT--Withdrawals.") A withdrawal may have adverse federal income tax
consequences including the possibility of being subject to a penalty tax. (See
"FEDERAL TAX CONSIDERATIONS.")
SURRENDERS
Upon Written Notice prior to the Annuity Date, an Owner may surrender the
Contract and receive its Surrender Value. An Owner may elect to have the
Surrender Value paid in a single sum or under an Annuity Payment Option. (See
"DESCRIPTION OF THE CONTRACT--Surrenders.") Surrenders may have adverse federal
income tax consequences including the possibility of being subject to a penalty
tax. (See "FEDERAL TAX CONSIDERATIONS.")
CHARGES AND FEES
The following charges and fees are assessed under the Contracts:
SURRENDER CHARGE. If a purchase payment is withdrawn or surrendered (or
received by a Payee as part of a lump sum payment) within five full calendar
years since the date the purchase payment was received, the Company assesses a
surrender charge. During the first five Contract Years, the Company also
assesses a surrender charge if a purchase payment is applied, as part of
Contract Value, to an Annuity Payment Option. The surrender charge is 7% of the
purchase payment if surrendered or withdrawn within two full years after the
purchase payment was received and reduces by 1% each year for the next three
years and is 0% after five full years following receipt of the purchase payment.
No surrender charge is assessed upon the withdrawal or surrender (or payment) of
Contract Value in excess of aggregate purchase payments (less prior withdrawals
of purchase payments). For purposes of determining the surrender charge, it is
assumed that Contract Value in excess of purchase payments (less prior
withdrawals of purchase payments) is surrendered or withdrawn before any
purchase payments and purchase payments are considered withdrawn on a
first-in-first-out basis. (See "DESCRIPTION OF THE CONTRACT--Surrender Charge
(Contingent Deferred Sales Charge)").
8
<PAGE> 13
ADMINISTRATION CHARGE. The Company makes a daily charge of 0.000411%
(approximately equivalent to an effective annual rate of 0.15%) of the Variable
Account's net assets to cover a portion of the Company's Contract administration
costs. (See "DESCRIPTION OF THE CONTRACT--Administration Charge.")
MORTALITY AND EXPENSE RISK CHARGE. The Company makes a daily charge of
0.003446% (approximately equivalent to an effective annual rate of 1.25%) of the
Variable Account's net assets to compensate the Company for assuming certain
mortality and expense risks. (See "DESCRIPTION OF THE CONTRACT--Mortality and
Expense Risk Charge.")
ANNUAL ADMINISTRATION FEE. The Company deducts an annual administration fee
of $30 per Contract Year if an Owner's Contract Value is less than $50,000 at
the time of deduction. (See "DESCRIPTION OF THE CONTRACT--Annual Administration
Fee.")
TRANSFER PROCESSING FEE. A $25 charge is assessed by the Company for each
transfer in excess of 12 during a Contract Year. (See "DESCRIPTION OF THE
CONTRACT--Transfer Processing Fee.")
TAXES ON PURCHASE PAYMENTS. Generally, taxes on purchase payments, if any,
are incurred as of the Annuity Date, and a charge for taxes on purchase payments
is deducted from the Contract Value as of that date. These taxes range generally
from 0% to 3.5% of purchase payments. (See "DESCRIPTION OF THE CONTRACT--Taxes
on Purchase Payments.")
EXPENSES OF THE FUNDS. The investment experience of each Subaccount
reflects that of the Fund whose shares it holds. The investment experience of
each Fund, in turn, reflects its fees and other operating expenses. Please read
the prospectus for each of the Funds for details.
CONDENSED FINANCIAL INFORMATION
The Variable Account commenced operations in 1997. Following are the number
of Accumulation Units outstanding and their values at inception and December 31,
1997. This information should be read in conjunction with the financial
statements, including related notes, for the Variable Annuity Separate Account
(as well as the independent auditor's report thereon) which are included in the
Statement of Additional Information ("SAI"). The SAI, having the same date as
this prospectus and providing additional information about the Contract and the
Variable Account, has been filed with the SEC and is incorporated herein by
reference.
The audited financial statements of the Company (as well as the independent
auditor's report thereon) appear elsewhere herein.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
FEDERATED
FEDERATED HIGH FIDELITY ALGER
PRIME FEDERATED INCOME FIDELITY VIP II FIDELITY AMERICAN ALGER
MONEY UTILITY BOND VIP ASSET VIP II FIDELITY SMALL AMERICAN
FUND II FUND II FUND II EQUITY-INCOME MANAGER INDEX 500 CONTRAFUND CAP GROWTH
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Unit value at
inception........... $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ --
Unit value at December
31, 1997............ $ 1.00 $ 14.29 $ 10.95 $ 24.28 $ 18.01 $ 114.39 $ 19.94 $ 43.75 $ 42.76
Units outstanding at
December 31, 1997... 861,083.8 3,546.7 17,395.3 20,427.1 14,845.4 4,920.8 16,502.8 4,473.8 5,832.2
===================================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
ALGER MFS SOGEN VANECK VANECK
AMERICAN MFS GROWTH MFS OVERSEAS WORLDWIDE WORLDWIDE
MID-CAP EMERGING MFS WITH LIMITED MFS VARIABLE HARD EMERGING
GROWTH GROWTH RESEARCH INCOME MATURITY TOTAL RETURN PORTFOLIO ASSETS MARKETS
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Unit value at
inception.............. $ -- $ -- $ -- $ -- $ -- $ -- $ -- $-- $ --
Unit value at December
31, 1997............... $ 24.18 $ 16.14 $ 15.79 $ 16.44 $ 10.01 $ 16.63 $ 9.77 $15.72 $ 11.00
Units outstanding at
December 31, 1997...... 1,754.7 8,776.2 9,906.0 13,322.2 8,162.4 15,625.0 77,061.7 574.9 1,535.5
==================================================================================================================================
</TABLE>
9
<PAGE> 14
THE COMPANY, THE VARIABLE ACCOUNT, THE FUNDS
AND THE GUARANTEED INTEREST OPTION
THE COMPANY
The Company is a life insurance company organized under the laws of the
Commonwealth of Pennsylvania in 1956 and is authorized to transact business in
the District of Columbia, Puerto Rico, Guam and all states except New York. The
Company's home office is located at 401 Penn St., Reading, Pennsylvania 19601,
and its executive office is located at CNA Plaza, Chicago, Illinois 60685. The
Company is a wholly-owned subsidiary of Continental Assurance Company
("Assurance"), a life insurance company which, as of December 31, 1997, had
consolidated assets of approximately $14.7 billion. Subject to a reinsurance
pooling agreement with Assurance, the Company assumes all insurance risks under
the Contracts, and the Company's assets, which as of December 31, 1997 exceeded
$2.3 billion, support the benefits under the Contracts. See "ADDITIONAL
INFORMATION ABOUT VALLEY FORGE LIFE INSURANCE COMPANY" for more detail regarding
the Company.
THE VARIABLE ACCOUNT
The Variable Account is a separate investment account of the Company
established under Pennsylvania law on October 18, 1995. The Company owns the
assets of the Variable Account. These assets are held separately from the
Company's General Account and its other separate accounts. That portion of the
Variable Account's assets that is equal to the reserves and other Contract
liabilities of the Variable Account is not chargeable with liabilities arising
out of any other business the Company may conduct. If the assets exceed the
required reserves and other contract liabilities, the Company may transfer the
excess to the Company's General Account. The Variable Account's assets will at
all times, equal or exceed the sum of the Subaccount Values of all Contracts
funded by the Variable Account.
The Variable Account is registered with the SEC under the Investment
Company Act of 1940 (the "1940 Act") as a unit investment trust and meets the
definition of a "separate account" under the federal securities laws. Such
registration does not involve any supervision by the SEC of the management of
the Variable Account or the Company. The Variable Account also is governed by
the laws of Pennsylvania, the Company's state of domicile, and may also be
governed by laws of other states in which the Company does business.
The Variable Account has 18 Subaccounts, each of which invests in shares of
a corresponding Fund. Income, gains and losses, realized or unrealized, from
assets allocated to a Subaccount are credited to or charged against that
Subaccount without regard to other income, gains or losses of the Company.
CHANGES TO THE VARIABLE ACCOUNT. Where permitted by applicable law, the
Company may make the following changes to the Variable Account:
1. any changes required by the 1940 Act or other applicable law or
regulation;
2. combine separate accounts, including the Variable Account;
3. add new Subaccounts to or remove existing Subaccounts from the
Variable Account or combine Subaccounts;
4. make Subaccounts (including new Subaccounts) available to such
classes of Contracts as the Company may determine;
5. add new Funds or remove existing Funds;
6. substitute new Fund(s) for any existing Fund if shares of the Fund
are no longer available for investment or if the Company determines that
investment in a Fund is no longer appropriate in light of the purposes of
the Variable Account;
7. deregister the Variable Account under the 1940 Act if such
registration is no longer required; and
8. operate the Variable Account as a management investment company
under the 1940 Act or as any other form permitted by law.
10
<PAGE> 15
No such changes will be made without any necessary approval of the SEC and
applicable state insurance departments. Owners will be notified of any changes.
THE FUNDS
Each Subaccount invests in a corresponding Fund. Each of the Funds is
either an open-end diversified management investment company or a separate
investment portfolio of such a company and is managed by a registered investment
adviser. The Funds as well as a brief description of their investment objectives
are provided below.
INSURANCE SERIES
The Federated High Income Bond Fund II, Federated Prime Money Fund II and
Federated Utility Fund II Subaccounts each invest in shares of corresponding
Funds (i.e., investment portfolios) of Insurance Series ("IS"). IS issues five
"series" or classes of shares, each of which represents an interest in a Fund of
IS. Three of these series of shares are available as investment options under
the Contract. The investment objectives of these Funds are set forth below.
FEDERATED HIGH INCOME BOND FUND II. This Fund invests primarily in
lower-rated fixed-income securities that seek to achieve high current
income.
FEDERATED PRIME MONEY FUND II. This Fund invests in money market
instruments maturing in thirteen months or less to achieve current income
consistent with stability of principal and liquidity.
FEDERATED UTILITY FUND II. This Fund invests in equity and debt
securities of utility companies to achieve high current income and moderate
capital appreciation.
IS is advised by Federated Advisers.
VARIABLE INSURANCE PRODUCTS FUND AND VARIABLE INSURANCE PRODUCTS FUND II
The Equity-Income Subaccount invests in shares of a corresponding Fund of
Variable Insurance Products Fund ("VIP Fund"). VIP Fund issues five "series" or
classes of shares, each of which represents an interest in a Fund of VIP Fund.
One of these series of shares is available as an investment option under the
Contracts. Asset Manager, Contrafund, and Index 500 Subaccounts each invest in
shares of corresponding Funds of Variable Insurance Products Fund II ("VIP Fund
II"). VIP Fund II issues five "series" or classes of shares, each of which
represents an interest in a Fund of VIP Fund II. Three of these series of shares
are available as investment options under the Contract. The investment
objectives of these Funds are set forth below.
ASSET MANAGER PORTFOLIO. This Fund seeks high total return with
reduced risk over the long-term by allocating its assets among domestic and
foreign stocks, bonds and short-term fixed-income instruments.
CONTRAFUND PORTFOLIO. This Fund seeks capital appreciation over the
long-term by investing in companies that are undervalued or out-of-favor.
EQUITY-INCOME PORTFOLIO. This Fund seeks current income by investing
primarily in income producing equity securities. In choosing these
securities, the Fund also considers the potential for capital appreciation.
INDEX 500 PORTFOLIO. This Fund seeks investment results that
correspond to the total return of common stocks publicly traded in the
United States, as represented by the Standard & Poor's 500 Composite Index
of 500 Common Stocks.
VIP Fund and VIP Fund II are each advised by Fidelity Management & Research
Company.
11
<PAGE> 16
THE ALGER AMERICAN FUND
Alger American Growth, Alger American MidCap Growth and Alger American
Small Capitalization Subaccounts each invest in shares of corresponding Funds of
The Alger American Fund ("AAF"). AAF issues six "series" or classes of shares,
each of which represents an interest in a Fund of AAF. Three of these series of
shares are available as investment options under the Contract. The investment
objectives of these Funds are set forth below.
ALGER AMERICAN GROWTH PORTFOLIO. This Fund seeks long-term capital
appreciation by investing in a diversified, actively managed portfolio of
equity securities, primarily of companies with total market capitalization
of $1 billion or greater.
ALGER AMERICAN MIDCAP GROWTH PORTFOLIO. This Fund seeks long-term
capital appreciation by investing in a diversified, actively managed
portfolio of equity securities, primarily of companies with total market
capitalization between $750 million and $3.5 billion.
ALGER AMERICAN SMALL CAPITALIZATION PORTFOLIO. This Fund seeks
long-term capital appreciation by investing in a diversified, actively
managed portfolio of equity securities, primarily of companies with total
market capitalization of less than $1 billion.
AAF is advised by Fred Alger Management, Inc.
MFS VARIABLE INSURANCE TRUST
The MFS Emerging Growth, MFS Growth with Income, MFS Limited Maturity, MFS
Research and MFS Total Return Subaccounts each invest in shares of corresponding
Funds of MFS Variable Insurance Trust ("MFSVIT"). MFSVIT issues 12 "series" or
classes of shares, each of which represents an interest in a Fund of MFSVIT.
Five of these series of shares are available as investment options under the
Contract. The investment objectives of these Funds are set forth below.
MFS EMERGING GROWTH SERIES. This Fund seeks to obtain long-term growth
of capital by investing primarily in common stocks of small and
medium-sized companies that are early in their life cycle but which have
the potential to become major enterprises.
MFS GROWTH WITH INCOME SERIES. This Fund seeks to provide reasonable
current income and long-term growth of capital and income.
MFS LIMITED MATURITY SERIES. This Fund seeks to provide as high a
level of current income as is believed to be consistent with prudent
investment risk, with capital protection as a secondary objective.
MFS RESEARCH SERIES. This Fund seeks to provide long-term growth of
capital and future income.
MFS TOTAL RETURN SERIES. This Fund seeks primarily to provide
above-average income consistent with prudent employment of capital and
secondarily to provide a reasonable opportunity for growth of capital and
income.
MFSVIT is advised by Massachusetts Financial Services Company.
SOGEN VARIABLE FUNDS, INC.
The SoGen Overseas Subaccount invests in shares of a corresponding Fund of
SoGen Variable Funds, Inc. ("SGVF"). SGVF issues one "series" or class of shares
which represents an interest in a Fund of SGVF. This series of shares is
available as an investment option under the Contract. The investment objective
of this Fund is set forth below.
SOGEN OVERSEAS VARIABLE FUND. This Fund seeks long-term growth of
capital by investing primarily in securities of small and medium size
non-U.S. companies.
SGVF is advised by Societe Generale Asset Management Corp.
12
<PAGE> 17
VAN ECK WORLDWIDE INSURANCE TRUST
The Worldwide Emerging Markets and Worldwide Hard Assets Subaccounts each
invest in shares of corresponding Funds of Van Eck Worldwide Insurance Trust
("VEWIT"). VEWIT issues five "series" or classes of shares, each of which
represents an interest in a Fund of VEWIT. Two of these series of shares are
available as investment options under the Contract. The investment objectives of
these Funds are set forth below.
WORLDWIDE EMERGING MARKETS FUND. This Fund seeks capital appreciation
by investing primarily in equity securities in emerging markets around the
world.
WORLDWIDE HARD ASSETS FUND. This Fund seeks long-term capital
appreciation by investing globally, primarily in securities of companies
engaged directly or indirectly in the exploration, development, production
and distribution of one or more of the following sectors: precious metals,
ferrous and non-ferrous metals, oil and gas, forest products, real estate
and other basic non-agricultural commodities.
VEWIT is advised by Van Eck Associates Corporation.
NO ONE CAN ASSURE THAT ANY FUND WILL ACHIEVE ITS STATED OBJECTIVES AND POLICIES.
More detailed information concerning the investment objectives, policies
and restrictions of the Funds, the expenses of the Funds, the risks attendant to
investing in the Funds and other aspects of their operations can be found in the
current prospectus for each Fund which accompanies this prospectus and the
current statement of additional information for the Funds. The Funds'
prospectuses should be read carefully before any decision is made concerning the
allocation of Purchase Payments or transfers among the Subaccounts.
Please note that not all of the Funds described in the prospectuses for the
Funds are available with the Contract. Moreover, the Company cannot guarantee
that each Fund will always be available for its variable annuity contracts, but
in the unlikely event that a Fund is not available, the Company will take
reasonable steps to secure the availability of a comparable fund. Shares of each
Fund are purchased and redeemed at net asset value, without a sales charge.
The Company has entered into agreements with the investment advisers of
several of the Funds pursuant to which each such investment adviser pays the
Company a servicing fee based upon an annual percentage of the average aggregate
net assets invested by the Company on behalf of the Variable Account. These
agreements reflect administrative services provided to the Funds by the Company.
Payments of such amounts by an adviser do not increase the fees paid by the
Funds or their shareholders.
Shares of the Funds are sold to separate accounts of insurance companies
that are not affiliated with the Company or each other, a practice known as
"shared funding." They are also sold to separate accounts to serve as the
underlying investment for both variable annuity contracts and variable life
insurance contracts, a practice known as "mixed funding." As a result, there is
a possibility that a material conflict may arise between the interests of
Owners, whose Contract Values are allocated to the Variable Account, and of
owners of other contracts whose contract values are allocated to one or more
other separate accounts investing in any one of the Funds. Shares of some of the
Funds may also be sold directly to certain qualified pension and retirement
plans qualifying under Section 401 of the Code. As a result, there is a
possibility that a material conflict may arise between the interests of Owners
or owners of other contracts (including contracts issued by other companies),
and such retirement plans or participants in such retirement plans. In the event
of any such material conflicts, the Company will consider what action may be
appropriate, including removing the Fund from the Variable Account or replacing
the Fund with another Fund. There are certain risks associated with mixed and
shared funding and with the sale of shares to qualified pension and retirement
plans, as disclosed in each Fund's prospectus.
13
<PAGE> 18
THE GUARANTEED INTEREST OPTION
The Guaranteed Interest Option is an investment option available under the
Contract and is supported by the Company's General Account and the GIO Account
(described below). All or a portion of an Owner's Purchase Payments may be
allocated to and transfers of Contract Value may be made to Guarantee Periods
under the Guaranteed Interest Option. Through the Guaranteed Interest Option,
the Company offers specified effective annual rates of interest (Guaranteed
Interest Rates) that are credited daily and available for specified periods of
time selected by an Owner (Guarantee Periods). Although the Guaranteed Interest
Rate may differ among Guarantee Periods, it will never be less than the
effective annual rate shown in the Contract.
Interests issued by the Company in connection with the Guaranteed Interest
Option have been registered under the Securities Act of 1933, but neither the
Guaranteed Interest Option, the GIO Account, nor the General Account has been
registered as an investment company under the 1940 Act. Accordingly, neither the
Guaranteed Interest Option, the GIO Account, nor the General Account, nor any
interest therein are generally subject to regulation under the 1940 Act.
Initial Guarantee Periods begin on the date as of which a Purchase Payment
is allocated to or a portion of Contract Value is transferred to the Guarantee
Period, and end when the number of years in the Guarantee Period elected
(measured from the end of the calendar month in which the amount was allocated
or transferred to the Guarantee Period) has elapsed. The last day of the
Guarantee Period is the expiration date for that Guarantee Period. Subsequent
Guarantee Periods begin on the first day following the expiration date of a
previous Guarantee Period.
Allocations of Purchase Payments and transfers of Contract Value to the
Guaranteed Interest Option may have different applicable Guaranteed Interest
Rates depending on the timing of such allocations or transfers. However, the
applicable Guaranteed Interest Rate does not change during a Guarantee Period.
If the allocated or transferred amount remains in the Guaranteed Interest Option
until the end of the applicable Guarantee Period, its value will be equal to the
amount originally allocated or transferred, multiplied, on an annually
compounded basis, by its Guaranteed Interest Rate. If a Guarantee Amount is
surrendered, withdrawn, transferred, or applied to an Annuity Payment Option
prior to 30 days before the expiration of the Guarantee Period, the Guaranteed
Interest Rate for that Guarantee Period is subject to a Market Value Adjustment,
as described below, the application of which may result in the payment of an
amount less than the amount originally allocated or transferred to the Guarantee
Period.
The Company will notify Owners in writing at least 30 days prior to the
expiration date of any Guarantee Period about the then currently available
Guarantee Periods and the Guaranteed Interest Rates applicable to such Guarantee
Periods. A new Guarantee Period of the same duration as the previous Guarantee
Period will commence automatically on the first day following the expiring
Guarantee Period, unless the Company receives Written Notice prior to the start
of the new Guarantee Period of the Owner's election of a different Guarantee
Period from among those being offered by the Company at that time, or
instructions to transfer all or a portion of the expiring Guarantee Amount to a
Subaccount. If the Company does not receive such Written Notice and is not
offering a Guarantee Period of the same duration as the expiring Guarantee
Period or if the duration of the expiring Guarantee Period would, if renewed,
extend beyond the Annuity Date, then a new Guarantee Period of one year will
commence automatically on the first day following the expiring Guarantee Period.
The minimum Guarantee Amount is $500.
To the extent permitted by law, the Company reserves the right at any time
to offer Guarantee Periods that differ from those available when an Owner's
Contract was issued. The Company also reserves the right, at any time, to stop
accepting Purchase Payment allocations or transfers of Contract Value to a
particular Guarantee Period. Since the specific Guarantee Periods available may
change periodically, please contact the Service Center to determine the
Guarantee Periods currently being offered.
GIO ACCOUNT. The assets in the GIO Account are used to support the values
and benefits under the Guaranteed Interest Option of the Contract and similar
contracts. The Company owns the assets in the GIO Account and holds such assets
separately from other Company assets and from the General Account. The portion
of the assets of the GIO Account equal to the reserves and other contract
liabilities of the GIO
14
<PAGE> 19
Account are not chargeable with liabilities that arise from any other business
that the Company conducts. The Company may transfer to the General Account any
assets of the GIO Account that are in excess of such reserves and other
liabilities.
Under Pennsylvania insurance law, the Company is required to maintain
assets in the GIO Account at least equal to the reserves and other contract
liabilities of the GIO Account. In the unlikely event of liquidation of the
Company, if the Company cannot satisfy all of its insurance obligations, Owners
with Guaranteed Interest Option Value will have a priority claim against assets
of the GIO Account equal to its liabilities, and a claim against the Company's
general account for any remaining Company liabilities. Thus, the GIO Account
represents a pool of assets that provides an additional measure of assurance
that Owners allocating Purchase Payments and Contract Value to the Guaranteed
Interest Option will receive full payment of benefits attributable to Guaranteed
Interest Option.
Owners allocating Purchase Payments and/or Contract Value to the Guaranteed
Interest Option do not participate in the investment performance of assets of
the GIO Account, and this performance does not determine the Guaranteed Interest
Option Value or benefits relating thereto. The Guaranteed Interest Option
provides values and benefits based only upon the Purchase Payments and Contract
Values allocated thereto, the Guaranteed Interest Rate credited on such amounts,
and any charges or Market Value Adjustments imposed on such amounts in
accordance with the terms of the Contract.
MARKET VALUE ADJUSTMENT. A Market Value Adjustment reflects the
relationship between: (i) the current Guaranteed Interest Rate that the Company
is crediting for a Guarantee Period equal to the time remaining in the Guarantee
Period from which the Guarantee Amount is requested to be surrendered,
withdrawn, transferred or annuitized; and (ii) the Guaranteed Interest Rate
being applied to the Guarantee Period from which the Guarantee Amount will be
surrendered, withdrawn, transferred or annuitized. Any surrender, withdrawal,
transfer or application to an Annuity Payment Option of a Guarantee Amount is
subject to a Market Value Adjustment that may be positive or negative, unless
the effective date of the surrender, withdrawal, transfer or application is
within 30 days prior to the end of a Guarantee Period. The Market Value
Adjustment will be applied after the deduction of any applicable annual
administration fee or transfer processing fee, and before the deduction of any
applicable surrender charge or charge for taxes on purchase payments (also
referred to as a "premium tax" charge).
Generally, if the Guaranteed Interest Rate for the selected Guarantee
Period is lower than the Guaranteed Interest Rate currently being offered for
new Guarantee Periods of a duration equal to the balance of the selected
Guarantee Period as of the date that the Market Value Adjustment is applied,
then the application of the Market Value Adjustment will result in the payment,
upon surrender, withdrawal, transfer or application of amounts to an Annuity
Payment Option, of an amount less than the Guarantee Amount (or portion thereof)
being surrendered, withdrawn, transferred or applied to an Annuity Payment
Option, or may even result in the payment of an amount less than the Purchase
Payment allocated to or the portion of Contract Value transferred to the
Guarantee Period. Similarly, if the Guaranteed Interest Rate for the selected
Guarantee Period is higher than the Guaranteed Interest Rate currently being
offered for new Guarantee Periods of a duration equal to the balance of the
selected Guarantee Period as of the date that the Market Value Adjustment is
applied, then the application of the Market Value Adjustment will result in the
payment, upon surrender, withdrawal, transfer or application of amounts to an
Annuity Payment Option, of an amount greater than the Guarantee Amount (or
portion thereof) being surrendered, withdrawn, transferred or applied to an
Annuity Payment Option.
The Market Value Adjustment is computed by multiplying the amount being
surrendered, withdrawn, transferred or applied to an Annuity Payment Option by
the Market Value Adjustment Factor. The Market Value Adjustment Factor is
calculated as follows:
<TABLE>
<S> <C> <C> <C> <C> <C> <C> <C>
Market Value Adjustment = Amount multiplied by 3 1 1+A 2 N/12 -1 4
1+B
</TABLE>
where:
"Amount" is the amount being surrendered, withdrawn, transferred or
applied to an Annuity Payment Option less any applicable annual
administration fees or transfer processing fees;
15
<PAGE> 20
"a" is the Guaranteed Interest Rate currently being credited to the
"Amount";
"b" is the Guaranteed Interest Rate that is currently being offered
for a Guarantee Period of duration equal to the time remaining to the
expiration of the Guarantee Period for the Guarantee Amount from which the
"Amount" is taken. Where the time remaining to the expiration of the
Guarantee Period is not 1, 3, 5, 7 or 10 years, "b" is the rate found by
linear interpolation of the rate for the Guarantee Period having the
duration closest to the time remaining or, if the time remaining is less
than 1 year, "b" is the rate for a 1 year period; and
"n" is the number of complete months remaining before the expiration
of the Guarantee Period for the Guarantee Amount from which the "Amount" is
taken.
Examples of computing the Market Value Adjustment are set forth in Appendix A.
DESCRIPTION OF THE CONTRACT
PURCHASING A CONTRACT
A prospective Owner may purchase a Contract by submitting an application
through a licensed agent of the Company who is also a representative of a
broker-dealer having a selling agreement with CNA Investor Services, Inc.
("CNA/ISI"), the principal underwriter for the Contracts. The maximum Age on the
Contract Effective Date for Owners who are Annuitants is 85. An initial purchase
payment must be delivered to the Service Center along with the Owner's
application. The minimum initial purchase payment is $2,000. The minimum
additional purchase payment the Company will accept is $100. Unless the Company
gives its prior approval, it will not accept an initial purchase payment in
excess of $500,000 and reserves the right not to accept any purchase payment for
any reason. The Company will send Owners a confirmation notice upon receipt and
acceptance of the Owner's purchase payment.
CANCELING THE CONTRACT
Owners may cancel the Contract during the Cancellation Period, which is the
10-day period after an Owner receives the Contract. Some states may require a
longer Cancellation Period. To cancel the Contract, the Owner must mail or
deliver the Contract to the Service Center or to the agent who sold it. The
Company will refund the Contract Value plus any fees or charges deducted except
for the mortality and expense risk charge and the administration charge. If the
Owner purchased a Contract in a state that requires the return of purchase
payments during the Cancellation Period and the Owner chooses to exercise the
cancellation right, the Company will return the purchase payments.
CREDITING AND ALLOCATING PURCHASE PAYMENTS
If the application for a Contract is properly completed and is accompanied
by all the information necessary to process it, including payment of the initial
purchase payment, the initial Purchase Payment will be allocated, as designated
by the Owner, to one or more of the Subaccounts or to one or more Guarantee
Periods within two business days of receipt of such Purchase Payment by the
Company at the Service Center. If the application is not properly completed, the
Company reserves the right to retain the Purchase Payment for up to five
business days while it attempts to complete the application. If the application
cannot be made complete within five business days, the applicant will be
informed of the reasons for the delay and the initial Purchase Payment will be
returned immediately unless the applicant specifically consents to the Company
retaining the initial Purchase Payment until the application is made complete.
The initial Purchase Payment will then be credited within two business days
after receipt of a properly completed application. The Company will credit
additional Purchase Payments that are accepted by the Company as of the end of
the Valuation Period during which the Payment was received at the Service
Center.
The initial Purchase Payment is allocated among the Subaccounts and
Guarantee Periods as specified on the application, unless the Contract is issued
in a state that requires the return of purchase payments during the Cancellation
Period. In those states, any portion of the initial Purchase Payment allocated
to the
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<PAGE> 21
Guaranteed Interest Option will be allocated to that option upon receipt; and
any portion of the initial Purchase Payment allocated to the Subaccounts will be
allocated to the Money Market Subaccount for a period equal to the number of
days in the Cancellation Period. At the expiration of this period, such portion
of the Purchase Payment, as adjusted to reflect the investment performance of
the Money Market Subaccount during this period, is then allocated to the
Subaccounts as described above.
Owners may allocate Purchase Payments among any or all Subaccounts or
Guarantee Periods available. If an Owner elects to invest in a particular
Subaccount or Guarantee Period, at least 1% of the Purchase Payment must be
allocated to that Subaccount or Guarantee Period. All percentage allocations
must be in whole numbers. The minimum amount that may be allocated to any
Guarantee Period is $500. The Company allocates any additional Purchase Payments
among the Subaccounts and the Guaranteed Interest Option in accordance with the
allocation schedule in effect when such Purchase Payment is received at the
Service Center unless it is accompanied by Written Notice directing a different
allocation.
VARIABLE CONTRACT VALUE
SUBACCOUNT VALUE. The Variable Contract Value is the sum of all Subaccount
Values and therefore reflects the investment experience of the Subaccounts to
which it is allocated. The Subaccount Value for any Subaccount as of the
Contract Effective Date is equal to the amount of the initial Purchase Payment
allocated to that Subaccount. On subsequent Valuation Days prior to the Annuity
Date, the Subaccount Value is equal to that part of any Purchase Payment
allocated to the Subaccount and any amount transferred to that Subaccount,
adjusted by interest income, dividends, net capital gains or losses, realized or
unrealized, and decreased by withdrawals (including any applicable surrender
charges and any applicable purchase payment tax charge) and any amounts
transferred out of that Subaccount.
ACCUMULATION UNITS. Purchase Payments allocated to a Subaccount or amounts
of Contract Value transferred to a Subaccount are converted into Accumulation
Units. For any Contract, the number of Accumulation Units credited to a
Subaccount is determined by dividing the dollar amount directed to the
Subaccount by the value of the Accumulation Unit for that Subaccount for the
Valuation Day on which the Purchase Payment or transferred amount is invested in
the Subaccount. Therefore, Purchase Payments allocated to or amounts transferred
to a Subaccount under a Contract increase the number of Accumulation Units of
that Subaccount credited to the Contract.
Decreases in Subaccount Value under a Contract are effected by the
cancellation of Accumulation Units of a Subaccount. Therefore, surrenders,
withdrawals, transfers out of a Subaccount, payment of a death benefit, the
application of Variable Contract Value to an Annuity Payment Option on the
Annuity Date, and the deduction of the annual administration fee all result in
the cancellation of an appropriate number of Accumulation Units of one or more
Subaccounts. Accumulation Units are canceled as of the end of the Valuation
Period in which the Company received Written Notice regarding the event.
The Accumulation Unit value for each Subaccount was arbitrarily set
initially at $10 when the Subaccount began operations. Thereafter, the
Accumulation Unit value at the end of every Valuation Day equals the
Accumulation Unit value at the end of the preceding Valuation Day multiplied by
the Net Investment Factor (described below). The Subaccount Value for a Contract
is determined on any day by multiplying the number of Accumulation Units
attributable to the Contract in that Subaccount by the Accumulation Unit value
for that Subaccount.
THE NET INVESTMENT FACTOR. The Net Investment Factor is an index applied to
measure the investment performance of a Subaccount from one Valuation Period to
the next. For each Subaccount, the Net Investment Factor reflects the investment
experience of the Fund in which that Subaccount invests and the charges assessed
against that Subaccount for a Valuation Period. The Net Investment Factor is
calculated by dividing (1) by (2) and subtracting (3) from the result, where:
(1) is the result of:
a. the Net Asset Value Per Share of the Fund held in the
Subaccount, determined at the end of the current Valuation
Period; plus
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<PAGE> 22
b. the per share amount of any dividend or capital gain
distributions made by the Fund held in the Subaccount, if the
"ex-dividend" date occurs during the current Valuation Period;
plus or minus
c. a per share charge or credit for any taxes reserved for, which
is determined by the Company to have resulted from the
operations of the Subaccount.
(2) is the Net Asset Value Per Share of the Fund held in the
Subaccount, determined at the end of the last prior Valuation Period.
(3) is a daily factor representing the mortality and expense risk
charge and the administration charge deducted from the Subaccount, adjusted
for the number of days in the Valuation Period.
TRANSFERS
GENERAL. Prior to the Annuity Date and after the Cancellation Period, by
Written Notice, an Owner may transfer all or part of any Subaccount Value to
another Subaccount(s) (subject to its availability) or to one or more available
Guarantee Periods, or transfer all or part of any Guarantee Amount to any
Subaccount(s) (subject to its availability) or to one or more available
Guarantee Periods, subject to the following restrictions. The minimum transfer
amount is $500 or the entire Subaccount Value or Guarantee Amount, if less. The
minimum Subaccount Value or Guarantee Amount that may remain following a
transfer is $500. A transfer request that would reduce any Subaccount Value or
Guarantee Amount below $500 is treated as a transfer request for the entire
Subaccount Value or Guarantee Amount. Only four transfers may be made per
Contract Year from all or part of any Guarantee Amount. The first 12 transfers
during each Contract Year are free. The Company assesses a transfer processing
fee of $25 for each transfer in excess of 12 during a Contract Year. The
transfer processing fee is deducted from the amount being transferred. Each
Written Notice of transfer is considered one transfer regardless of how many
Subaccounts or Guarantee Periods are affected by the transfer.
DOLLAR-COST AVERAGING FACILITY. If elected in the application or at any
time thereafter prior to the Annuity Date by Written Notice, an Owner may
systematically transfer (on a monthly, quarterly, semi-annual or annual basis)
specified dollar amounts from the Money Market Subaccount to other Subaccounts.
This is known as the "dollar-cost averaging" method of investment. The
fixed-dollar amount purchases more Accumulation Units of a Subaccount when their
value is lower and fewer units when their value is higher. Over time, the cost
per unit averages out to be less than if all purchases of Units had been made at
the highest value and greater than if all purchases had been made at the lowest
value. The dollar-cost averaging method of investment reduces the risk of making
purchases only when the price of Accumulation Units is high. It does not assure
a profit or protect against a loss in declining markets.
Owners may only elect to use the dollar-cost averaging facility if their
Money Market Subaccount Value is at least $1,000 at the time of the election.
The minimum transfer amount under the facility is $100 per month (or the
equivalent). If dollar-cost averaging transfers are to be made to more than one
Subaccount, then the Owner must indicate the dollar amount of the transfer to be
made to each. At least $50 must be designated to each Subaccount.
Transfers under the dollar-cost averaging facility are made as of the same
calendar day each month. If this calendar day is not a Valuation Day, transfers
are made as of the next Valuation Day. Once elected, transfers under the
dollar-cost averaging facility continue until the Money Market Subaccount Value
is depleted, the Annuity Date occurs or until the Owner cancels the election by
Written Notice at least seven days in advance of the next transfer date.
Alternatively, Owners may specify in advance a date for transfers under the
facility to cease. There is no additional charge for using the dollar-cost
averaging facility. Transfers under the facility do not count towards the 12
transfers permitted without a transfer processing fee in any Contract Year. The
Company reserves the right to discontinue offering the dollar-cost averaging
facility at any time and for any reason or to change its features.
If elected in the application, an Owner may use the dollar-cost averaging
facility to systematically transfer specified dollar amounts (on a monthly or
quarterly basis) from a Guarantee Amount under the Guaranteed
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<PAGE> 23
Interest Option. For this purpose, the Company may, from time to time, offer a
special one-year or six-month Guarantee Period designed for use with the
dollar-cost averaging facility. When available, an Owner may allocate all or
part of the initial purchase payment to a special Guarantee Period. These
special Guarantee Periods are not available for subsequent purchase payments or
transfers of Contract Value. The minimum dollar amount that may be transferred
from a Guarantee Amount using the dollar-cost averaging facility is that amount
which results in the entire Guarantee Amount being transferred to one or more
Subaccounts by the end of the special Guarantee Period and in no case shall be
less than $5,000. Once elected, transfers from a Guarantee Amount under the
facility do not cease until the Guarantee Amount is depleted. No Market Value
Adjustment applies to transfers described in this paragraph. All other
requirements applicable to dollar-cost averaging transfers from the Money Market
Subaccount apply to transfers described in this paragraph.
AUTOMATIC SUBACCOUNT VALUE REBALANCING. If elected in the application or
requested by Written Notice at any time thereafter prior to the Annuity Date, an
Owner may instruct the Company to automatically transfer (on a quarterly,
semi-annual or annual basis) Variable Contract Value between and among specified
Subaccounts in order to achieve a particular percentage allocation of Variable
Contract Value among such Subaccounts ("automatic Subaccount Value
rebalancing"). Such percentage allocations must be in whole numbers. Once
elected, automatic Subaccount Value rebalancing begins on the first Valuation
Day of the next calendar quarter or other period (or, if later, the next
calendar quarter or other period after the expiration of the Cancellation
Period).
Owners may stop automatic Subaccount Value rebalancing at any time by
Written Notice at least seven calendar days before the first Valuation Day in a
new period. Owners may specify allocations between and among as many Subaccounts
as are available at the time automatic Subaccount Value rebalancing is elected.
Once automatic Subaccount Value rebalancing has been elected, any subsequent
allocation instructions that differ from the then-current rebalancing allocation
instructions are treated as a request to change the automatic Subaccount Value
rebalancing allocation. Owners may change automatic Subaccount Value rebalancing
allocations at any time. Allocation changes will take effect as of the Valuation
Day that instructions are received at the Service Center. Once automatic
Subaccount Value rebalancing is in effect, an Owner may only transfer Subaccount
Value among or between Subaccounts by changing the automatic Subaccount Value
rebalancing allocation instructions. Changes to automatic Subaccount Value
rebalancing must be made by Written Notice.
There is no additional charge for automatic Subaccount Value rebalancing
and rebalancing transfers do not count as one the 12 transfers available without
a transfer processing fee during any Contract Year. If automatic Subaccount
Value rebalancing is elected at the same time as the dollar-cost averaging
facility or when the dollar-cost averaging facility is being utilized, automatic
Subaccount Value rebalancing will be postponed until the first Valuation Day in
the calendar quarter or other period following the termination of dollar-cost
averaging facility. The Company reserves the right to discontinue offering
automatic Subaccount Value rebalancing at any time for any reason or to change
its features.
WITHDRAWALS
GENERAL. Prior to the Annuity Date and after the Cancellation Period, an
Owner may withdraw part of the Surrender Value, subject to certain limitations.
Each withdrawal must be requested by Written Notice. The minimum withdrawal
amount is $500. The maximum withdrawal is the amount that would leave a minimum
Surrender Value of $1,000. A withdrawal request that would reduce any Subaccount
Value or Guarantee Amount below $500 will be treated as a request for a
withdrawal of all of that Subaccount Value or Guarantee Amount.
The Company withdraws the amount requested from the Contract Value as of
the day that the Company receives an Owner's Written Notice, and sends the Owner
that amount. The Company will then deduct any applicable surrender charge and
any applicable purchase payment tax charge from the remaining Contract Value. If
the withdrawal is requested from a Guarantee Amount, the Company deducts any
applicable Market Value Adjustment from, or adds any applicable Market Value
Adjustment to, remaining Contract Value. A deduction of a Market Value
Adjustment from Contract Value may result in the payment of an amount
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<PAGE> 24
which, when added to any remaining Guarantee Amount and amounts previously
withdrawn or transferred, is less than the amount allocated or transferred to a
Guarantee Period to create that Guarantee Amount.
A Written Notice of withdrawal must specify the amount to be withdrawn from
each Subaccount or Guarantee Amount. If the Written Notice does not specify this
information, or if any Subaccount Value or Guarantee Amount is inadequate to
comply with the request, the Company will make the withdrawal based on the
proportion that each Subaccount Value and each Guarantee Amount bears to the
Contract Value as of the day of the withdrawal.
SYSTEMATIC WITHDRAWALS. If elected in the application or requested at any
time thereafter prior to the Annuity Date by Written Notice, an Owner may elect
to receive periodic withdrawals under the Company's systematic withdrawal plan.
Under the systematic withdrawal plan, the Company will make withdrawals (on a
monthly, quarterly, semi-annual or annual basis) from Subaccounts specified by
the Owner. Systematic withdrawals must be at least $100 each and may only be
made from Variable Contract Value. Withdrawals under the systematic withdrawal
plan may only be made from Subaccounts having $1,000 or more of Subaccount Value
at the time of election. The systematic withdrawal plan is not available to
Owners using the dollar-cost averaging facility or automatic Subaccount Value
rebalancing.
The Company makes systematic withdrawals on the following basis: (1) as a
specified dollar amount, or (2) as a specified whole percent of Subaccount
Value.
Participation in the systematic withdrawal plan terminates on the earliest
of the following events: (1) the Subaccount Value from which withdrawals are
being made becomes zero, (2) a termination date specified by the Owner is
reached, or (3) the Owner requests that his or her participation in the plan
cease. Systematic withdrawals being made in order to meet the required minimum
distribution under the Code or to make substantially equal payments as required
under the Code will continue even though a surrender charge is deducted.
TAX CONSEQUENCES OF WITHDRAWALS. Consult your tax adviser regarding the tax
consequences associated with making withdrawals. A withdrawal made before the
taxpayer reaches Age 59 1/2, including systematic withdrawals, may result in
imposition of a penalty tax of 10% of the taxable portion withdrawn. See
"FEDERAL TAX CONSIDERATIONS" for more details.
SURRENDERS
An Owner may surrender the Contract for its Surrender Value at any time
prior to the Annuity Date. A Contract's Surrender Value fluctuates daily as a
function of the investment experience of the Subaccounts in which an Owner is
invested. The Company does not guarantee any minimum Surrender Value for amounts
invested in the Subaccounts. Likewise, the Company does not guarantee any
minimum Surrender Value for Guarantee Amounts surrendered, withdrawn,
transferred or applied to an Annuity Payment Option before the 30-day period
prior to the expiration of a Guarantee Period.
An Owner may elect to have the Surrender Value paid in a single sum or
under an Annuity Payment Option. The Surrender Value will be determined as of
the date the Company receives the Written Notice for surrender and the Contract
at the Service Center.
Consult your tax adviser regarding the tax consequences of a Surrender. A
Surrender made before age 59 1/2 may result in the imposition of a penalty tax
of 10% of the taxable portion of the Surrender Value. See "FEDERAL TAX
CONSIDERATIONS" for more details.
DEATH OF OWNER OR ANNUITANT
DEATH BENEFITS ON OR AFTER THE ANNUITY DATE. If an Owner dies on or after
the Annuity Date, any surviving joint Owner becomes the sole Owner. If there is
no surviving Owner, any successor Owner becomes the new Owner. If there is no
surviving or successor Owner, the Payee becomes the new Owner. If an Annuitant
or an Owner dies on or after the Annuity Date, the remaining undistributed
portion, if any, of the
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<PAGE> 25
Contract Value will be distributed at least as rapidly as under the method of
distribution being used as of the date of such death. Under some Annuity Payment
Options, there will be no death benefit.
DEATH BENEFITS WHEN THE OWNER DIES BEFORE THE ANNUITY DATE. If any Owner
dies prior to the Annuity Date, any surviving joint Owner becomes the new sole
Owner. If there is no surviving joint Owner, any successor Owner becomes the new
Owner and if there is no successor Owner the Annuitant becomes the new Owner
unless the deceased Owner was also the Annuitant. If the sole deceased Owner was
also the Annuitant, then the provisions relating to the death of the Annuitant
(described below) will govern unless the deceased Owner was one of two joint
Annuitants, in which event the surviving Annuitant becomes the new Owner.
The following options are available to new Owners:
1. to receive the Adjusted Contract Value in a single lump sum within
five years of the deceased Owner's death; or
2. elect to receive the Adjusted Contract Value paid out under an
Annuity Payment Option provided that: (a) Annuity Payments begin within one
year of the deceased Owner's death, and (b) Annuity Payments are made in
substantially equal installments over the life of the new Owner or over a
period not greater than the life expectancy of the new Owner; or
3. if the new Owner is the spouse of the deceased Owner, he or she may
by Written Notice within one year of the Owner's death, elect to continue
the Contract as the new Owner. If the spouse so elects, all of his or her
rights as a Beneficiary cease and if the deceased Owner was also the sole
Annuitant and appointed no Contingent Annuitant, he or she will become the
Annuitant. The spouse will be deemed to have made the election to continue
the Contract if he or she makes no election before the expiration of the
one year period or if he or she makes any purchase payments under the
Contract.
With regard to new Owners who are not the spouse of the deceased Owner: (a)
1 and 2 apply even if the Annuitant or Contingent Annuitant is alive at the time
of the deceased Owner's death, (b) if the new Owner is not a natural person,
only option 1 is available, (c) if no election is made within one year of the
deceased Owner's death, option 1 is deemed to have been elected.
Adjusted Contract Value is computed as of the date that the Company
receives Due Proof of Death of the Owner. Payments under this provision are in
full settlement of all of the Company's liability under the Contract.
DEATH BENEFITS WHEN THE ANNUITANT DIES BEFORE THE ANNUITY DATE. If the
Annuitant dies before the Annuity Date while the Owner is still living, any
Contingent Annuitant will become the Annuitant. If the Annuitant dies before the
Annuity Date and no Contingent Annuitant has been named, the Company will pay
the death benefit described below to the Beneficiary. If there is no surviving
Beneficiary, the Company will pay the death benefit to any Contingent
Beneficiary. If there is no surviving Contingent Beneficiary, the Company will
immediately pay the death benefit to the Owner's estate in a lump sum.
If the Annuitant who is also an Owner dies or if the Annuitant dies and the
Owner is not a natural person, a Beneficiary (or a Contingent Beneficiary):
1. will receive the death benefit in a single lump sum within 5 years
of the deceased Annuitant's death; or
2. may elect to receive the death benefit paid out under an Annuity
Payment Option provided that: (a) Annuity Payments begin within 1 year of
the deceased Annuitant's death, and (b) Annuity Payments are made in
substantially equal installments over the life of the Beneficiary or over a
period not greater than the life expectancy of the Beneficiary; or
3. if the Beneficiary is the spouse of the deceased Annuitant, he or
she may by Written Notice within one year of the Annuitant's death, elect
to continue the Contract as the new Owner. If the spouse so elects, all his
or her rights as a Beneficiary cease and if the deceased Annuitant was also
the sole Annuitant and appointed no Contingent Annuitant, he or she will
become the Annuitant. The spouse will
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be deemed to have made the election to continue the Contract if he or she
makes no election before the expiration of the one year period or if he or
she makes any purchase payments under the Contract.
THE DEATH BENEFIT. The death benefit is an amount equal to the greatest of:
1. aggregate purchase payments made less any withdrawals as of the
date that the Company receives Due Proof of Death of the Annuitant; or
2. the Contract Value as of the date that the Company receives Due
Proof of Death of the Annuitant; or
3. the minimum death benefit described below;
less any applicable purchase payment tax charge on the date that the death
benefit is paid.
The minimum death benefit is the death benefit floor amount as of the date
of the Annuitant's death (a) adjusted, for each withdrawal made since the most
recent reset of the death benefit floor amount, multiplying that amount by the
product of all ratios of the Contract Value immediately after a withdrawal to
the Contract Value immediately before such withdrawal (b) plus any purchase
payments made since the most recent reset of the death benefit floor amount.
The death benefit floor amount is the largest Contract Value attained on
any prior Contract Anniversary prior to the Annuitant's Age 81. Therefore, the
death benefit floor amount is reset when, on a Contract Anniversary, Contract
Value exceeds the current death benefit floor amount.
Examples of the computation of the death benefit are shown in Appendix B.
PAYMENTS BY THE COMPANY
The Company generally makes payments of withdrawals, surrenders, death
benefits, or any Annuity Payments within seven days of receipt of all applicable
Written Notices and/or Due Proofs of Death. However, the Company may postpone
such payments for any of the following reasons:
1. when the New York Stock Exchange ("NYSE") is closed for trading
other than customary holiday or weekend closing, or trading on the NYSE is
restricted, as determined by the SEC; or
2. when the SEC by order permits a postponement for the protection of
Owners; or
3. when the SEC determines that an emergency exists that would make
the disposal of securities held in the Variable Account or the
determination of their value not reasonably practicable.
If a recent check or draft has been submitted, the Company has the right to
defer payment of surrenders, withdrawals, death benefits or Annuity Payments
until the check or draft has been honored.
The Company may defer payment of any withdrawal, surrender or transfer of
Guaranteed Interest Option Value up to six months after it receives an Owner's
Written Notice. The Company pays interest on the amount of any payment that is
deferred.
TELEPHONE TRANSACTION PRIVILEGES
If an Owner has elected this privilege in a form provided by the Company,
an Owner may make transfers or change allocation instructions by telephoning the
Service Center. A telephone authorization form received by the Company at the
Service Center is valid until it is rescinded or revoked by Written Notice or
until a subsequently dated form signed by the Owner is received at the Service
Center. The Company will send Owners a written confirmation of all transfers and
allocation changes made pursuant to telephone instructions.
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The Service Center requires a form of personal identification prior to
acting on instructions received by telephone and also may tape record
instructions received by phone. If the Company follows these procedures, it is
not liable for any losses due to unauthorized or fraudulent transactions. The
Company reserves the right to suspend telephone transaction privileges at any
time for any reason.
CONTRACT CHARGES AND FEES
SURRENDER CHARGE (CONTINGENT DEFERRED SALES CHARGE)
GENERAL. No sales charge is deducted from purchase payments at the time
that such payments are made. However, within certain time limits described
below, a surrender charge is deducted upon any withdrawal or surrender. A
surrender charge is assessed on Cash Value applied to an Annuity Payment Option
during the first five Contract Years. No surrender charge is assessed on
Contract Value applied to an Annuity Payment Option after the fifth Contract
Year. If on the Annuity Date, however, the Payee elects (or the Owner previously
elected) to receive a lump sum, this sum will equal the Surrender Value on such
date.
In the event that surrender charges are not sufficient to cover sales
expenses, such expenses will be borne by the Company. Conversely, if the revenue
from such charges exceeds such expenses, the excess of revenues from such
charges over expenses will be retained by the Company. The Company does not
currently believe that the surrender charges deducted will cover the expected
costs of distributing the Contracts. Any shortfall will be made up from the
Company's general assets, which may include amounts derived from the mortality
and expense risk charge.
CHARGE FOR SURRENDER OR WITHDRAWALS. The surrender charge is equal to the
percentage of each purchase payment surrendered or withdrawn (or applied to an
Annuity Payment Option during the first five Contract Years) as shown in the
table below. The surrender charge is separately calculated and applied to each
purchase payment at the time that the purchase payment is surrendered or
withdrawn. No surrender charge applies to the Contract Value in excess of
aggregate purchase payments (less prior withdrawals of the payments). The
surrender charge is calculated using the assumption that purchase payments are
surrendered Contract Value in excess of aggregate purchase payments (less prior
withdrawals of purchase payments) is surrendered or withdrawn before any
purchase payments and that purchase payments are withdrawn on a first-
in-first-out basis.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
SURRENDER CHARGE
NUMBER OF FULL YEARS AS A PERCENTAGE
ELAPSED BETWEEN DATE OF OF PURCHASE
RECEIPT OF PURCHASE PAYMENT PAYMENT WITHDRAWN
AND DATE OF SURRENDER OF WITHDRAWAL OR SURRENDERED
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
0 7%
1 7%
2 6%
3 5%
4 4%
5+ 0%
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
WITHDRAWALS. With regard to all withdrawals, the Company withdraws the
amount requested from the Contract Value as of the day that it receives the
Written Notice regarding the withdrawal and sends the Owner that amount. The
Company then deducts any surrender charge and any applicable purchase payment
tax charge from the remaining Contract Value. If the withdrawal is requested
from a Guarantee Amount, the Company deducts any applicable Market Value
Adjustment from, or adds any applicable Market Value Adjustment to, remaining
Contract Value.
AMOUNTS NOT SUBJECT TO A SURRENDER CHARGE. Each Contract Year after the
first Contract Year (or the first Contract Year if systematic withdrawals are in
effect), an Owner may withdraw an amount equal to 15% of the greater of: (1)
aggregate purchase payments (less prior withdrawals of purchase payments) as of
the
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first Valuation Day of that Contract Year, or (2) Contract Value as of the day
Written Request for the withdrawal is received, without incurring surrender
charge. The Company reserves the right to limit the number of such "free"
withdrawals in any Contract Year. Owners may carry over to subsequent Contract
Years, any unused "free" withdrawal percentages. For example, if 10% of either
aggregate purchase payments (less prior withdrawals of purchase payments) or
Contract Value is withdrawn in a Contract Year, then in the next Contract Year,
the Owner may withdraw an amount equal to 20% of the greater of: (1) aggregate
purchase payments (less prior withdrawals of purchase payments) as of the first
Valuation Day of that Contract Year, or (2) Contract Value as of the day Written
Request for the withdrawal is received, without incurring surrender charge.
WAIVER OF SURRENDER CHARGE. The Company will waive the surrender charge in
the event that the Owner: (1) enters an "eligible nursing home," as defined in
the Contract, for a period of at least 90 days, (2) is diagnosed as having a
"terminal medical condition," as defined in the Contract, or (3) is less than
age 65 and sustains a "permanent and total disability," as defined in the
Contract. The Company reserves the right to require written proof of terminal
medical condition or permanent and total disability satisfactory to it and to
require an examination by a licensed physician of its choice. The surrender
charge waiver is not available in all states due to applicable insurance laws in
effect in various states.
ANNUAL ADMINISTRATION FEE
An annual administration fee is deducted as of each Contract Anniversary
for the prior Contract Year. The Company also deducts this fee for the current
Contract Year when determining the Surrender Value prior to the end of a
Contract Year and on the Annuity Date. If Contract Value is $50,000 or less at
the time of the fee deduction, then the annual administration fee is $30. The
fee is zero for Contracts where the Contract Value exceeds $50,000 at the time
the fee would be deducted. This fee is to cover a portion of the Company's
administrative expenses related to the Contracts. The Company does not expect to
make a profit from this fee.
The annual administration fee is assessed against Subaccount Values and
Guarantee Amounts based on the proportion that each bears to the Contract Value.
Where the fee is deducted from Subaccount Values, the Company will cancel an
appropriate number of Accumulation Units. Where the fee is obtained from a
Guarantee Amount, the Company will reduce the Guarantee Amount by the amount of
the fee.
TRANSFER PROCESSING FEE
Prior to the Annuity Date, the Company permits 12 free transfers per
Contract Year among and between the Subaccounts and the Guarantee Periods. For
each additional transfer, the Company charges $25 at the time each such transfer
is processed. The fee is deducted from the amount being transferred. The Company
does not expect to make a profit from this fee.
TAXES ON PURCHASE PAYMENTS
Certain states and municipalities impose a tax on the Company in connection
with the receipt of annuity considerations. This tax generally can range from 0%
to 3.5% of such considerations and generally varies based on the Annuitant's
state of residence. Taxes on annuity considerations are generally incurred by
the Company as of the Annuity Date based on the Contract Value on that date, and
the Company deducts the charge for taxes on annuity considerations from the
Contract Value as of the Annuity Date. Some jurisdictions impose a tax on
annuity considerations at the time such considerations are made. In those
jurisdictions, the Company's current practice is to pay the tax on annuity
considerations and then deduct the charge for these taxes from the Contract
Value upon surrender, payment of the death benefit, or upon the Annuity Date.
The Company reserves the right to deduct any state and local taxes on annuity
considerations from the Contract Value at the time such tax is due.
MORTALITY AND EXPENSE RISK CHARGE
The Company deducts a daily charge from the assets of the Variable Account
to compensate it for mortality and expense risks that it assumes under the
Contract. The daily charge is at the rate of 0.003446%
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(approximately equivalent to an effective annual rate of 1.25%) of the net
assets of the Variable Account. Approximately .70% of this annual charge is for
the assumption of mortality risk and .55% is for the assumption of expense risk.
If the mortality and expense risk charge is insufficient to cover the actual
cost of the mortality and expense risks undertaken by the Company, the Company
will bear the shortfall. Conversely, if the charge proves more than sufficient,
the excess will be profit to the Company and will be available for any proper
purpose including, among other things, payment of expenses incurred in selling
the Contracts.
The mortality risk that the Company assumes is the risk that Annuitants, as
a group, will live for a longer period of time than the Company estimated when
it established the guaranteed Annuity Payment rates in the Contract. Because of
these guarantees, each Payee is assured that his or her longevity will not have
an adverse effect on the Annuity Payments that he or she receives under Annuity
Payment Options based on life contingencies. The Company also assumes a
mortality risk because the Contracts guarantee a death benefit if the Annuitant
dies before the Annuity Date. The expense risk that the Company assumes is the
risk that administration charge, annual administration fee and the transfer
processing fee may be insufficient to cover the actual expenses of administering
the Contracts.
ADMINISTRATION CHARGE
The Company deducts a daily administration charge from the assets of the
Variable Account to compensate it for a portion of the expenses it incurs in
administering the Contracts. The daily charge is at a rate of 0.000411%
(approximately equivalent to an effective annual rate of 0.15%) of the net
assets of the Variable Account. The Company does not expect to make a profit
from this charge.
FUND EXPENSES
The investment performance of each Fund reflects the management fee that it
pays to its investment manager or adviser as well as other operating expenses
that it incurs. Investment management fees are generally daily fees computed as
a percent of a Fund's average daily net assets at an annual rate. Please read
the prospectus for each Fund for complete details.
POSSIBLE CHARGE FOR THE COMPANY'S TAXES
At the present time, the Company makes no charge to the Variable Account
for any federal, state or local taxes that the Company incurs which may be
attributable to the Variable Account or the Contracts. The Company, however,
reserves the right in the future to make a charge for any such tax or other
economic burden resulting from the application of the tax laws that it
determines to be properly attributable to the Subaccounts or to the Contracts.
SELECTING AN ANNUITY PAYMENT OPTION
ANNUITY DATE
The Owner selects the Annuity Date. For Non-Qualified Contracts, the
Annuity Date must be no later than the later of the Contract Anniversary
following the Annuitant's Age 85 (Age 99 where permitted under state law). For
most Qualified Contracts, the Annuity Date must be no later than April 1 of the
calendar year following the calendar year in which the Owner attains age 70 1/2.
An Owner may change the Annuity Date by Written Notice, subject to the following
limitations:
1. Written Notice is received at least 30 days before the current
Annuity Date; and
2. the requested new Annuity Date must be at least 30 days after the
Company receives Written Notice.
ANNUITY PAYMENT DATES
The Company computes the first Annuity Payment as of the Annuity Date and
makes the first Annuity Payment as of the initial Annuity Payment Date selected
by the Owner. The initial Annuity Payment Date is the Annuity Date unless the
Annuity Date is the 29th, 30th or 31st day of a calendar month, in which event,
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the Owner must select a different date. All subsequent Annuity Payments are
computed and payable as of Annuity Payment Dates. These dates will be the same
day of the month as the initial Annuity Payment Date. Monthly Annuity Payments
will be computed and payable as of the same day each month as the initial
Annuity Payment Date. Quarterly Annuity Payments will be computed and payable as
of the same day in the third, sixth, ninth, and twelfth month following the
initial Annuity Payment Date and on the same days of such months in each
successive Contract Year. Semi-annual Annuity Payment Dates will be computed and
payable as of the same day in the sixth and twelfth month following the initial
Annuity Payment Date and on the same days of such months in each successive
Contract Year. Annual Annuity Payments will be computed and payable as of the
same day in each Contract Year as the initial Annuity Payment Date. The
frequency of Annuity Payments selected is shown in the Contract. In the event
that the Owner does not select a payment frequency, payments will be made
monthly.
ELECTION AND CHANGES OF ANNUITY PAYMENT OPTIONS
On the Annuity Date, the Surrender Value or Adjusted Contract Value is
applied under an Annuity Payment Option, unless the Owner elects to receive the
Surrender Value in a lump sum. If the Annuity Date falls during the first five
Contract Years, Surrender Value is applied under an Annuity Payment Option. If
the Annuity Date falls after the fifth Contract Anniversary, Adjusted Contract
Value is applied under an Annuity Payment Option. The Annuity Payment Option
specifies the type of annuity to be paid and determines how long the annuity
will be paid, the frequency, and the amount of each payment. The Owner may elect
or change the Annuity Payment Option by Written Notice at any time prior to the
Annuity Date. (See "Annuity Payment Options.") The Owner may elect to apply any
portion of the Surrender Value or Adjusted Contract Value to provide either
Variable Annuity Payments or Fixed Annuity Payments or a combination of both. If
Variable Annuity Payments are selected, the Owner must also select the
Subaccounts to which Surrender Value or Adjusted Contract Value will be applied.
If no selection has been made by the Annuity Date, Surrender Value or Adjusted
Contract Value from any Guaranteed Interest Option Value will be applied to
purchase Fixed Annuity Payments and Surrender Value or Adjusted Contract Value
from each Subaccount Value will be applied to purchase Variable Annuity Payments
from that Subaccount. If no Annuity Payment Option has been selected by the
Annuity Date, Surrender Value or Adjusted Contract Value will be applied under
Annuity Payment Option 5 (Life Annuity with Period Certain) with a designated
period of 10 years. Any death benefit applied to purchase Annuity Payments is
allocated among the Subaccounts and/or the Guaranteed Interest Option as
instructed by the Beneficiary unless the Owner previously made the foregoing
elections.
ANNUITY PAYMENTS
FIXED ANNUITY PAYMENTS. Fixed Annuity Payments are periodic payments from
the Company to the designated Payee, the amount of which is fixed and guaranteed
by the Company. The dollar amount of each Fixed Annuity Payment depends on the
form and duration of the Annuity Payment Option chosen, the Age of the
Annuitant, the sex of the Annuitant (if applicable), the amount of Adjusted
Contract Value applied to purchase the Fixed Annuity Payments and, for Annuity
Payment Options 3-6, the applicable annuity purchase rates. The annuity purchase
rates in the Contract are based on a Guaranteed Interest Rate of not less than
3%. The Company may, in its sole discretion, make Fixed Annuity Payments in an
amount based on a higher interest rate. If Fixed Annuity Payments are computed
based on an interest rate in excess of the minimum Guaranteed Interest Rate,
then, for the period of the higher rate, the dollar amount of such Fixed Annuity
Payments will be greater than the dollar amount based on 3%. The Company
guarantees that any higher rate will be in effect for at least 12 months.
Except for Annuity Payment Options 1 and 2, the dollar amount of the first
Fixed Annuity Payment is determined by dividing the dollar amount of Adjusted
Contract Value being applied to purchase Fixed Annuity Payments by $1,000 and
multiplying the result by the annuity purchase rate in the Contract for the
selected Annuity Payment Option. Subsequent Fixed Annuity Payments are of the
same dollar amount unless the Company makes payments based on an interest rate
different from that used to compute the first payment.
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VARIABLE ANNUITY PAYMENTS. Variable Annuity Payments are periodic payments
from the Company to the designated Payee, the amount of which varies from one
Annuity Payment Date to the next as a function of the net investment experience
of the Subaccounts selected by the Owner or Payee to support such payments. The
dollar amount of the first Variable Annuity Payment is determined in the same
manner as that of a Fixed Annuity Payment. Therefore, provided that the interest
rate on which Fixed Annuity Payments are based equals the Benchmark Rate of
Return on which Variable Annuity Payments are based, for any particular amount
of Adjusted Contract Value applied to a particular Annuity Payment Option, the
dollar amount of the first Variable Annuity Payment would be the same as the
dollar amount of each Fixed Annuity Payment. Variable Annuity Payments after the
first Payment are similar to Fixed Annuity Payments except that the amount of
each Payment varies to reflect the net investment experience of the Subaccounts
selected by the Owner or Payee.
The dollar amount of the initial Variable Annuity Payment attributable to
each Subaccount is determined by dividing the dollar amount of the Adjusted
Contract Value to be allocated to that Subaccount on the Annuity Date by $1,000
and multiplying the result by the annuity purchase rate in the Contract for the
selected Annuity Payment Option. The dollar value of the total initial Variable
Annuity Payment is the sum of the initial Variable Annuity Payments attributable
to each Subaccount.
The number of Annuity Units attributable to a Subaccount is derived by
dividing the initial Variable Annuity Payment attributable to that Subaccount by
the Annuity Unit Value for that Subaccount for the Valuation Period ending on
the Annuity Date or during which the Annuity Date falls if the Valuation Period
does not end on such date. The number of Annuity Units attributable to each
Subaccount under a Contract remains fixed unless there is an exchange of Annuity
Units.
The dollar amount of each subsequent Variable Annuity Payment attributable
to each Subaccount is determined by multiplying the number of Annuity Units of
that Subaccount credited under the Contract by the Annuity Unit Value (described
below) for that Subaccount for the Valuation Period ending on the Annuity
Payment Date, or during which the Annuity Payment Date falls if the Valuation
Period does not end on such date. The dollar value of each subsequent Variable
Annuity Payment is the sum of the subsequent Variable Annuity Payments
attributable to each Subaccount.
The Annuity Unit Value of each Subaccount for any Valuation Period is equal
to (a) multiplied by (b) divided by (c) where:
(a) is the Net Investment Factor for the Valuation Period for which
the Annuity Unit Value is being calculated;
(b) is the Annuity Unit Value for the preceding Valuation Period; and
(c) is a daily Benchmark Rate of Return factor (for the 3% benchmark
rate of return) adjusted for the number of days in the Valuation Period.
The Benchmark Rate of Return factor is equal to one plus 3%, or 1.03. The
annual factor can be translated into a daily factor of 1.00008098.
If the net investment return of the Subaccount for an Annuity Payment
period is equal to the pro-rated portion of the 3% Benchmark Rate of Return, the
Variable Annuity Payment attributable to that Subaccount for that period will
equal the Payment for the prior period. To the extent that such net investment
return exceeds an annualized rate of return of 3% for a Payment period, the
Payment for that period will be greater than the Payment for the prior period
and to the extent that such return for a period falls short of an annualized
rate of 3%, the Payment for that period will be less than the Payment for the
prior period.
"TRANSFERS" BETWEEN SUBACCOUNTS. By Written Notice at any time after the
Annuity Date, the Payee may change the Subaccount(s) from which Annuity Payments
are being made by exchanging the dollar value of a designated number of Annuity
Units of a particular Subaccount for an equivalent dollar amount of Annuity
Units of another Subaccount. On the date of the exchange, the dollar amount of a
Variable Annuity Payment generated from the Annuity Units of either Subaccount
would be the same. Exchanges of Annuity Units are treated as transfers for the
purpose of computing any transfer processing fee.
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ANNUITY PAYMENT OPTIONS
OPTION 1. INTEREST PAYMENTS. The Company holds the Adjusted Contract Value
as principal and pays interest to the Payee. The interest rate is 3% per year
compounded annually. The Company pays interest every 1 year, 6 months, 3 months
or 1 month, as specified at the time this option is selected. At the death of
the Payee, the value of the remaining payments are paid in a lump sum to the
Payee's estate. Only Fixed Annuity Payments are available under Annuity Payment
Option 1.
OPTION 2. PAYMENTS OF A SPECIFIED AMOUNT. The Company pays the Adjusted
Contract Value in equal payments every 1 year, 6 months, 3 months or 1 month.
The amount and frequency of the payments is specified at the time this option is
selected. After each payment, interest is added to the remaining amount applied
under this option that has not yet been paid. The interest rate is 3% per year
compounded annually. Payments are made to the Payee until the amount applied
under this option, including interest, is exhausted. The total of the payments
made each year must be at least 5% of the amount applied under this option. If
the Payee dies before the amount applied is exhausted, the Company pays the
value of the remaining payments in a lump sum to the Payee's estate. Only Fixed
Annuity Payments are available under Annuity Payment Option 2.
ADDITIONAL INTEREST EARNINGS. The Company may pay interest at rates in
excess of the rates guaranteed in Annuity Payment Options 1 and 2.
OPTION 3. PAYMENTS FOR A SPECIFIED PERIOD. The Company pays the lump sum in
equal payments for the number of years specified when the option is selected.
Payments are made every 1 year, 6 months, 3 months or 1 month, as specified when
the option is selected. If the Payee dies before the expiration of the specified
number of years, the Company pays the commuted value of the remaining payments
in a lump sum to the Payee's estate.
OPTION 4. LIFE ANNUITY. The Company makes monthly payments to the Payee for
as long as the Annuitant lives. UNDER THIS OPTION, A PAYEE COULD RECEIVE ONLY
ONE PAYMENT IF THE ANNUITANT DIES AFTER THE FIRST PAYMENT, TWO PAYMENTS IF THE
ANNUITANT DIES AFTER THE SECOND PAYMENT, ETC.
OPTION 5. LIFE ANNUITY WITH PERIOD CERTAIN. The Company makes monthly
payments to the Payee for as long as the Annuitant lives. At the time this
option is selected, a period certain of 5, 10, 15, or 20 years must also be
selected. If the Annuitant dies before the specified period certain ends, the
payments to the Payee will continue until the end of the specified period. The
amount of the monthly payments therefore depends on the period certain selected.
OPTION 6. JOINT LIFE AND SURVIVORSHIP ANNUITY. The Company makes monthly
payments to the Payee while both Annuitants are living. After the death of
either Annuitant, payments continue to the Payee for as long as the other
Annuitant lives. UNDER THIS OPTION, THE PAYEE COULD RECEIVE ONLY ONE PAYMENT IF
BOTH ANNUITANTS DIE AFTER THE FIRST PAYMENT, TWO PAYMENTS IF BOTH ANNUITANTS DIE
AFTER THE SECOND PAYMENT, ETC.
ADDITIONAL CONTRACT INFORMATION
OWNERSHIP
The Contract belongs to the Owner. An Owner may exercise all of the rights
and options described in the Contract.
Subject to more specific provisions elsewhere herein, an Owner's rights
include the right to: (1) select or change a successor Owner, (2) select or
change any Beneficiary or Contingent Beneficiary, (3) select or change the Payee
prior to the Annuity Date, (4) select or change the Annuity Payment Option, (5)
allocate Purchase Payments among and between the Subaccounts and Guarantee
Periods, (6) transfer Contract Value among and between the Subaccounts and
Guarantee Periods, and (7) select or change the Subaccounts on which Variable
Annuity Payments are based.
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The rights of Owners of Qualified Contracts may be restricted by the terms
of a related employee benefit plan. For example, such plans may require an Owner
of a Qualified Contract to obtain the consent of his or her spouse before
exercising certain ownership rights or may restrict withdrawals. See "FEDERAL
TAX CONSIDERATIONS" for more details.
Selection of an Annuitant or Payee who is not the Owner may have tax
consequences. See "FEDERAL TAX CONSIDERATIONS" for more details.
CHANGING THE OWNER OR BENEFICIARY
Prior to the Annuity Date and after the Cancellation Period, an Owner may
transfer ownership of the Contract subject to the Company's published rules at
the time of the change.
At any time before a death benefit is paid, the Owner may name a new
Beneficiary by Written Notice unless an irrevocable Beneficiary has previously
been named. When an irrevocable Beneficiary has been designated, the Owner must
provide the irrevocable Beneficiary's written consent to the Company before a
new Beneficiary is designated.
These changes take effect as of the day the Written Notice is received at
the Service Center and the Company is not liable for any payments made under the
Contract prior to the effectiveness of any change. For possible tax consequences
of these changes, see "FEDERAL TAX CONSIDERATIONS."
MISSTATEMENT OF AGE OR SEX
If an Age or sex of the Annuitant given in the application is misstated,
the Company will adjust the benefits it pays under the Contract to the amount
that would have been payable at the correct Age or sex. If the Company made any
underpayments because of any such misstatement, it shall pay the amount of such
underpayment plus interest at an annual effective rate of 3%, immediately to the
Payee or Beneficiary in one sum. If the Company makes any overpayments because
of a misstatement of Age or sex, it shall deduct from current or future payments
due under the Contract, the amount of such overpayment plus interest at an
annual effective rate of 3%.
CHANGE OF CONTRACT TERMS
Upon notice to the Owner, the Company may modify the Contract to:
1. conform the Contract or the operations of the Company or of the
Variable Account to the requirements of any law (or regulation issued by a
government agency) to which the Contract, the Company or the Variable
Account is subject;
2. assure continued qualification of the Contract as an annuity
contract or a Qualified Contract under the Code;
3. reflect a change (as permitted in the Contract) in the operation of
the Variable Account; or
4. provide additional Subaccounts and/or Guarantee Periods.
In the event of any such modification, the Company will make appropriate
endorsements to the Contract.
Only one of the Company's officers may modify the Contract or waive any of
the Company's rights or requirements under the Contract. Any modification or
waiver must be in writing. No agent may bind the Company by making any promise
not contained in the Contract.
REPORTS TO OWNERS
Prior to the Annuity Date, the Company will send each Owner a report at
least annually, or more often as required by law, indicating: the number of
Accumulation or Annuity Units credited to the Contract and the dollar value of
such units; the Contract Value, Adjusted Contract Value and Surrender Value; any
purchase
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payments, withdrawals, or surrenders made, death benefits paid and charges
deducted since the last report; the current interest rate applicable to each
Guarantee Amount; and any other information required by law.
The reports, which will be mailed to Owners at their last known address,
will include any information that may be required by the SEC or the insurance
supervisory official of the jurisdiction in which the Contract is delivered. The
Company will also send any other reports, notices or documents required by law
to be furnished to Owners.
MISCELLANEOUS
NON-PARTICIPATING. The Contract does not participate in the surplus or
profits of the Company and the Company does not pay dividends on the Contract.
PROTECTION OF PROCEEDS. To the extent permitted by law, no benefits payable
under the Contract to a Beneficiary or Payee are subject to the claims of an
Owner's or a Beneficiary's creditors.
DISCHARGE OF LIABILITY. Any payments made by the Company under any Annuity
Payment Option or in connection with the payment of any withdrawal, surrender or
death benefit, shall discharge the Company's liability to the extent of each
such payment.
PROOF OF AGE AND SURVIVAL. The Company reserves the right to require proof
of the Annuitant's Age prior to the Annuity Date. In addition, for life
contingent Annuity Options, the Company reserves the right to require proof of
the Annuitant's survival before any Annuity Payment Date.
CONTRACT APPLICATION. The Company issues the Contract in consideration of
the Owner's application and payment of the initial purchase payment. The entire
Contract is made up of the Contract, any attached endorsements or riders, and
the application. In the absence of fraud, the Company considers statements made
in the application to be representations and not warranties. The Company will
not use any statement in defense of a claim or to void the Contract unless it is
contained in the application. The Company will not contest the Contract.
YIELDS AND TOTAL RETURNS
From time to time, the Company may advertise or include in sales literature
certain performance related information for the Subaccounts, including yields
and average annual total returns. Certain Funds have been in existence prior to
the commencement of the offering of the Contracts. The Company may advertise or
include in sales literature the performance of the Subaccounts that invest in
these Funds for these prior periods. The performance information of any period
prior to the commencement of the offering of the Contracts is calculated as if
the Contract had been offered during those periods, using current charges and
expenses.
Performance information discussed herein is based on historic results and
does not indicate or project future performance. For a description of the
methods used to determine yield and total return for the Subaccounts, see the
Statement of Additional Information.
Effective yields and total returns for the Subaccounts are based on the
investment performance of the corresponding Funds. The performance of a Fund in
part reflects its expenses. See the prospectuses for the Funds for Fund expense
information.
The yield of the Money Market Subaccount refers to the annualized income
generated by an investment in the Subaccount over a specified seven-day period.
The yield is calculated by assuming that the income generated for that seven-day
period is generated each seven-day period over a 52-week period and is shown as
a percentage of the investment. The effective yield is calculated similarly but,
when annualized, the income earned by an investment in the Subaccount is assumed
to be reinvested. The effective yield will be slightly higher than the yield
because of the compounding effect of this assumed reinvestment.
The yield of a Subaccount other than the Money Market Subaccount refers to
the annualized income generated by an investment in the Subaccount over a
specified 30-day or one-month period. The yield is
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calculated by assuming that the income generated by the investment during that
30-day or one-month period is generated each period over a 12-month period and
is shown as a percentage of the investment.
The total return of a Subaccount refers to return quotations assuming an
investment under a Contract has been held in the Subaccount for various periods
of time including, but not limited to, a period measured from the date the
Subaccount commenced operations. Average annual total return refers to total
return quotations that are annualized based on an average return over various
periods of time.
The average annual total return quotations represent the average annual
compounded rates of return that would equate an initial investment of $1,000
under a Contract to the redemption value of that investment as of the last day
of each of the periods for which total return quotations are provided. Average
annual total return information shows the average annual percentage change in
the value of an investment in the Subaccount from the beginning date of the
measuring period to the end of that period. This standardized version of average
annual total return reflects all historical investment results, less all charges
and deductions applied against the Subaccount (including any surrender charge
that would apply if an Owner terminated the Contract at the end of each period
indicated, but excluding any deductions for premium taxes). When a Subaccount,
other than the Money Market Subaccount, has been in operation for one, five and
ten years respectively, the standard version average annual total return for
these periods will be provided.
In addition to the standard version described above, total return
performance information computed on two different non-standard bases may be used
in advertisements or sales literature. Average annual total return information
may be presented, computed on the same basis as described above, except
deductions will not include the surrender charge. In addition, the Company may
from time to time disclose cumulative total return for Contracts funded by
Subaccounts.
From time to time, yields, standard average annual total returns, and
non-standard total returns for the Funds may be disclosed, including such
disclosures for periods prior to the date the Variable Account commenced
operations.
Non-standard performance data will only be disclosed if the standard
performance data for the required periods is also disclosed. For additional
information regarding the calculation of other performance data, please refer to
the Statement of Additional Information.
In advertising and sales literature, the performance of each Subaccount may
be compared with the performance of other variable annuity issuers in general or
to the performance of particular types of variable annuities investing in mutual
funds, or investment portfolios of mutual funds with investment objectives
similar to the Subaccount. Lipper Analytical Services, Inc. ("Lipper"), Variable
Annuity Research Data Service ("VARDS") and Morningstar, Inc. ("Morningstar")
are independent services which monitor and rank the performance of variable
annuity issuers in each of the major categories of investment objectives on an
industry-wide basis.
Lipper's and Morningstar's rankings include variable life insurance issuers
as well as variable annuity issuers. VARDS rankings compare only variable
annuity issuers. The performance analyses prepared by Lipper, VARDS and
Morningstar each rank such issuers on the basis of total return, assuming
reinvestment of distributions, but do not take sales charges, redemption fees or
certain expense deductions at the separate account level into consideration. In
addition, VARDS prepares risk rankings, which consider the effects of market
risk on total return performance. This type of ranking provides data as to which
funds provide the highest total return within various categories of funds
defined by the degree of risk inherent in their investment objectives.
Advertising and sales literature may also compare the performance of each
Subaccount to the Standard & Poor's Index of 500 Common Stocks, a widely used
measure of stock performance. This unmanaged index assumes the reinvestment of
dividends but does not reflect any "deduction" for the expense of operating or
managing an investment portfolio. Other independent ranking services and indices
may also be used as a source of performance comparison.
The Company may also report other information including the effect of
tax-deferred compounding on a Subaccount's investment returns, or returns in
general, which may be illustrated by tables, graphs or charts.
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FEDERAL TAX CONSIDERATIONS
THE FOLLOWING DISCUSSION IS GENERAL AND IS NOT INTENDED AS TAX ADVICE
INTRODUCTION
This discussion is not intended to address the tax consequences resulting
from all of the situations in which a person may be entitled to or may receive a
distribution under the Contract issued by the Company. Any person concerned
about these tax implications should consult a competent tax adviser before
initiating any transaction. This discussion is based upon the Company's
understanding of the present federal income tax laws, as they are currently
interpreted by the Internal Revenue Service ("IRS"). No representation is made
as to the likelihood of the continuation of the present federal income tax laws
or of the current interpretation by the IRS. Moreover, no attempt has been made
to consider any applicable state or other tax laws.
The Contract may be purchased on a non-qualified basis or purchased and
used in connection with plans qualifying for favorable tax treatment. The
Qualified Contract is designed for use by individuals whose purchase payments
are comprised solely of proceeds from and/or contributions under retirement
plans that are intended to qualify as plans entitled to special income tax
treatment under sections 401(a), 408, or 457 of the Code. The ultimate effect of
federal income taxes on the amounts held under a Contract, or Annuity Payments,
and on the economic benefit to the Owner, the Annuitant, or the Beneficiary
depends on the type of retirement plan, on the tax and employment status of the
individual concerned, and on the Company's tax status. In addition, certain
requirements must be satisfied in purchasing a Qualified Contract with proceeds
from a tax-qualified plan and receiving distributions from a Qualified Contract
in order to continue receiving favorable tax treatment. Therefore, purchasers of
Qualified Contracts should seek competent legal and tax advice regarding the
suitability of a Contract for their situation, the applicable requirements, and
the tax treatment of the rights and benefits of a Contract. The following
discussion assumes that Qualified Contracts are purchased with proceeds from
and/or contributions under retirement plans that qualify for the intended
special federal income tax treatment.
TAX STATUS OF THE CONTRACT
DIVERSIFICATION REQUIREMENTS. Section 817(h) of the Code provides that
separate account investments underlying a contract must be "adequately
diversified" in accordance with Treasury Department regulations in order for the
contract to qualify as an annuity contract under Section 72 of the Code. The
Variable Account, through each underlying Fund, intends to comply with the
diversification requirements prescribed in regulations under Section 817(h) of
the Code, which affect how the assets in the various Subaccounts may be
invested. Although the Company does not have direct control over the Funds in
which the Variable Account invests, the Company believes that each Fund will
meet the diversification requirements, and therefore, the Contract will be
treated as an annuity contract under the Code.
In certain circumstances, owners of variable annuity contracts may be
considered the owners, for federal income tax purposes, of the assets of the
separate account used to support their contracts. In those circumstances, income
and gains from the separate account assets would be includible in the variable
annuity contract owner's gross income. The IRS has stated in published rulings
that a variable contract owner will be considered the owner of separate account
assets if the contract owner possesses incidents of ownership in those assets,
such as the ability to exercise investment control over the assets. The Treasury
Department has also announced, in connection with the issuance of regulations
concerning investment diversification, that those regulations "do not provide
guidance concerning the circumstances in which investor control of the
investments of a segregated asset account may cause the investor (i.e., the
contract owner), rather than the insurance company, to be treated as the owner
of the assets in the account." This announcement also states that guidance would
be issued by way of regulations or rulings on the "extent to which policyholders
may direct their investments to particular subaccounts without being treated as
owners of the underlying assets." The ownership rights under the Contracts are
similar to, but different in certain respects from, those described by the IRS
in rulings in which it was determined that contract owners were not owners of
separate account
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<PAGE> 37
assets. For example, the Owner of a Contract has the choice of several
Subaccounts in which to allocate Purchase Payments and Contract Values, and may
be able to transfer among Subaccounts more frequently than in such rulings.
These differences could result in an Owner being treated as the owner of the
assets of the Variable Account. In addition, the Company does not know what
standards will be set forth, if any, in the regulations or rulings which the
Treasury Department has stated it expects to issue. The Company therefore
reserves the right to modify the Contract as necessary to attempt to prevent the
Owner from being considered the owner of the Variable Account's assets.
REQUIRED DISTRIBUTIONS. In order to be treated as an annuity contract for
federal income tax purposes, section 72(s) of the Code requires any
Non-Qualified Contract to provide that: (a) if any Owner dies on or after the
Annuity Date but prior to the time the entire interest in the Contract has been
distributed, the remaining portion of such interest will be distributed at least
as rapidly as under the method of distribution being used as of the date of that
Owner's death; and (b) if any Owner dies prior to the Annuity Date, the entire
interest in the Contract will be distributed within five years after the date of
the Owner's death. These requirements will be considered satisfied as to any
portion of the Owner's interest that is payable to or for the benefit of a
"designated beneficiary," and that is distributed over the life of such
beneficiary or over a period not extending beyond the life expectancy of that
beneficiary, provided that such distributions begin within one year of that
Owner's death. The Owner's "designated beneficiary" is the person designated by
such Owner as a beneficiary and to whom ownership of the contract passes by
reason of death and must be a natural person. However, if the Owner's
"designated beneficiary" is the surviving spouse of the Owner, the Contract may
be continued with the surviving spouse as the new Owner.
Non-Qualified Contracts contain provisions that are intended to comply with
the requirements of section 72(s) of the Code, although no regulations
interpreting these requirements have yet been issued. The Company intends to
review such provisions and modify them if necessary to assure that they comply
with the requirements of Code section 72(s) when clarified by regulation or
otherwise.
Other Rules may apply to Qualified Contracts.
The following discussion assumes that the Contracts will qualify as annuity
contracts for federal income tax purposes.
TAXATION OF ANNUITIES
IN GENERAL. Section 72 of the Code governs taxation of annuities in
general. The Company believes that an Owner who is a natural person is not taxed
on increases in Contract Value until distribution occurs by withdrawing all or
part of the Contract Value (e.g., withdrawals and surrenders) or as Annuity
Payments under the Annuity Payment Option elected. For this purpose, the
assignment, pledge or agreement to assign or pledge any portion of the Contract
Value (and in the case of a Qualified Contract, any portion of an interest in
the qualified plan) generally will be treated as a distribution. The taxable
portion of a distribution (in the form of a single sum payment or payment
option) is taxable as ordinary income.
The owner of any annuity contract who is not a natural person generally
must include in income any increase in the excess of the contract value over the
"investment in the contract" during the taxable year. There are some exceptions
to this rule, and a prospective Owner that is not a natural person may wish to
discuss these with a tax adviser.
The following discussion generally applies to Contracts owned by natural
persons.
WITHDRAWALS. In the case of a withdrawal from a Qualified Contract, under
section 72(e) of the Code, a ratable portion of the amount received is taxable,
generally based on the ratio of the "investment in the contract" to the
participant's total accrued benefit or balance under the retirement plan. The
"investment in the contract" generally equals the portion, if any, of any
purchase payments paid by or on behalf of the individual under a Contract that
was not excluded from the individual's gross income. For Contracts issued in
connection with qualified plans, the "investment in the contract" can be zero.
Special tax rules may be available for certain distributions from Qualified
Contracts.
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<PAGE> 38
In the case of a withdrawal from a Non-Qualified Contract, under section
72(e), any amounts received are generally first treated as taxable income to the
extent that the Contract Value immediately before the withdrawal exceeds the
"investment in the contract" at that time. Any additional amount withdrawn is
not taxable.
In the case of a surrender under a Qualified or Non-Qualified Contract, the
amount received generally will be taxable only to the extent it exceeds the
"investment in the contract."
Section 1035 of the Code generally provides that no gain or loss shall be
recognized on the exchange of one annuity contract for another. If the
surrendered contract was issued prior to August 14, 1982, the tax rules formerly
provided that the surrender was taxable only to the extent the amount received
exceeds the owner's investment in the contract will continue to apply to amounts
allocable to investments in that contract prior to August 14, 1982. In contrast,
contracts issued after January 19, 1985 in a Code section 1035 exchange are
treated as new contracts for purposes of the penalty and distribution-at-death
rules. Special rules and procedures apply to section 1035 transactions.
Prospective Owners wishing to take advantage of section 1035 should consult
their tax adviser.
ANNUITY PAYMENTS. Although tax consequences may vary depending on the
payment option elected under an annuity contract, under Code section 72(b),
generally (prior to recovery of the investment in the contract) gross income
does not include that part of any amount received as an annuity under an annuity
contract that bears the same ratio to such amount as the investment in the
contract bears to the expected return at the annuity starting date. For variable
annuity payments, the taxable portion is generally determined by an equation
that establishes a specific dollar amount of each payment that is not taxed. The
dollar amount is determined by dividing the "investment in the contract" by the
total number of expected periodic payments. However, the entire distribution
will be taxable once the recipient has recovered the dollar amount of his or her
"investment in the contract." For fixed annuity payments, in general, there is
no tax on the portion of each payment that represents the same ratio that the
"investment in the contract" bears to the total expected value of the annuity
payments for the term of the payments; however, the remainder of each annuity
payment is taxable until the recovery of the investment in the contract, and
thereafter the full amount or each annuity payment is taxable. If death occurs
before full recovery of the investment in the contract, the unrecovered amount
may be deducted on the annuitant's final tax return.
TAXATION OF DEATH BENEFIT PROCEEDS. Amounts may be distributed from a
Contract because of the death of an Owner. Generally, such amounts are
includible in the income of the recipient as follows: (i) if distributed in a
lump sum, they are taxed in the same manner as a full surrender of the Contract
or (ii) if distributed under an Annuity Payment Option, they are taxed in the
same way as Annuity Payments.
PENALTY TAX ON CERTAIN WITHDRAWALS. In the case of a distribution pursuant
to a Non-Qualified Contract, there may be imposed a federal penalty tax equal to
10% of the amount treated as taxable income. In general, however, there is no
penalty on distributions:
1. made on or after the taxpayer reaches age 59 1/2;
2. made on or after the death of the holder (or if the holder is not
an individual, the death of the primary annuitant);
3. attributable to the taxpayer's becoming disabled;
4. a part of a series of substantially equal periodic payments (not
less frequently than annually) for the life (or life expectancy) of the
taxpayer or the joint lives (or joint life expectancies) of the taxpayer
and his or her designated beneficiary;
5. made under certain annuities issued in connection with structured
settlement agreements; and
6. made under an annuity contract that is purchased with a single
purchase payment when the annuity date is no later than a year from
purchase of the annuity and substantially equal periodic payments are made,
not less frequently than annually, during the annuity payment period.
Other tax penalties may apply to certain distributions under a Qualified
Contract.
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<PAGE> 39
POSSIBLE CHANGES IN TAXATION. Legislation has been proposed in 1998 that,
if enacted, would adversely modify the federal taxation of certain insurance and
annuity contracts. For example, one proposal would tax transfers among
investment options and tax exchanges involving variable contracts. A second
proposal would reduce the "investment in the contract" under cash value life
insurance and certain annuity contracts by certain amounts, thereby increasing
the amount of income for purposes of computing gain. Although the likelihood of
there being any changes is uncertain, there is always the possibly that the tax
treatment of the Contracts could change by legislation or other means. Moreover,
it is also possible that any change could be retroactive (that is, effective
prior to the date of the change). You should consult a tax adviser with respect
to legislative developments and their effect on the Contract.
TRANSFERS, ASSIGNMENTS OR EXCHANGES OF A CONTRACT
A transfer of ownership of a Contract, the designation of an Annuitant,
Payee or other Beneficiary who is not also the Owner, the selection of certain
Annuity Dates or the exchange of a Contract may result in certain tax
consequences to the Owner that are not discussed herein. An Owner contemplating
any such transfer, assignment or exchange of a Contract should contact a tax
adviser with respect to the potential tax effects of such a transaction.
WITHHOLDING
Distributions from Contracts generally are subject to withholding for the
Owner's federal income tax liability. The withholding rate varies according to
the type of distribution and the Owner's tax status. The Owner will be provided
the opportunity to elect not have tax withheld from distributions.
"Eligible rollover distributions" from section 401(a) plans are subject to
a mandatory federal income tax withholding of 20%. An eligible rollover
distribution is the taxable portion of any distribution from such a plan, except
certain distributions such as distributions required by the Code or
distributions in a specified annuity form. The 20% withholding does not apply,
however, if the Owner chooses a "direct rollover" from the plan to another
tax-qualified plan or IRA.
Certain states also require withholding of state income tax whenever
federal income tax is withheld.
MULTIPLE CONTRACTS
All non-qualified deferred annuity contracts that are issued by the Company
(or its affiliates) to the same owner during any calendar year are treated as
one annuity contract for purposes of determining the amount includible in gross
income under section 72(e) of the Code. The effects of this rule are not yet
clear; however, it could affect the time when income is taxable and the amount
that might be subject to the 10% penalty tax described above. In addition, the
Treasury Department has specific authority to issue regulations that prevent the
avoidance of section 72(e) of the Code through the serial purchase of annuity
contracts or otherwise. There may also be other situations in which the Treasury
Department may conclude that it would be appropriate to aggregate two or more
annuity contracts purchased by the same owner. Accordingly, a Contract Owner
should consult a tax adviser before purchasing more than one annuity contract.
TAXATION OF QUALIFIED PLANS
The Contracts are designed for use with several types of qualified plans.
The tax rules applicable to participants in these qualified plans vary according
to the type of plan and the terms and conditions of the plan itself. Special
favorable tax treatment may be available for certain types of contributions and
distributions. Adverse tax consequences may result from contributions in excess
of specified limits; distributions prior to age 59 1/2 (subject to certain
exceptions); distributions that do not conform to specified commencement and
minimum distribution rules; and in other specified circumstances. Therefore, no
attempt is made to provide more than general information about the use of the
Contracts with the various types of qualified retirement plans. Owners,
Annuitants and Beneficiaries are cautioned that the rights of any person to any
benefits under these qualified retirement plans may be subject to the terms and
conditions of the plans themselves, regardless
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<PAGE> 40
of the terms and conditions of the Contract, but the Company shall not be bound
by the terms and conditions of such plans to the extent such terms contradict
the Contract, unless the Company consents to be bound.
For qualified plans under Section 401(a) and 457, the Code requires that
distributions generally must commence no later than the later of April 1 of the
calendar year following the calendar year in which the Owner (or plan
participant) (i) reaches age 70 1/2 or (ii) retires, and must be made in a
specified form or manner. If the plan participant is a "5 percent owner" (as
defined in the Code), distributions generally must begin no later than April 1
of the calendar year following the calendar year in which the Owner (or plan
participant) reaches age 70 1/2. For IRAs described in Section 408,
distributions generally must commence no later than the later of April 1 of the
calendar year following the calendar year in which the Owner (or plan
participant) reaches age 70 1/2. Roth IRAs under Section 408A do not require
distributions at any time prior to the Owner's death.
Brief descriptions follow of the various types of qualified retirement
plans in connection with a Contract. The Company will amend the Contract as
necessary to conform it to the requirements of such plan.
CORPORATE PENSION AND PROFIT SHARING PLANS AND H.R. 10 PLANS. Section
401(a) of the Code permits corporate employers to establish various types of
retirement plans for employees, and permits self-employed individuals to
establish these plans for themselves and their employees. Such retirement plans
may permit the purchase of the Contract to provide benefits under the plans. The
Contract includes an Enhanced Death Benefit that in some cases may exceed the
greater of the Purchase Payments or the Contract Value. The Enhanced Death
Benefit could be characterized as an incidental benefit, the amount of which is
limited in any pension or profit-sharing plan. Because the Enhanced Death
Benefit may exceed this limitation, employers using the Contract in connection
with such plans should consult their tax adviser. Employers intending to use the
Contract with such plans should seek competent advice.
INDIVIDUAL RETIREMENT ANNUITIES. Section 408 of the Code permits eligible
individuals to contribute to an individual retirement program known as an
"Individual Retirement Annuity" or "IRA." These IRAs are subject to limits on
the amount that may be contributed, the persons who may be eligible, and on the
time when distributions may commence. Also, distributions from certain other
types of qualified retirement plans may be "rolled over" on a tax-deferred basis
into an IRA. Sales of the Contract for use with IRAs may be subject to special
requirements of the IRS. Earnings in an IRA are not taxed until distribution.
IRA contributions are limited each year to the lesser of $2,000 or 100% of the
Owner's adjusted gross income and may be deductible in whole or in part
depending on the individual's income. The limit on the amount contributed to an
IRA does not apply to distributions from certain other types of qualified plans
that are "rolled over" on a tax-deferred basis into an IRA. Amounts in the IRA
(other than nondeductible contributions) are taxed when distributed from the
IRA. Distributions prior to age 59 1/2 (unless certain exceptions apply) are
subject to a 10% penalty tax. The Internal Revenue Service has not reviewed the
Contract for qualification as an IRA and has not generally ruled whether a death
benefit provision such as the provision in the Contract comports with IRA
qualification requirements.
SIMPLIFIED EMPLOYEE PENSIONS (SEP) IRAS. Employers may establish Simplified
Employee Pension (SEP) IRAs under Code section 408(k) to provide IRA
contributions on behalf of their employees. In addition to all of the general
Code rules governing IRAs, such plans are subject to certain Code requirements
regarding participation and amounts of contributions.
SIMPLE IRAS. Beginning January 1, 1997, certain small employers may
establish Simple plans as provided by Section 408(p) of the Code, under which
employees may elect to defer to a Simple IRA a percentage of compensation up to
$6,000 (as increased for cost of living adjustments). The sponsoring employer is
required to make matching or non-elective contributions on behalf of employees.
Distributions from Simple IRAs are subject to the same restrictions that apply
to IRA distributions and are taxed as ordinary income. Subject to certain
exceptions, premature distributions prior to age 59 1/2 are subject to a 10
percent penalty tax, which is increased to 25 percent if the distribution occurs
within the first two years after the commencement of the employee's
participation in the plan.
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<PAGE> 41
ROTH IRAS. Effective January 1, 1998, section 408A of the Code permits
certain eligible individuals to contribute to a Roth IRA. Contributions to a
Roth IRA, which are subject to certain limitations, are not deductible and must
be made in cash or as a rollover or transfer from another Roth IRA or other IRA.
A rollover from or conversion of an IRA to a Roth IRA may be subject to tax and
other special rules may apply. You should consult a tax adviser before combining
any converted amounts with any other Roth IRA contributions, including any other
conversion amounts from other tax years. Distributions from a Roth IRA generally
are not taxed, except that, once aggregate distributions exceed contributions to
the Roth IRA, income tax and a 10% penalty tax may apply to distributions made
(1) before age 59 1/2 (subject to certain exceptions) or (2) during the five
taxable years starting with the year in which the first contribution is made to
the Roth IRA.
DEFERRED COMPENSATION PLANS. Section 457 of the Code provides for certain
deferred compensation plans. These plans may be offered with respect to service
for state governments, local governments, political subdivisions, agencies,
instrumentalities, certain affiliates of such entities and tax exempt
organizations. The plans may permit participants to specify the form of
investment for their deferred compensation account. With respect to
non-governmental plans, all investments are owned by the sponsoring employer and
are subject to the claims of the general creditors of the employer; and
depending on the terms of the particular plan, the employer may be entitled to
draw on the deferred amounts for purposes unrelated to its Section 457 plan
obligations.
OTHER TAX CONSEQUENCES
As noted above, the foregoing comments about the federal tax consequences
under these Contracts are not exhaustive, and special rules are provided with
respect to other tax situations not discussed in the prospectus. Further, the
federal income tax consequences discussed herein reflect the Company's
understanding of current law and the law may change. Federal estate and gift,
and state and local estate, inheritance and other tax consequences of ownership
or receipt of distributions under a Contract depend on the individual
circumstances of each Owner or recipient of the distribution. A tax adviser
should be consulted for further information.
OTHER INFORMATION
DISTRIBUTION OF THE CONTRACTS
CNA Investor Services, Inc. ("CNA/ISI"), which is located at CNA Plaza,
Chicago, Illinois 60685, is principal underwriter and distributor of the
Contracts. CNA/ISI is an affiliate of the Company, is registered with the SEC as
a broker-dealer, and is a member of the National Association of Securities
Dealers, Inc. The Company pays CNA/ISI for acting as principal underwriter under
a distribution agreement. The Contracts are offered on a continuous basis and
the Company does not anticipate discontinuing the offer.
Applications for Contracts are solicited by agents who are licensed by
applicable state insurance authorities to sell the Company's insurance contracts
and who are also registered representatives of a broker-dealer having a selling
agreement with CNA/ISI. Such broker-dealers will generally receive commissions
based on a percent of purchase payments made (up to a maximum of 7%). The
writing agent will receive a percentage of these commissions from the respective
broker-dealer, depending on the practice of that broker-dealer. Owners do not
pay these commissions.
ADMINISTRATIVE SERVICES
Financial Administration Services, Inc. administers the Contract on behalf
of the Company at the Service Center. In this capacity, Financial Administration
Services, Inc. is responsible for the following: processing death benefits,
surrenders, withdrawals and transfers; preparing confirmation notices and
periodic reports; calculating mortality and expense risk charges; calculating
Accumulation and Annuity Unit Values; distributing voting materials and tax
reports; and generally assisting Owners.
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<PAGE> 42
VOTING PRIVILEGES
In accordance with current interpretations of applicable law, the Company
votes Fund shares held in the Variable Account at regular and special
shareholder meetings of the Funds in accordance with instructions received from
persons having voting interests in the corresponding Subaccounts. If, however,
the 1940 Act or any regulation thereunder should be amended, or if the present
interpretation thereof should change, or the Company otherwise determines that
it is allowed to vote the shares in its own right, it may elect to do so.
The number of votes that an Owner or Annuitant has the right to instruct
are calculated separately for each Subaccount, and may include fractional votes.
Prior to the Annuity Date, the Owner holds a voting interest in each Subaccount
to which Variable Contract Value is allocated. After the Annuity Date, the Payee
has a voting interest in each Subaccount from which Variable Annuity Payments
are made.
For each Owner, the number of votes attributable to a Subaccount will be
determined by dividing the Owner's Subaccount Value by the Net Asset Value Per
Share of the Fund in which that Subaccount invests. For each Payee, the number
of votes attributable to a Subaccount is determined by dividing the liability
for future Variable Annuity Payments to be paid from that Subaccount by the Net
Asset Value Per Share of the Fund in which that Subaccount invests. This
liability for future payments is calculated on the basis of the mortality
assumptions, the selected Benchmark Rate of Return and the Annuity Unit Value of
that Subaccount on the date that the number of votes is determined. As Variable
Annuity Payments are made to the Payee, the liability for future payments
decreases as does the number of votes.
The number of votes available to an Owner or Payee are determined as of the
date coinciding with the date established by the Fund for determining
shareholders eligible to vote at the relevant meeting of the Fund's
shareholders. Voting instructions are solicited by written communication prior
to such meeting in accordance with procedures established for the Fund. Each
Owner or Payee having a voting interest in a Subaccount will receive proxy
materials and reports relating to any meeting of shareholders of the Funds in
which that Subaccount invests.
Fund shares as to which no timely instructions are received and shares held
by the Company in a Subaccount as to which no Owner or Payee has a beneficial
interest are voted in proportion to the voting instructions that are received
with respect to all Contracts participating in that Subaccount. Voting
instructions to abstain on any item to be voted upon are applied to reduce the
total number of votes eligible to be cast on a matter. Under the 1940 Act,
certain actions affecting the Variable Account may require Contract Owner
approval. In that case, an Owner will be entitled to vote in proportion to his
Variable Contract Value.
LEGAL PROCEEDINGS
There are no legal proceedings to which the Separate Accounts are a party
or to which the assets of the Variable Account are subject. The Company, as an
insurance company, is ordinarily involved in litigation including class action
lawsuits. In some class action and other lawsuits involving insurance companies,
substantial damages have been sought and/or material settlement payments have
been made. Although the outcome of any litigation cannot be predicted with
certainty, the Company believes that at the present time there are no pending or
threatened lawsuits that are reasonably likely to have a material adverse impact
on its ability to meet its obligations under the Contract or to the Variable
Account nor does the Company expect to incur significant losses from such
actions.
COMPANY HOLIDAYS
The Company is closed on the following days in 1998: New Year's Day,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day, the day after
Thanksgiving Day, and Christmas Day.
LEGAL MATTERS
All matters relating to Pennsylvania law pertaining to the Contracts,
including the validity of the Contracts and the Company's authority to issue the
Contracts, have been passed upon by Lynne Gugenheim,
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Esquire, Vice President and Associate General Counsel of the Company.
Sutherland, Asbill & Brennan LLP of Washington, D.C. has provided advice on
certain matters relating to the federal securities laws.
EXPERTS
The balance sheets of the Company as of December 31, 1997 and 1996, and the
related statements of operations, stockholder's equity and cash flows for each
of the three years in the period ended December 31, 1997, have been audited by
Deloitte & Touche LLP, independent auditors, as set forth in their report
thereon and included herein. Such financial statements are included in this
prospectus in reliance upon such report given upon the authority of such firm as
experts in accounting and auditing.
ADDITIONAL INFORMATION ABOUT
VALLEY FORGE LIFE INSURANCE COMPANY
HISTORY AND BUSINESS
Valley Forge Life Insurance Company ("VFL" or "the Company") is a
wholly-owned subsidiary of Continental Assurance Company ("Assurance").
Assurance is a wholly-owned subsidiary of Continental Casualty Company
("Casualty") which is wholly-owned by CNA Financial Corporation ("CNAF"). Loews
Corporation owns approximately 84% of the outstanding common stock of CNAF.
VFL sells a variety of individual and group insurance products. The
individual insurance products consist primarily of term and universal life
insurance policies and individual annuities. Group insurance products include
life, pension and accident and health, consisting primarily of major medical and
hospitalization. A new portfolio of variable products, including annuity and
universal life products, was marketed in 1997. These 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, Assurance,
are managed, to a large extent, on a combined basis. Pursuant to a Reinsurance
Pooling Agreement, amended July 1, 1996, VFL cedes all of its business,
excluding its separate account business, to its parent, Assurance. This business
is then pooled with the business of Assurance, which excludes Assurance's
participating contracts and separate account business, and 10% of the combined
pool is assumed by VFL.
SELECTED FINANCIAL DATA
The following selected financial data for the Company should be read in
conjunction with the financial statements and notes thereto included in this
prospectus.
SELECTED FINANCIAL DATA FOR THE PERIODS ENDED DECEMBER 31
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS OF DOLLARS) 1997 1996 1995 1994 1993
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Investment Income................................. $ 29,913 $ 29,312 $ 31,494 $ 22,759 $ 16,144
- ----------------------------------------------------------------------------------------------------------------------------
Net Operating Income (Excluding Realized Investment
Gains/Losses)....................................... $ 10,600 $ 13,618 $ 13,551 $ 10,408 $ 4,655
- ----------------------------------------------------------------------------------------------------------------------------
Net Income............................................ $ 13,300 $ 16,719 $ 22,510 $ 7,482 $ 7,107
- ----------------------------------------------------------------------------------------------------------------------------
Total Assets.......................................... $2,368,426 $1,980,802 $1,641,438 $1,447,122 $1,258,039
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Valley Forge Life Insurance Company ("VFL") is a wholly-owned subsidiary of
Continental Assurance Company ("Assurance"). Assurance is a wholly-owned
subsidiary of Continental Casualty Company ("Casualty") which is wholly-owned by
CNA Financial Corporation ("CNAF"). Loews Corporation owns approximately 84% of
the outstanding common stock of CNAF.
VFL sells a variety of individual and group insurance products. The
individual insurance products consist primarily of term 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. A new portfolio of variable products,
including annuity and universal life products was marketed in 1997. These
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, Assurance,
are managed, to a large extent, on a combined basis. Pursuant to a Reinsurance
Pooling Agreement, amended July 1, 1996, VFL cedes all of its business,
excluding its separate account business to its parent, Assurance. This business
is then pooled with the business of Assurance, which excludes Assurance's
participating contracts and separate account business, and 10% of the combined
pool is assumed by VFL.
RESULTS OF OPERATIONS
The following table summarizes key components of VFL's operating results
for each of the last three years:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31 1997 1996 1995
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(In thousands of dollars)
OPERATING REVENUES:
(excluding realized investment gains/losses):
Revenues:
Group premium............................................. $273,939 $272,914 $248,285
Individual premium........................................ 58,233 52,572 48,368
-------- -------- --------
Total premiums.......................................... 332,172 325,486 296,653
-------- -------- --------
Net investment income....................................... 29,913 29,312 31,494
Other....................................................... 6,872 8,217 4,818
-------- -------- --------
Total revenues.......................................... 368,957 363,015 332,965
Benefits and expenses....................................... 352,530 342,039 312,038
-------- -------- --------
Operating income before income tax........................ 16,427 20,976 20,927
Income tax expense.......................................... (5,827) (7,358) (7,376)
- --------------------------------------------------------------------------------------------
Net operating income
(excluding realized investment gains/losses) $ 10,600 $ 13,618 $ 13,551
============================================================================================
SUPPLEMENTAL FINANCIAL DATA:
Net operating income:
Group..................................................... $ 4,255 $ 5,409 $ 7,954
Individual................................................ 6,345 8,209 5,597
-------- -------- --------
Net operating income.................................... 10,600 13,618 13,551
Net realized investment gains............................. 2,730 3,101 8,959
- --------------------------------------------------------------------------------------------
Net income $ 13,330 $ 16,719 $ 22,510
============================================================================================
</TABLE>
VFL's revenues, excluding net realized investment gains/losses, increased
1.6% to $369.0 million for 1997 as compared to $363.0 million for 1996 and up
10.8% from $333.0 million for 1995. Premiums for 1997 increased 2.1% to $332.2
million as compared to $325.5 million for 1996 and up 12.0% from 1995 premiums
of $296.7 million. This increase is primarily due to the continued growth in
individual sales of ViaTerm, a term
40
<PAGE> 45
life insurance product, of $5.5 million. Group premiums were up slightly for
1997 to $273.9 million as compared to $272.9 million for 1996. Increases in
group accident and health premiums were offset by decreases in group annuities
and reinsurance premiums.
VFL's investment income increased from $29.3 million in 1996 to $29.9
million in 1997. Both years were lower than 1995's investment income of $31.5
million. The increase in 1997 can be attributed to a larger asset base of VFL's
investment portfolio, offset by a slightly lower average yield on VFL's
portfolio in 1997, as compared to 1996. The decrease in 1996 was mainly due to
negative cash flow experienced in 1996 resulting in a reduction in the total
investment portfolio.
FINANCIAL CONDITION
Assets totaled $2,368.4 million at December 31, 1997, an increase of 19.6%
over 1996. VFL's cash and invested assets of $570.5 million increased by $118.7
million, or 26.3%, over the 1996 level of $451.8 million.
VFL's stockholder's equity was $216.3 million at December 31, 1997,
compared to approximately $199.5 million and $195.5 million at December 31, 1996
and 1995, respectively. The increase in stockholder's equity in 1997 is due to
net income of $13.3 million and a $3.4 million increase in net unrealized
investment gains. The increase in stockholder's equity in 1996 was primarily due
to net income of $16.7 million offset by $12.7 million decrease in net
unrealized investment gains.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------
STOCKHOLDER'S
ASSETS EQUITY
- ----------------------------------------------------------------------------------------
<S> <C> <C>
(In thousands of dollars)
December 31, 1997........................................... $2,368,426 $216,260
December 31, 1996........................................... 1,980,802 199,540
December 31, 1995........................................... 1,641,438 195,472
December 31, 1994........................................... 1,447,122 156,196
December 31, 1993........................................... 1,258,039 153,249
- ----------------------------------------------------------------------------------------
</TABLE>
INVESTMENTS
The following table summarizes VFL's investments shown at cost or amortized
cost and carrying value for each of the last two years:
DISTRIBUTION OF INVESTMENTS
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
DECEMBER 31 1997 % 1996 %
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
(In thousands of dollars)
Fixed maturities:
U.S. Treasury Securities and obligations of government
agencies.............................................. $299,066 55.4% $117,213 27.5%
Asset-backed securities................................. 68,612 12.7 113,376 26.6
Other debt securities................................... 98,589 18.3 90,843 21.4
-------- ----- -------- -----
Total fixed maturities................................ 466,267 86.4 321,432 75.5
Common stocks............................................. 981 0.2 1,073 0.3
Policy loans.............................................. 66,971 12.4 60,267 14.2
Other invested assets..................................... 579 0.1 -- --
Short-term investments.................................... 4,597 0.9 42,757 10.0
- -----------------------------------------------------------------------------------------------------------------
Investments at Amortized Cost $539,395 100.0% $425,529 100.0%
=================================================================================================================
Investments at Carrying Value* $545,968 $427,049
=================================================================================================================
</TABLE>
* As reported in the Balance Sheet
The operations, assets and liabilities of VFL and Assurance are, to a large
extent, managed on a combined basis. The investment portfolio is managed to
maximize after-tax investment return while minimizing credit risks with
investments concentrated in high quality securities to support insurance
41
<PAGE> 46
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 maturities are carried at a fair value of $471.7
million at December 31, 1997, compared with $321.1 million at December 31, 1996.
At December 31, 1997, net unrealized gains on fixed maturities amounted to
approximately $5.4 million. This compares with net unrealized losses of
approximately $.4 million at December 31, 1996. The gross unrealized gains and
losses for the fixed maturities portfolio at December 31, 1997 were $6.2 million
and $.8 million, respectively, compared to $3.2 million and $3.6 million,
respectively, at December 31, 1996. Such fluctuations from year-to-year are
primarily due to changes in interest rates.
VFL's investments in equity securities are carried at a fair value of $2.3
million at December 31, 1997, compared with $3.0 million at December 31, 1996.
At December 31, 1997, net unrealized gains on equity securities amounted to
approximately $1.3 million. This compares with net unrealized gains of
approximately $1.9 million at December 31, 1996. There were no unrealized losses
on equity securities as of December 31, 1997 and 1996.
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 maturities are classified as available-for-sale.
See Note 2 of the Financial Statements for further information.
The following table summarizes the ratings of VFL's fixed maturity
portfolio at carrying value (market):
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
DECEMBER 31 1997 % 1996 %
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
(In thousands of dollars)
U.S. government and affiliated securities................. $300,676 63.8% $115,926 36.1%
Other AAA rated........................................... 75,531 16.0 127,910 39.8
AA and A rated............................................ 61,404 13.0 33,913 10.6
BBB rated................................................. 27,292 5.8 38,272 11.9
Below investment grade.................................... 6,804 1.4 5,045 1.6
- -----------------------------------------------------------------------------------------------------------------
Total $471,707 100.0% $321,066 100.0%
=================================================================================================================
</TABLE>
Included in VFL's fixed maturities at December 31, 1997, are $68.7 million
of asset-backed securities, consisting of approximately 65.0% in collateralized
mortgage obligations ("CMOs"), 28.2% in corporate asset-backed obligations, 6.4%
in corporate mortgage-backed pass-through certificates and 0.4% in U.S.
government and agency issued pass-through certificates. The majority of CMOs
held 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. At December 31, 1997, net unrealized gains on CMOs amounted
to approximately $.1 million, compared with unrealized losses of approximately
$.1 million at December 31, 1996. 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 certain derivative financial instruments
primarily to reduce its exposure to market risk. See Notes 1 and 3 of VFL's
Financial Statements for further information regarding derivatives.
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
42
<PAGE> 47
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
0.3% of total assets as of December 31, 1997 and 1996.
RISKS AND UNCERTAINTIES
The following section discusses risks and uncertainties to which VFL is
subject.
Credit Risk
Credit risk arises from the potential inability of counterparties to
perform on an obligation in accordance with the terms of the contract. VFL is
exposed to credit risk in its capacity as counterparty in financial and
insurance contracts, reinsurance arrangements and as a holder of securities. VFL
accepts risk whenever a counterparty is obligated to perform under a contract.
As a holder of securities, VFL is exposed to default by the issuer or to the
possibility of market price deterioration. As a purchaser of reinsurance, VFL
has exposure that a reinsurer may not be able to reimburse VFL under the terms
of the reinsurance agreement. VFL has established policies and procedures to
manage credit risk, including collateral requirements and master "netting
arrangements."
Legal/Regulatory Risk
Legal/regulatory risk is the risk that changes in the legal or regulatory
environment in which VFL operates will create additional expenses not
anticipated by VFL in pricing its products. Regulatory initiatives, tax law
changes, new legal theories or insurance company insolvencies, through guaranty
fund assessments, may create costs for the insurer beyond those currently
recorded in the financial statements. VFL mitigates this risk by offering a wide
range of products and by operating throughout the United States, thus reducing
its exposure to any single product or region, and also by employing underwriting
practices which identify and minimize the adverse impact of this risk.
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 the year 1999. Such malfunctions
could lead to business delays and disruptions. All subsidiaries of CNAF,
including VFL, utilize the same systems in conducting day-to-day operations. VFL
is in the process of replacing many of its legacy systems and is upgrading its
systems to accommodate business for the year 2000 and beyond. VFL believes that
it is on schedule to resolve the year 2000 issue in a timely manner. VFL's cost
to upgrade and replace its systems will be included as part of the total cost
incurred by CNAF to replace and upgrade its systems. Based upon current
assessments, CNAF estimates its total cost will be approximately $60 to $70
million. VFL will be allocated its proportionate share of this cost upon
completion of the upgrade; however, a reasonable estimate of this cost is not
currently available. Due to the interdependent nature of computer systems, VFL
may be adversely impacted depending upon whether it or other entities not
affiliated with VFL (vendors and business partners) address this issue
successfully. To mitigate this impact, CNAF is communicating with its vendors
and business partners to coordinate the year 2000 conversion. At this time,
management is unable to determine whether the adverse impact, if any, in
connection with the foregoing circumstances would be material to VFL.
LIQUIDITY AND CAPITAL RESOURCES
The liquidity requirements of VFL have been met by funds generated from
operating, investing and financing activities. VFL's principal operating cash
flow sources are premiums, investment income, receipts for investment contracts
sold and sales and maturities of investments. The primary operating cash flow
uses are payments for claims, policy benefits, payments on matured policyholder
contracts and operating expenses.
43
<PAGE> 48
For the year ended December 31, 1997, VFL's operating activities generated
net positive cash flows of $20.5 million, compared with net negative cash flows
of $136.8 million in 1996 and $18.9 million in 1995. The net positive cash flows
from operations in 1997 are due, in large part, to the settlement of certain
receivables from affiliates and higher revenues generated by the increase in
premium volume. The deterioration in cash flow in 1996 was caused by significant
acquisition and other first-year expenses related to the large volume of new
business generated by VFL, as well as the delayed settlement of receivables from
affiliates.
VFL believes that future liquidity needs will be met primarily by cash
generated from operations. Net cash flows from operations are primarily 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.
VFL's insurance ratings are pooled ratings with Assurance. The table below
reflects insurance ratings for VFL/Assurance as of December 31, 1997:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
FINANCIAL STRENGTH CLAIMS PAYING ABILITY
<CAPTION>
A.M. BEST STANDARD & POOR'S DUFF & PHELPS
<S> <C> <C> <C>
RATING................................ A AA- AA
</TABLE>
ACCOUNTING STANDARDS
Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities
In June 1996, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities."
This Statement provides standards for distinguishing transfers of financial
assets that are sales from transfers that are secured borrowings. This Statement
has been amended and is now effective for transfers and servicing of financial
assets and extinguishment of liabilities occurring after December 31, 1996 or
1997, depending on the type of transaction. This Statement has not and is not
expected to have a significant impact on VFL.
Reporting Comprehensive Income
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which establishes accounting standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general-purpose financial statements. This Statement requires
that an enterprise (a) classify items of other comprehensive income by their
nature in a financial statement and (b) display the accumulated balance of other
comprehensive income separately from retained earnings and additional paid-in
capital in the equity section of a statement of financial position. This
Statement is effective for fiscal years beginning after December 15, 1997. This
Statement is not expected to result in a significant change in VFL's
disclosures.
Disclosures about Segments of an Enterprise and Related Information
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which establishes standards for the way
that public business enterprises report information about operating segments in
interim and annual financial statements. It requires that those enterprises
report a measure of segment profit or loss, certain specific revenue and expense
items and segment assets, and that the enterprises reconcile the total of those
amounts to the general-purpose financial statements. It also establishes
standards for related disclosures about products and services, geographic areas
and major customers. This Statement is effective for financial statements for
periods beginning after December 15, 1997. VFL is currently evaluating the
effect of this Statement on its business segment disclosure.
44
<PAGE> 49
Accounting by Insurance and Other Enterprises for Insurance-Related Assessments
In December 1997, the American Institute of Certified Public Accountants'
Accounting Standards Executive Committee issued Statement of Position ("SOP")
97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related
Assessments," which provides guidance on accounting by entities that are subject
to insurance-related assessments. It requires that entities recognize
liabilities for insurance-related assessments when all of the following criteria
have been met: an assessment has been imposed or a probable assessment will be
imposed; the event obligating an entity to pay an imposed or probable assessment
has occurred on or before the date of the financial statements; and the amount
of the assessment can be reasonably estimated. This SOP is effective for
financial statements for fiscal years beginning after December 15, 1998. VFL is
currently evaluating the effects of this SOP on its accounting for
insurance-related assessments.
Employers' Disclosures about Pensions and Other Postretirement Benefits
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits," which standardizes disclosure
requirements for pension and other postretirement benefits to the extent
practicable, and requires additional information on changes in the benefit
obligations and fair values of plan assets that will facilitate financial
analysis. The Statement also suggests combined formats for presentation of
pension and other postretirement benefit disclosures. The Statement changes
disclosure only and does not address measurement or recognition. It is effective
for fiscal years beginning after December 15, 1997. VFL has no employees,
however, expenses are allocated to VFL for services provided by Casualty
employees. VFL is currently evaluating the effects of this Statement on its
benefit plan disclosures.
FORWARD-LOOKING STATEMENTS
When included in management's discussion and analysis, the words "expects,"
"intends," "anticipates," "estimates" and analogous expressions are intended to
identify forward-looking statements. Such statements inherently are subject to a
variety of risks and uncertainties that could cause actual results to differ
materially from those projected. Such risks and uncertainties include, among
others, general economic and business conditions, competition, changes in
financial markets (credit, currency, commodities and stocks) changes in foreign,
political, social and economic conditions, regulatory initiatives and compliance
with governmental regulations, judicial decisions and rulings, and various other
matters, many of which are beyond VFL's control. See discussions elsewhere in
this report on how these risks may affect VFL. These forward-looking statements
speak only as of the date of this Report. VFL expressly disclaims any obligation
or undertaking to release publicly any updates or revisions to any
forward-looking statement contained herein to reflect any change in VFL's
expectations with regard thereto or any change in events, conditions or
circumstances on which any statement is based.
OTHER ADDITIONAL INFORMATION
EMPLOYEES
As of December 31, 1997, the Company had no employees as it has contracted
with Casualty for services provided by Casualty employees. Casualty has
experienced satisfactory labor relations and has never had work stoppages due to
labor disputes.
PROPERTIES
The Company does not own or directly lease any office space. The Company
reimburses Casualty for its proportionate share of office facilities.
CERTAIN AGREEMENTS
The Company is party to the Reinsurance Pooling Agreement with Assurance
which was previously mentioned and is also discussed in the Notes to the
Company's Financial Statements included in this
45
<PAGE> 50
Prospectus. In addition, the Company is party to the CNA Intercompany Expense
Agreement whereby expenses incurred by CNAF and each of its subsidiaries are
allocated to the appropriate company. All acquisition and underwriting expenses
allocated to the Company are further subject to the Reinsurance Pooling
Agreement with Assurance, so that acquisition and underwriting expenses
recognized by the Company approximates ten percent of the combined acquisition
and underwriting expenses of the Company and Assurance. For information
regarding expenses pursuant to the CNA Intercompany Expense Agreement see Note 8
of the Notes to Financial Statements.
REGULATION
The Company is subject to the laws of the Commonwealth of Pennsylvania
governing insurance companies and to the regulations of the Pennsylvania
Department of Insurance (the "Insurance Department"). Regulation by the
Insurance Department includes periodic examination to determine, among other
items, contract liabilities and reserves so that the Insurance Department may
certify that these items are correct. The Company's books and accounts are
subject to review by the Insurance Department at all times.
In addition, the Company is subject to regulation under the insurance laws
of all jurisdictions in which it operates. The laws of the various jurisdictions
establish supervisory agencies with broad administrative powers with respect to
various matters, including licensing to transact business, overseeing trade
practices, licensing agents, approving contract forms, establishing reserve
requirements, fixing maximum interest rates on life insurance contract loans and
minimum rates for accumulation of surrender values, prescribing the form and
content of required financial statements and regulating the type and amounts of
investments permitted.
Further, many states regulate affiliated groups of insurers, such as the
Company and its affiliates, under insurance holding company legislation. Under
such laws, inter-company transfers of assets and dividend payments from
insurance subsidiaries may be subject to prior notice or approval, depending on
the size of the transfer payments in relation to the financial positions of the
companies involved.
Under insurance guaranty fund laws in most states, insurers doing business
therein can be assessed as a result of the insolvencies of other insurers. The
assessments are based on formulas, subject to prescribed limits, and are
intended to fund the benefits and continuation of coverage for policyholders of
the insolvent insurers. Most of these laws provide that an assessment may be
excused or deferred if it would threaten an insurer's own solvency.
Although the Federal government generally does not directly regulate the
business of insurance, Federal initiatives often have an impact on the business
in a variety of ways. Certain insurance products of the Company are subject to
various Federal securities laws and regulations. In addition, current and
proposed Federal measures that may significantly affect the insurance business
include regulation of insurance company solvency, employee benefit regulation,
removal of barriers preventing banks from engaging in the insurance business,
tax law changes affecting the taxation of insurance companies and the tax
treatment of insurance products and its impact on the relative desirability of
various personal investment vehicles.
Increased scrutiny of state regulated insurer solvency requirements by
certain members of the U.S. Congress resulted in the National Association of
Insurance Commissioners ("NAIC") developing industry minimum Risk-Based Capital
("RBC") requirements, establishing a formal state accreditation process designed
to more closely regulate for solvency, minimizing the diversity of approved
statutory accounting and actuarial practices, and increasing the annual
statutory statement disclosure requirements.
The RBC formulas are designed to identify an insurer's minimum capital
requirements based upon the inherent risks (e.g., asset default, credit and
underwriting) of its operations. In addition to the minimum capital
requirements, the RBC formula and related regulations identify various levels of
capital adequacy and corresponding actions that the state insurance departments
should initiate. The level of capital adequacy below which insurance departments
would take action is defined as the Company Action Level. As of December 31,
1997, the Company has capital in excess of the Company Action Level.
46
<PAGE> 51
DIRECTORS AND EXECUTIVE OFFICERS
The name, age, positions and offices, term as director, and business
experience during the past five years for the Company's directors and executive
officers are listed in the following table:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------
OFFICERS OF THE COMPANY
- ----------------------------------------------------------------------------------------------------
POSITION(S) HELD
NAME AND ADDRESS AGE WITH THE COMPANY PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Dennis H. Chookaszian 54 Director, Chairman of the Board and Chief Executive
CNA Plaza Chairman of the Officer of CNA since September 1992. Prior
Chicago, IL 60685 Board and Chief thereto, Mr. Chookaszian was President and
Executive Chief Operating Officer of CNA. Mr.
Officer Chookaszian has served as a Director of the
Company since April 1978.
- ----------------------------------------------------------------------------------------------------
Philip L. Engel 57 Director and President of CNA since September 1992. Prior
CNA Plaza President thereto, Mr. Engel was Executive Vice
Chicago, IL 60685 President of CNA. Mr. Engel has served as a
Director of the Company since September 1992.
- ----------------------------------------------------------------------------------------------------
Michael C. Garner 45 Senior Vice Senior Vice President of CNA since September
CNA Plaza President and 1993. Prior thereto, Mr. Garner was a partner
Chicago, IL 60685 Director of Coopers & Lybrand LLP. Mr. Garner has
served as a Director of the Company since
October 1996.
- ----------------------------------------------------------------------------------------------------
Bernard L. Hengesbaugh 51 Executive Vice Executive Vice President and Chief Operating
CNA Plaza President and Officer of CNA since February 1998. Prior
Chicago, IL 60685 Chief Operating thereto, Mr. Hengesbaugh was Senior Vice
Officer President of CNA since November 1990.
- ----------------------------------------------------------------------------------------------------
Peter E. Jokiel 50 Director and Senior Vice President of CNA since November
CNA Plaza Senior Vice 1990. Chief Financial Officer of CNA from
Chicago, IL 60685 President November 1990 through October 1997. Mr. Jokiel
served as a Director of the Company from July
1992 through October 1997.
- ----------------------------------------------------------------------------------------------------
Jonathan D. Kantor 42 Senior Vice Senior Vice President, Secretary and General
CNA Plaza President, Counsel of CNA since April 1997. Group Vice
Chicago, IL 60685 Secretary, President of CNA since April 1994. Prior
General Counsel thereto, Mr. Kantor was a partner at the law
and Director firm of Shea & Gould.* Mr. Kantor has served
as a Director of the Company since April 1997.
- ----------------------------------------------------------------------------------------------------
Patricia L. Kubera 42 Group Vice Group Vice President and Controller of CNA
CNA Plaza President, since January 1993. Prior thereto, Ms. Kubera
Chicago, IL 60685 Controller and was Assistant Vice President of CNA. Ms.
Director Kubera has served as a Director of the Company
since November 1994.
- ----------------------------------------------------------------------------------------------------
W. James MacGinnitie 59 Senior Vice Senior Vice President and Chief Financial
CNA Plaza President, Chief Officer of CNA since October 1997. From 1994
Chicago, IL 60685 Financial through 1997, Mr. MacGinnitie was a partner at
Officer and Ernst & Young. Prior thereto, Mr. MacGinnitie
Director was a principal with Tillinghast. Mr.
MacGinnitie has served as a Director of the
Company since October 1997.
- ----------------------------------------------------------------------------------------------------
</TABLE>
47
<PAGE> 52
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------
OFFICERS OF THE COMPANY
- ----------------------------------------------------------------------------------------------------
POSITION(S) HELD
NAME AND ADDRESS AGE WITH THE COMPANY PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
William H. Sharkey, Jr. 50 Senior Vice Senior Vice President of CNA since January
CNA Plaza President and 1994. Prior thereto, Mr. Sharkey was Senior
Chicago, IL 60685 Director Vice President of Cigna Healthcare from
October 1991 through February 1994. Mr.
Sharkey has served as a Director of the
Company since November 1994.
- ----------------------------------------------------------------------------------------------------
</TABLE>
Each director is elected to serve until the next annual meeting of
stockholders or until his or her successor is elected and shall have qualified.
Some directors hold various executive positions with insurance company
affiliates of the Company. Executive officers serve at the discretion of the
Board of Directors.
* Shea & Gould declared bankruptcy in 1995.
EXECUTIVE COMPENSATION
The following table includes compensation paid by CNAF and its subsidiaries
for services rendered in all capacities for the years indicated for the Chief
Executive Officer and the next four most highly compensated Executive Officers
as of December 31, 1997. These officers also serve as executive officers of VFL;
therefore, an applicable portion of their compensation (4.45%) is charged to
VFL.
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
ANNUAL COMPENSATION LONG-TERM
---------------------- COMPENSATION ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY(A) BONUS(B) PAYMENTS(C) COMPENSATION(D)
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Dennis H. Chookaszian............... 1997 950,000 -- 1,650,000 129,288(e)
Chairman of the Board and 1996 950,000 -- 1,450,000 51,362(f)
Chief Executive Officer of 1995 1,593,027 -- -- 66,587
CNA Insurance Companies
Philip L. Engel..................... 1997 800,000 -- 500,000 62,226(e)
President 1996 800,000 -- 400,000 40,131(f)
CNA Insurance Companies 1995 962,587 -- -- 40,429
Carolyn L. Murphy................... 1997 600,000 480,000 -- 25,200
Senior Vice President 1996 600,000 317,000 -- 25,200
CNA Insurance Companies 1995 562,307 206,000 -- 23,100
Adrian M. Tocklin................... 1997 550,000 417,000 -- 23,100
Senior Vice President 1996 548,595 225,000 -- 23,100
CNA Insurance Companies 1995 474,808 170,000 154,180(g) 10,741
Peter E. Jokiel..................... 1997 550,000 399,000 -- 23,100
Senior Vice President 1996 500,000 240,000 -- 21,000
CNA Insurance Companies 1995 450,000 154,000 -- 18,900
- -----------------------------------------------------------------------------------------------------------
</TABLE>
48
<PAGE> 53
Notes
(a) Base salary includes compensation deferred under the CNA Savings Plan and
CNA Supplemental Savings Plan.
(b) Amounts disclosed are for bonus awards earned and accrued in the year
indicated under the company's annual incentive plans hereinafter described.
Bonus awards are typically paid in March of the following year.
(c) Represents payout under the Incentive Compensation Plan for Executive
Officers.
(d) Represents amounts contributed or accrued to the named officers for the CNA
Savings Plan and CNA Supplemental Savings Plan.
(e) Includes $27,356 and $11,260 of insurance premiums paid by the company on
behalf of Messrs. Chookaszian and Engel, respectively.
(f) Includes $10,422, and $6,009 of Long Term Disability Insurance Premium paid
by the company on behalf Mr. Chookaszian and Mr. Engel, respectively.
(g) Continental Long-Term Incentive Program payment.
EMPLOYMENT CONTRACTS
The Company is a wholly-owned subsidiary of Assurance. Assurance is a
wholly-owned subsidiary of Casualty which is wholly-owned by CNAF. Loews
Corporation owns approximately 84% of the outstanding common stock of CNAF. All
employees of the CNA Insurance Companies are employed by Casualty, with the
exception of Dennis H. Chookaszian and Philip L. Engel who are employees of
CNAF.
CNAF is party to employment agreements (the "Agreements") with each of
Dennis H. Chookaszian and Philip L. Engel. The Agreements are for a three-year
term at an annual Base Salary of $950,000 for Mr. Chookaszian and $800,000 for
Mr. Engel. The Agreements provide for the adoption by the Board of an Incentive
Compensation Plan which will provide Mr. Chookaszian and Mr. Engel with an
opportunity to earn a bonus based on performance and attainment of specified
corporate goals. In all other respect, the agreements contain substantially the
same terms as the prior agreements as approved by the Board in February of 1992.
A brief summary of the Plan as adopted by the CNA Board is set forth herein.
Each of the Agreements requires CNAF to provide long-term disability
coverage and permits the employee to participate in other benefit programs
offered by the Company to its employees. In the event of death or disability,
the employee is entitled to be paid the Base Salary to the end of the month in
which such death or disability occurs and a prorated amount based on assumed
attainment of the incentive compensation in effect at the time. Any incentive
compensation paid is included in the computation of pensionable earnings under
the Company's retirement plans. The employee may participate in the Qualified
and Supplemental Savings Plan established by CNAF wherein CNAF pays a matching
percentage of 70% of the first 6% of the employee's contributions. This matching
amount is also included in the computation of pensionable earnings.
CNAF may terminate each Agreement without cause at any time, in which event
CNAF is required to continue to make payments to the employee for a period of
three years from the date of termination at a fixed rate based on Base Salary
and the incentive compensation in effect at the time of such termination. Each
Agreement contemplates negotiation of a renewal for an additional three year
period at the expiration of its term on December 31, 1998 and provides that if
the parties have not reached an agreement before March 31, 1999 at a Base Salary
and opportunity for incentive compensation of not less than the amount of Base
Salary and incentive compensation provided for the year 1998 at substantially
the same terms as the expiring agreement, then the employment shall be
considered terminated by CNAF and the employee shall be entitled to termination
pay for a period of three years based on the combined Base Salary and the
assumed incentive compensation for 1998. If a renewal is not negotiated before
December 31, 1998, the Executives shall become employees-at-will for a three
month period at an actual salary representing the combined Base Salary and
assumed Incentive Compensation for the year 1998.
49
<PAGE> 54
The Incentive Compensation Committee of CNAF has granted Mr. Chookaszian
and Mr. Engel, subject to shareholder approval of the Incentive Compensation
Plan, allocations under the Incentive Compensation Plan entitling each of them
to awards thereunder of a maximum of $1,650,000 for Mr. Chookaszian and $500,000
for Mr. Engel for the year 1997. A maximum of $1,850,000 for 1998 has been
granted to Mr. Chookaszian and a maximum of $600,000 for the year 1998, has been
granted to Mr. Engel. The actual awards to Messrs. Chookaszian and Engel would
be subject to the attainment of specific performance goals in relation to
after-tax income CNAF, excluding realized investment gains and losses.
RETIREMENT PLANS
PENSION PLAN TABLE
NORMAL RETIREMENT IN 1997
<TABLE>
<CAPTION>
ESTIMATED ANNUAL PENSION FOR
REPRESENTATIVE YEARS OF CREDITED SERVICE
- --------------------------------------------------------------------------------------------------------------
AVERAGE
ANNUAL
COMPENSATION 15 20 25 30 35
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 400,000............ $116,618 $ 155,491 $ 194,364 $ 206,570 $ 218,777
500,000............ 146,618 195,491 244,364 259,904 275,444
600,000............ 176,618 235,491 294,364 313,237 332,111
700,000............ 206,618 275,491 344,364 366,571 388,778
800,000............ 236,618 315,491 394,364 419,904 445,445
900,000............ 266,618 355,491 444,364 473,238 502,112
1,000,000............ 296,618 395,491 494,364 526,571 558,779
1,100,000............ 326,618 435,491 544,364 579,905 615,446
1,200,000............ 356,618 475,491 594,364 633,238 672,113
1,300,000............ 386,618 515,491 644,364 686,572 728,780
1,400,000............ 416,618 555,491 694,364 739,905 785,447
1,500,000............ 446,618 595,491 744,364 793,219 842,114
1,600,000............ 476,618 635,491 794,364 846,572 898,781
1,700,000............ 506,618 675,491 844,364 899,906 955,448
1,800,000............ 536,618 715,491 894,364 953,239 1,012,115
1,900,000............ 566,618 755,491 944,364 1,006,573 1,068,782
2,000,000............ 596,618 795,491 994,364 1,059,906 1,125,449
2,100,000............ 626,618 835,491 1,044,364 1,113,240 1,182,116
2,200,000............ 656,618 875,491 1,094,364 1,166,573 1,238,783
2,300,000............ 686,618 915,491 1,144,364 1,219,907 1,295,450
2,400,000............ 716,618 955,491 1,194,364 1,273,240 1,352,117
2,500,000............ 746,618 995,491 1,244,364 1,326,574 1,408,784
2,600,000............ 776,618 1,035,491 1,294,364 1,379,907 1,465,451
2,700,000............ 806,618 1,075,491 1,344,364 1,433,241 1,522,118
2,800,000............ 836,618 1,115,491 1,394,364 1,486,574 1,578,785
2,900,000............ 866,618 1,155,491 1,444,364 1,539,908 1,635,452
- --------------------------------------------------------------------------------------------------------------
</TABLE>
The amounts in the table reflect deductions for estimated Social Security
payments.
Mr. Chookaszian, Mr. Engel, Ms. Murphy, Ms. Tocklin and Mr. Jokiel have 22,
32, 20, 22 and 16 years of credited service, respectively.
Casualty provides funded, tax qualified, non-contributory retirement plans
for all salaried employees, including executive officers (the "Retirement
Plans") and an unfunded, non-qualified, non-contributory benefits equalization
plan for all eligible salaried employees, including executive officers, (the
"Supplemental Retirement Plan") which provides for the accrual and payment of
benefits which are not available under tax
50
<PAGE> 55
qualified plans such as the Retirement Plans. The following description of the
Retirement Plans gives effect to benefits provided under the Supplemental
Retirement Plan.
The Retirement Plans provide for retirement benefits based upon average
final compensation (i.e., based upon the highest average sixty consecutive
months compensation and years of credited service with Casualty). Compensation
under the Retirement Plans consists of salary paid by Casualty and its
subsidiaries included under "Salary", "Bonus", and "Long-Term Compensation
Payouts" in the Summary Compensation Table above. The table shows estimated
annual benefits payable upon retirement under the Retirement Plans for various
compensation levels and years of credited service, based upon normal retirement
in 1997 and a straight life annuity form of benefit. In addition to a straight
life annuity, the Plans also allow the participant to elect payment to be made
in a Joint and Contingent (or Survivor) Annuitant form where the Contingent (or
Survivor) Annuitant would receive payment at 50%, 66 2/3% or 100% of the
participant's benefit amount.
51
<PAGE> 56
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholder
Valley Forge Life Insurance Company
We have audited the accompanying balance sheets of Valley Forge Life
Insurance Company (a wholly-owned subsidiary of Continental Assurance Company,
which is a wholly-owned subsidiary of Continental Casualty Company, a
wholly-owned subsidiary of CNA Financial Corporation, an affiliate of Loews
Corporation) as of December 31, 1997 and 1996, and the related statements of
operations, stockholder's equity and cash flows for each of the three years in
the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of Valley Forge Life Insurance Company as of
December 31, 1997 and 1996, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1997 in conformity
with generally accepted accounting principles.
Deloitte & Touche LLP
Chicago, Illinois
February 18, 1998
52
<PAGE> 57
The following financial statements are those of Valley Forge Life Insurance
Company and not those of the Separate Account. They are included for the purpose
of informing investors as to the financial position and operations of the
Company.
VALLEY FORGE LIFE INSURANCE COMPANY
BALANCE SHEET
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------
DECEMBER 31 1997 1996
- -------------------------------------------------------------------------------------
<S> <C> <C>
(In thousands of dollars)
ASSETS:
Investments:
Fixed maturities available-for-sale (cost: $466,267 and
$321,432).............................................. $ 471,707 $ 321,066
Equity securities available-for-sale (cost: $981 and
$1,073)................................................ 2,260 2,959
Policy loans............................................ 66,971 60,267
Other invested assets................................... 433 --
Short-term investments.................................. 4,597 42,757
---------- ----------
TOTAL INVESTMENTS................................... 545,968 427,049
Cash...................................................... 24,565 24,759
Receivables:
Reinsurance receivables................................. 1,586,471 1,320,583
Premium and other insurance receivables................. 65,196 61,390
Less allowance for doubtful accounts.................... (285) (378)
Deferred acquisition costs................................ 95,354 74,589
Accrued investment income................................. 5,245 4,945
Receivables for securities sold........................... 744 --
Deferred income taxes..................................... -- 312
Due from affiliates....................................... 35,999 67,499
Other..................................................... 228 54
Separate Account business................................. 8,941 --
- -------------------------------------------------------------------------------------
TOTAL ASSETS $2,368,426 $1,980,802
=====================================================================================
LIABILITIES AND STOCKHOLDER'S EQUITY:
Liabilities:
Insurance reserves:
Future policy benefits.................................. $1,906,899 $1,621,504
Claims.................................................. 81,242 60,568
Policyholders' funds.................................... 39,928 38,145
Payables for securities purchased......................... 497 --
Federal income taxes payable.............................. 5,975 3,824
Deferred income taxes..................................... 4,098 --
Commissions and other payables............................ 19,787 22,004
Other..................................................... 84,799 35,217
Separate Account business................................. 8,941 --
---------- ----------
TOTAL LIABILITIES................................... 2,152,166 1,781,262
---------- ----------
Commitments and contingent liabilities--Note 7 and 9
Stockholder's Equity
Common stock ($50 par value; Authorized-200,000 shares;
Issued-50,000 shares)................................... 2,500 2,500
Additional paid-in capital................................ 39,150 39,150
Retained earnings......................................... 170,230 156,900
Net unrealized investment gains........................... 4,380 990
---------- ----------
TOTAL STOCKHOLDER'S EQUITY.......................... 216,260 199,540
- -------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $2,368,426 $1,980,802
=====================================================================================
</TABLE>
See accompanying Notes to Financial Statements.
53
<PAGE> 58
VALLEY FORGE LIFE INSURANCE COMPANY
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31 1997 1996 1995
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(In thousands of dollars)
Revenues:
Premiums.................................................. $332,172 $325,486 $296,653
Net investment income..................................... 29,913 29,312 31,494
Realized investment gains................................. 4,200 4,771 13,783
Other..................................................... 6,872 8,217 4,818
-------- -------- --------
373,157 367,786 346,748
-------- -------- --------
Benefits and expenses:
Insurance claims and policyholders' benefits.............. 307,207 304,840 270,936
Amortization of deferred acquisition costs................ 11,818 1,177 6,066
Other operating expenses.................................. 33,505 36,022 35,036
-------- -------- --------
352,530 342,039 312,038
-------- -------- --------
Income before income tax................................ 20,627 25,747 34,710
Income tax expense.......................................... 7,297 9,028 12,200
================================================================================================
NET INCOME $ 13,330 $ 16,719 $ 22,510
================================================================================================
</TABLE>
See accompanying Notes to Financial Statements.
54
<PAGE> 59
VALLEY FORGE LIFE INSURANCE COMPANY
STATEMENT OF STOCKHOLDER'S EQUITY
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
NET
ADDITIONAL UNREALIZED
COMMON PAID-IN RETAINED INVESTMENT
STOCK CAPITAL EARNINGS GAINS (LOSSES) TOTAL
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
(In thousands of dollars)
BALANCE, JANUARY 1, 1995................................... $2,500 $39,150 $117,671 $ (3,125) $156,196
Net income............................................... -- -- 22,510 -- 22,510
Change in net unrealized gains/(losses).................. -- -- -- 16,766 16,766
------ ------- -------- -------- --------
BALANCE, DECEMBER 31, 1995................................. 2,500 39,150 140,181 13,641 195,472
Net income............................................... -- -- 16,719 -- 16,719
Change in net unrealized gains/(losses).................. -- -- -- (12,651) (12,651)
------ ------- -------- -------- --------
BALANCE, DECEMBER 31, 1996................................. 2,500 39,150 156,900 990 199,540
Net income............................................... -- -- 13,330 -- 13,330
Change in net unrealized gains/(losses).................. -- -- -- 3,390 3,390
=======================================================================================================================
BALANCE, DECEMBER 31, 1997 $2,500 $39,150 $170,230 $ 4,380 $216,260
=======================================================================================================================
</TABLE>
See accompanying Notes to Financial Statements.
55
<PAGE> 60
VALLEY FORGE LIFE INSURANCE COMPANY
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31 1997 1996 1995
- -----------------------------------------------------------------------------------------------
(In thousands of dollars)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 13,330 $ 16,719 $ 22,510
--------- --------- ---------
Adjustments to reconcile net income to net cash flows from
operating activities:
Net realized investment gains, pre-tax.................. (4,200) (4,771) (13,783)
Amortization of bond discount........................... (2,438) (4,922) (3,921)
Changes in:
Insurance receivables, net............................ (269,787) (254,549) (151,415)
Deferred acquisition costs............................ (20,765) (23,989) (9,267)
Accrued investment income............................. (300) (258) 69
Due from affiliates................................... 31,500 (62,563) (55,308)
Federal income taxes.................................. 2,151 4,399 (28)
Deferred income taxes................................. 2,581 3,309 453
Insurance reserves.................................... 221,252 198,239 156,530
Commissions and other payables........................ (2,217) 9,368 5,594
Other, net............................................ 49,429 (17,744) 29,619
--------- --------- ---------
TOTAL ADJUSTMENTS............................... 7,206 (153,481) (41,457)
--------- --------- ---------
NET CASH FLOWS FROM OPERATING ACTIVITIES........ 20,536 (136,762) (18,947)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of fixed maturities............................. (464,361) (535,263) (361,579)
Proceeds from fixed maturities:
Sales................................................... 278,459 530,828 336,731
Maturities, calls and redemptions....................... 45,442 36,726 51,046
Purchases of equity securities............................ (1,334) (728) --
Proceeds from sales of equity securities.................. 2,447 1,306 --
Change in short-term investments.......................... 39,301 (2,851) 1,901
Change in policy loans.................................... (6,704) (4,259) (9,007)
Change in other invested assets........................... (580) -- --
Other, net................................................ -- 72 85
--------- --------- ---------
NET CASH FLOWS FROM INVESTING ACTIVITIES........ (107,330) 25,831 19,177
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Receipts for investment contracts credited to policyholder
account balances........................................ 111,478 98,091 40,398
Return of policyholder account balances in investment
contracts............................................... (24,878) (4,504) (451)
--------- --------- ---------
NET CASH FLOWS FROM FINANCING ACTIVITIES........ 86,600 93,587 39,947
--------- --------- ---------
NET CASH FLOWS.................................. (194) (17,344) 40,177
Cash at beginning of period................................. 24,759 42,103 1,926
- -----------------------------------------------------------------------------------------------
CASH AT END OF PERIOD....................................... $ 24,565 $ 24,759 $ 42,103
===============================================================================================
Supplemental disclosures of cash flow information:
Federal income taxes paid................................. $ 2,488 $ 1,965 $ 6,531
===============================================================================================
</TABLE>
See accompanying Notes to Financial Statements.
56
<PAGE> 61
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION
Valley Forge Life Insurance Company ("VFL") is a wholly-owned subsidiary of
Continental Assurance Company ("Assurance"). Assurance is a wholly-owned
subsidiary of Continental Casualty Company ("Casualty") which is wholly-owned by
CNA Financial Corporation ("CNAF"). Loews Corporation owns approximately 84% of
the outstanding common stock of CNAF.
VFL sells a variety of individual and group insurance products. The
individual insurance products consist primarily of term and universal life
insurance policies and individual annuities. Group insurance products include
life, pension and accident and health, consisting primarily of major medical and
hospitalization.
The operations, assets and liabilities of VFL and its parent, Assurance,
are managed, to a large extent, on a combined basis. Pursuant to a Reinsurance
Pooling Agreement, amended July 1, 1996, VFL cedes all of its business,
excluding its separate account business, to its parent, Assurance. This business
is then pooled with the business of Assurance, which excludes Assurance's
participating contracts and separate account business, and 10% of the combined
pool is assumed by VFL.
The accompanying financial statements have been prepared in conformity with
generally accepted accounting principles ("GAAP"). Certain amounts applicable to
prior years have been reclassified to conform to classifications followed in
1997.
The preparation of financial statements in conformity with GAAP 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.
INSURANCE
Premium revenue--Revenues on universal life type contracts are comprised of
contract charges and fees which are recognized over the coverage period.
Accident and health insurance premiums are earned ratably over the terms of the
policies after provision for estimated adjustments on retrospectively rated
policies and deductions for ceded insurance. Other life insurance premiums are
recognized as revenue when due, after deductions for ceded insurance.
Future policy benefit reserves--Reserves for traditional life insurance
products (whole and term life products) are computed based upon the net level
premium method using actuarial assumptions as to interest rates, mortality,
morbidity, withdrawals and expenses. Actuarial assumptions include a margin for
adverse deviation and generally vary by plan, age at issue and policy duration.
Interest rates range from 3% to 11%, and mortality, morbidity and withdrawal
assumptions reflect VFL and industry experience prevailing at the time of issue.
Expense assumptions include the estimated effects of inflation and expenses
beyond the premium paying period. Reserves for universal life-type contracts are
equal to the account balances that accrue to the benefit of the policyholders.
Interest crediting rates ranged from 4.9% to 7.3% for the three years ended
December 31, 1997.
Claim reserves--Claim reserves include provisions for reported claims in
the course of settlement and estimates of unreported losses based upon past
experience.
Reinsurance--In addition to the pooling agreement with Assurance, VFL also
assumes and cedes insurance with other insurers and reinsurers and members of
various reinsurance pools and associations. VFL utilizes reinsurance
arrangements to limit its maximum loss, provide greater diversification of risk
and minimize exposures on larger risks. The reinsurance coverages are tailored
to the specific risk characteristics of each product line with VFL's retained
amount varying by type of coverage. VFL's reinsurance includes quota
57
<PAGE> 62
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--CONTINUED
NOTE 1.--(CONTINUED)
share, yearly renewable term and facultative programs. Amounts recoverable from
reinsurers are estimated in a manner consistent with the claim liability.
Deferred acquisition costs--Life acquisition costs are capitalized and
amortized based on assumptions consistent with those used for computing policy
benefit reserves. Acquisition costs on traditional life business are amortized
over their assumed premium paying periods. Universal life and annuity
acquisition costs are amortized in proportion to the present value of the
estimated gross profits over the products' assumed durations, which are
regularly evaluated and adjusted, as appropriate. Based on 1996 evaluations, the
assumed interest rate spreads were adjusted, the effect of which was to reduce
amortization by approximately $3.0 million for the year ended December 31, 1996.
INVESTMENTS
Valuation of investments--VFL classifies its fixed maturities and its
equity securities as available-for-sale, and as such, they are carried at fair
value. The amortized cost of fixed maturities is adjusted for amortization of
premiums and accretion of discounts to maturity. Such amortization and accretion
are included in investment income.
Policy loans are carried at unpaid balances. Short-term investments, which
have an original maturity of one year or less, are carried at amortized cost
which approximates market value. VFL has no real estate or mortgage loans. VFL
accounts for its derivative securities under the fair value method. Under this
method the derivative securities are recorded at fair value at the reporting
date with changes in fair value reflected in realized investment gains and
losses. VFL's derivatives are made up of interest rate caps and purchased
options and are classified as other invested assets.
Investment gains and losses--All securities transactions are recorded on
the trade date. Realized investment gains and losses are determined on the basis
of the cost of the specific securities sold. Unrealized investment gains and
losses on fixed maturities and equity securities are reflected as part of
stockholder's equity, net of applicable deferred income taxes. Investments are
written down to estimated fair values and losses are charged to income when a
decline in value is considered to be other than temporary.
Securities sold under repurchase agreements--VFL has a securities lending
program where securities are loaned to third parties, primarily major brokerage
firms. Borrowers of these securities must deposit 100% of the fair value of the
securities if the collateral is cash, or 102% if the collateral is securities.
Cash deposits from these transactions are invested in short-term investments
(primarily commercial paper). VFL continues to receive the interest on the
loaned debt securities, as beneficial owner and, accordingly, the loaned debt
securities are included within fixed maturities. The liabilities for securities
sold subject to repurchase agreements are recorded at their contractual
repurchase amounts. VFL had no securities on loan at December 31, 1997 or 1996.
Separate Account business--VFL writes certain annuity contracts and
universal life policies. The supporting assets and liabilities of these
contracts and policies are legally segregated and reflected as assets and
liabilities of Separate Account business. Substantially all assets of the
Separate Account business are carried at fair value. Separate account
liabilities are principally obligations due to contractholders, which are
carried at contract values.
INCOME TAXES
The provision for income taxes includes deferred taxes, resulting from
temporary differences between the financial statement and tax return bases of
assets and liabilities under the liability method. Temporary differences
primarily relate to insurance reserves, investment valuation differences, net
unrealized investment gains/losses and deferred acquisition costs.
58
<PAGE> 63
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--CONTINUED
NOTE 2. INVESTMENTS:
<TABLE>
<CAPTION>
NET INVESTMENT INCOME
- -----------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31 1997 1996 1995
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(In thousands of dollars)
Fixed maturities:
Taxable bonds............................................. $20,669 $21,597 $21,576
Tax exempt bonds.......................................... 1 12 23
Equity securities........................................... 72 59 64
Policy loans................................................ 4,264 3,669 3,925
Short-term investments...................................... 4,885 4,197 6,037
Security repurchase transactions............................ -- -- 135
Other....................................................... 200 -- 2
------- ------- -------
30,091 29,534 31,762
Investment expense.......................................... 178 222 268
- -----------------------------------------------------------------------------------------------
NET INVESTMENT INCOME $29,913 $29,312 $31,494
===============================================================================================
</TABLE>
<TABLE>
<CAPTION>
ANALYSIS OF INVESTMENT GAINS (LOSSES)
- ------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31 1997 1996 1995
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(In thousands of dollars)
Realized investment gains (losses):
Fixed maturities.......................................... $ 3,333 $ 4,123 $13,674
Equity securities......................................... 1,021 578 --
Other..................................................... (154) 70 109
------- -------- -------
4,200 4,771 13,783
Income tax expense.......................................... (1,470) (1,670) (4,824)
------- -------- -------
NET REALIZED INVESTMENT GAINS....................... 2,730 3,101 8,959
------- -------- -------
Change in net unrealized investment gains (losses):
Fixed maturities.......................................... 5,806 (20,726) 25,405
Equity securities......................................... (607) 1,263 389
Other, principally Separate Account business.............. 20 -- --
------- -------- -------
5,219 (19,463) 25,794
Income tax (expense) benefit.............................. (1,829) 6,812 (9,028)
------- -------- -------
CHANGE IN NET UNREALIZED INVESTMENT GAINS
(LOSSES)............................................ 3,390 (12,651) 16,766
- ------------------------------------------------------------------------------------------------
NET REALIZED AND UNREALIZED INVESTMENT GAINS
(LOSSES) $ 6,120 $ (9,550) $25,725
================================================================================================
</TABLE>
SUMMARY OF GROSS REALIZED
INVESTMENT GAINS (LOSSES) FOR FIXED
MATURITIES AND EQUITY SECURITIES
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
----------------------- ----------------------- -----------------------
FIXED EQUITY FIXED EQUITY FIXED EQUITY
YEAR ENDED DECEMBER 31 MATURITIES SECURITIES MATURITIES SECURITIES MATURITIES SECURITIES
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
(In thousands of dollars)
Proceeds from sales......................... $278,459 $2,447 $530,828 $1,306 $336,731 $ --
======== ====== ======== ====== ======== =====
Gross realized gains........................ $ 4,793 $1,113 $ 7,927 $ 578 $ 18,185 --
Gross realized losses....................... (1,460) (92) (3,804) -- (4,511) --
- -------------------------------------------------------------------------------------------------------------------------
NET REALIZED GAINS ON SALES $ 3,333 $1,021 $ 4,123 $ 578 $ 13,674 $ --
=========================================================================================================================
</TABLE>
59
<PAGE> 64
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--CONTINUED
NOTE 2.--(CONTINUED)
ANALYSIS OF NET UNREALIZED INVESTMENT GAINS
(LOSSES) INCLUDED IN STOCKHOLDER'S EQUITY
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996
--------------------------- ---------------------------
DECEMBER 31 GAINS LOSSES NET GAINS LOSSES NET
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
(In thousands of dollars)
Fixed maturities............................................ $6,227 $(787) $ 5,440 $3,226 $(3,592) $ (366)
Equity securities........................................... 1,279 -- 1,279 1,886 -- 1,886
Other, principally Separate Account business................ 20 -- 20 -- -- --
------ ----- ------- ------ ------- ------
$7,526 $(787) 6,739 $5,112 $(3,592) 1,520
====== ===== ====== =======
Deferred income tax expense................................. (2,359) (530)
- --------------------------------------------------------------------------------------------------------------------------
NET UNREALIZED INVESTMENT GAINS $ 4,380 $ 990
==========================================================================================================================
</TABLE>
SUMMARY OF INVESTMENTS IN FIXED MATURITIES
AND EQUITY SECURITIES AVAILABLE FOR SALE
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
DECEMBER 31, 1997 COST GAINS LOSSES VALUE
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(In thousands of dollars)
United States Treasury securities and obligations of
government agencies....................................... $299,066 $2,073 $ 711 $300,428
Asset-backed securities..................................... 68,612 147 74 68,685
Corporate securities........................................ 72,431 2,384 2 74,813
Other debt securities....................................... 26,158 1,623 -- 27,781
-------- ------ ------ --------
Total fixed maturities.................................. 466,267 6,227 787 471,707
Equity securities........................................... 981 1,279 -- 2,260
- -----------------------------------------------------------------------------------------------------------------
TOTAL $467,248 $7,506 $ 787 $473,967
=================================================================================================================
DECEMBER 31, 1996
United States Treasury securities and obligations of
government agencies....................................... $117,213.. $ 141 $2,486 $114,868
Asset-backed securities..................................... 113,376 641 767 113,251
States, municipalities and political
subdivisions-tax-exempt................................... 30 -- -- 30
Corporate securities........................................ 55,196 988 335 55,849
Other debt securities....................................... 35,617 1,456 4 37,068
-------- ------ ------ --------
Total fixed maturities.................................. 321,432 3,226 3,592 321,066
Equity securities........................................... 1,073 1,886 -- 2,959
- -----------------------------------------------------------------------------------------------------------------
TOTAL $322,505.. $5,112 $3,592 $324,025
=================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
SUMMARY OF INVESTMENTS IN FIXED
MATURITIES BY CONTRACTUAL MATURITY
- --------------------------------------------------------------------------------------------------------------
1997 1996
--------------------- ---------------------
AMORTIZED MARKET AMORTIZED MARKET
DECEMBER 31 COST VALUE COST VALUE
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(In thousands of dollars)
Due in one year or less..................................... $ 2,249 $ 2,255 $ 3,299 $ 3,305
Due after one year through five years....................... 302,053 301,749 118,507 116,223
Due after five years through ten years...................... 54,663 56,502 47,998 48,866
Due after ten years......................................... 38,690 42,516 38,252 39,421
Asset-backed securities not due at a single maturity date... 68,612 68,685 113,376 113,251
- --------------------------------------------------------------------------------------------------------------
TOTAL $466,267 $471,707 $321,432 $321,066
==============================================================================================================
</TABLE>
Actual maturities may differ from contractual maturities because securities
may be called or prepaid with or without call or prepayment penalties.
60
<PAGE> 65
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--CONTINUED
NOTE 2.--(CONTINUED)
There are no investments, other than equity securities, that have not
produced income for the years ended December 31, 1997 and 1996. There are no
investments in a single issuer, other than the U.S. government, that when
aggregated exceed 10% of stockholder's equity.
NOTE 3. FAIR VALUE OF FINANCIAL INSTRUMENTS:
Fair values are required to be disclosed for all financial instruments,
whether or not recognized in the balance sheet, for which it is practicable to
estimate that value. In cases where quoted market prices are not available, fair
values may be based on estimates using present value or other valuation
techniques. These techniques are significantly affected by the assumptions used,
including the discount rates and estimates of future cash flows. Potential taxes
and other transaction costs have not been considered in estimating fair value.
The estimates presented herein are subjective in nature and are not necessarily
indicative of the amounts VFL could realize in a current market exchange. Any
difference would not be expected to be material.
All nonfinancial instruments such as deferred acquisition costs,
reinsurance receivables, deferred income taxes and insurance reserves are
excluded from fair value disclosure. Thus, the total fair value amounts cannot
be aggregated to determine the underlying economic value of VFL.
The carrying amounts reported in the balance sheet approximate fair value
for cash, short-term investments, premium and other insurance receivables,
accrued investment income, receivables for securities sold, payables for
securities purchased and certain other assets and other liabilities because of
their short-term nature. Accordingly, these financial instruments are not listed
in the table below.
The carrying amounts and estimated fair values of VFL's other financial
instrument assets and liabilities are listed below:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
1997 1996
--------------------- ---------------------
CARRYING ESTIMATED CARRYING ESTIMATED
DECEMBER 31 AMOUNT FAIR VALUE AMOUNT FAIR VALUE
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(In thousands of dollars)
FINANCIAL ASSETS
Investments:
Fixed maturities.......................................... $471,707 $471,707 $321,066 $321,066
Equity securities......................................... 2,260 2,260 2,959 2,959
Policy loans.............................................. 66,971 63,756 60,267 56,169
Other invested assets..................................... 433 433 -- --
Separate Account business:
Fixed maturities.......................................... 3,198 3,198 -- --
Equity securities......................................... 5,233 5,233 -- --
Other..................................................... 305 305 -- --
FINANCIAL LIABILITIES
Premium deposits and annuity contracts...................... 266,093 247,567 167,049 153,676
===========================================================================================================
</TABLE>
The following methods and assumptions were used by VFL in estimating the
fair value amounts for financial instruments:
Fixed maturities and equity securities are based on quoted market
prices, where available. For securities not actively traded, fair values
are estimated using values obtained from independent pricing services,
costs to settle, or quoted market prices of comparable instruments.
The fair values for policy loans are estimated using discounted cash
flow analyses at interest rates currently offered for similar loans to
borrowers with comparable credit ratings. Loans with similar
characteristics are aggregated for purposes of the calculations.
61
<PAGE> 66
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--CONTINUED
NOTE 3.--(CONTINUED):
Valuation techniques to determine fair value of other Separate Account
business assets consist of discounted cash flows and quoted market prices
of (a) the investments or (b) comparable instruments. The fair value of
other Separate Account business liabilities approximates their carrying
value.
Premium deposits and annuity contracts are valued based on cash
surrender values and the outstanding fund balances.
VFL invests from time to time in certain derivative financial instruments
primarily to reduce its exposure to market risk. Financial instruments used for
such purposes may include interest rate caps, put and call options, commitments
to purchase securities, futures and forwards. 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 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 December 31,
1997. The gross notional principal or contractual amounts of derivative
financial instruments in the general account at December 31, 1997 totaled $50
million. The gross notional principal or contractual amounts of derivative
financial instruments in the Separate Accounts totaled $1.5 million at December
31, 1997. VFL had no derivative financial instrument holdings at December 31,
1996. The contract or notional amounts are used to calculate the exchange of
contractual payments under the agreements and are not representative of the
potential for gain or loss on these agreements.
The fair values associated with derivative financial instruments are
generally affected by interest rates, equity stock prices and foreign exchange
rates. The credit exposure associated with these instruments is generally
limited to the fair value of the instruments and will vary based on the
creditworthiness of the counterparties. The risk of default depends on the
creditworthiness of the counterparty to the instrument. Although VFL is exposed
to the aforementioned credit risk, it does not expect any counterparty to fail
to perform as contracted based on the creditworthiness of the counterparties.
Due to the nature of the derivative securities, VFL does not require collateral.
The fair value of derivatives generally reflects the estimated amounts that
VFL would receive or pay upon termination of the contracts at the reporting
date. Dealer quotes are available for substantially all of VFL's derivatives.
For securities not actively traded, fair values are estimated using values
obtained from independent pricing services, costs to settle, or quoted market
prices of comparable instruments. The fair value of derivative financial
instruments in the general account and Separate Accounts at December 31, 1997
totaled $.4 million and $.3 million, respectively. Net realized losses on
derivative financial instruments held in the general account totaled $.1 million
for the year ended December 31, 1997, while net realized losses on derivatives
in the Separate Accounts were negligible for the same period.
Options are contracts that grant the purchaser, for a premium payment, the
right, but not the obligation, to either purchase or sell a financial instrument
at a specified price within a specified period of time.
An interest rate cap consists of a guarantee given by the issuer to the
purchaser in exchange for the payment of a premium. This guarantee states that
if interest rates rise above a specified rate, the issuer will pay to the
purchaser the difference between the then current market rate and the specified
rate on the notional principal amount. The notional principal amount is not
actually borrowed or repaid.
62
<PAGE> 67
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--CONTINUED
NOTE 4. STATUTORY CAPITAL AND SURPLUS:
Statutory capital and surplus and net income for VFL are determined in
accordance with accounting practices prescribed or permitted by the Pennsylvania
Insurance Department. Prescribed statutory accounting practices are set forth in
a variety of publications of the National Association of Insurance Commissioners
as well as state laws, regulations, and general administrative rules. VFL has no
material permitted accounting practices. VFL had statutory net losses of $1.0
million and $2.7 million for the years ended December 31, 1997 and 1996, and net
income of $8.9 million for the year ended December 31, 1995. The statutory net
losses for 1997 and 1996 were primarily due to the immediate expensing of
acquisition costs which were substantial as a result of the increase in sales of
individual life and annuity products. Under GAAP, such costs are capitalized and
amortized to income over the duration of these contracts. Statutory capital and
surplus for VFL was $125.3 million and $124.3 million at December 31, 1997 and
1996, respectively.
The payment of dividends by VFL to Assurance without prior approval of the
Pennsylvania Insurance Department is limited to formula amounts. As of December
31, 1997 and 1996, approximately $12.5 million and $12.4 million, respectively,
was not subject to prior Insurance Department approval.
NOTE 5. BENEFIT PLANS:
VFL has no employees as it has contracted with Casualty for services
provided by Casualty employees. As Casualty is a wholly-owned subsidiary of
CNAF, all Casualty employees are covered by CNAF's Benefit Plans. The plans are
discussed below.
PENSION PLAN
CNAF has noncontributory pension plans covering all full-time employees age
21 or over who have completed at least one year of service. Casualty is included
in the CNA Employees' Retirement Plan and VFL is allocated their proportionate
share of these expenses. While the benefits for the plans vary, they are
generally based on years of credited service and the employee's highest sixty
consecutive months of compensation.
CNAF's funding policy is to make contributions in accordance with
applicable governmental regulatory requirements. The assets of the plans are
invested primarily in U.S. government securities with the balance in short-term
investments, common stocks and other fixed income securities.
The funded status is determined using assumptions at the end of the year.
Underfunded plans are those plans for which the accumulated benefit obligation
is in excess of plan assets. Overfunded plans are those plans for which plan
assets exceed the accumulated benefit obligations. Pension cost is determined
using assumptions at the beginning of the year.
The net pension cost allocated to VFL was $4.0 million, $3.6 million and
$1.7 million for the years ended December 31, 1997, 1996 and 1995, respectively.
63
<PAGE> 68
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--CONTINUED
NOTE 5.--(CONTINUED):
The following table sets forth the plans' funded status and amounts
recognized in CNAF's consolidated financial statements at December 31, 1997,
1996 and 1995:
ACCUMULATED BENEFIT OBLIGATION
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
----------- ------------------------ ------------------------
UNDERFUNDED OVERFUNDED UNDERFUNDED OVERFUNDED UNDERFUNDED
DECEMBER 31 PLANS PLANS PLANS PLANS PLANS
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
(In thousands of dollars)
Actuarial present value of accumulated plan benefits:
Vested................................................ $1,339,708 $517,221 $622,548 $491,052 $646,017
Nonvested............................................. 76,992 37,718 32,369 28,346 14,126
- ---------------------------------------------------------------------------------------------------------------------------
ACCUMULATED BENEFIT OBLIGATION $1,416,700 $554,939 $654,917 $519,398 $660,143
===========================================================================================================================
</TABLE>
NET PENSION ASSET (LIABILITY)
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
----------- ------------------------ ------------------------
UNDERFUNDED OVERFUNDED UNDERFUNDED OVERFUNDED UNDERFUNDED
DECEMBER 31 PLANS PLANS PLANS PLANS PLANS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
(In thousands of dollars)
Projected benefit obligation........................... $1,779,799 $777,755 $ 788,333 $ 769,999 $ 809,308
Plan assets at fair value.............................. 1,312,592 701,854 503,623 629,673 496,264
---------- -------- --------- --------- ---------
Plan assets less than projected benefit obligation... (467,207) (75,901) (284,710) (140,326) (313,044)
Unrecognized net asset at January 1, 1986, being
recognized over 12 years............................. (2,124) (7,099) -- (12,176) --
Unrecognized prior service costs....................... 88,006 19,077 77,747 21,445 104,042
Unrecognized net gain (loss)........................... 218,204 122,173 (11,793) 164,585 13,508
- --------------------------------------------------------------------------------------------------------------------------
NET PENSION (LIABILITY) ASSET $ (163,121) $ 58,250 $(218,756) $ 33,528 $(195,494)
==========================================================================================================================
</TABLE>
NET PERIODIC PENSION COST
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
----------- ------------------------ ------------------------
UNDERFUNDED OVERFUNDED UNDERFUNDED OVERFUNDED UNDERFUNDED
DECEMBER 31 PLANS PLANS PLANS PLANS PLANS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
(In thousands of dollars)
Net periodic pension cost:
Service cost-benefits attributed to employee service
during the year.................................... $ 54,321 $ 36,489 $ 18,825 $ 32,118 $ 11,596
Interest cost on projected benefit obligation........ 118,668 53,549 56,771 51,056 32,760
Actual return on plan assets......................... (102,950) (31,106) (29,013) (115,363) (43,432)
Net amortization and deferral........................ 17,370 (16,059) (5,982) 72,415 19,547
- --------------------------------------------------------------------------------------------------------------------------
NET PERIODIC PENSION COST $ 87,409 $ 42,873 $ 40,601 $ 40,226 $ 20,471
==========================================================================================================================
</TABLE>
Actuarial assumptions are set forth in the following table:
ASSUMPTIONS
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
DECEMBER 31 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Discount rate............................................... 7.25% 7.50% 7.25% 8.50%
Rate of increase in compensation levels*.................... 2.75 2.75 2.75 4.00
Expected long-term rate of return on plan assets............ 7.50 7.75-8.50 7.50-8.50 8.75
- --------------------------------------------------------------------------------------------------------
</TABLE>
* Excludes age/service related merit and productivity increases.
POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFITS
CNAF provides certain health and dental care benefits for eligible
retirees, through age 64, and provides life insurance and reimbursement of
Medicare Part B premiums for all eligible retired persons. CNAF funds benefit
costs principally on the basis of current benefit payments.
64
<PAGE> 69
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--CONTINUED
NOTE 5.--(CONTINUED):
The net postretirement benefit cost allocated to VFL was $2.1 million, $1.3
million and $.7 million for the years ended December 31, 1997, 1996 and 1995,
respectively.
The following table sets forth the amounts recognized in CNAF's
consolidated financial statements at December 31, 1997, 1996 and 1995:
<TABLE>
<CAPTION>
ACCRUED POSTRETIREMENT BENEFIT COST
- ------------------------------------------------------------------------------------------------
DECEMBER 31 1997 1996 1995
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(In thousands of dollars)
Accumulated postretirement benefit obligation:
Retirees.................................................. $201,985 $171,950 $185,507
Fully eligible, active plan participants.................. 72,818 89,009 59,173
Other active plan participants............................ 87,207 88,191 62,540
-------- -------- --------
Total accumulated postretirement benefit obligation..... 362,010 349,150 307,220
Plan assets at fair value................................... (509) -- --
Unrecognized prior service cost............................. (203) (70) --
Unrecognized net (loss) gain................................ (8,197) (12,215) 7,380
- ------------------------------------------------------------------------------------------------
ACCRUED POSTRETIREMENT BENEFIT COST $353,101 $336,865 $314,600
================================================================================================
</TABLE>
<TABLE>
<CAPTION>
NET PERIODIC POSTRETIREMENT BENEFIT COST
- ------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31 1997 1996 1995*
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(In thousands of dollars)
Net periodic postretirement benefit cost:
Service cost/benefits attributed to employee service
during the year......................................... $ 10,156 $ 11,935 $ 5,969
Interest cost on accumulated post retirement benefit
obligation.............................................. 25,135 24,146 17,506
Expected return on assets................................. (25) -- --
Amortization.............................................. (322) 374 (941)
- ------------------------------------------------------------------------------------------------
NET PERIODIC POSTRETIREMENT BENEFIT COST $ 34,944 $ 36,455 $ 22,534
================================================================================================
</TABLE>
* The 1995 data includes The Continental Corporation Retirement Plans from
acquisition date.
<TABLE>
<CAPTION>
ASSUMPTIONS
- ------------------------------------------------------------------------------------------
DECEMBER 31 1997 1996 1995
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Discount rate:
Assumptions used in determining net periodic benefit
cost.................................................... 7.50% 7.25% 8.50%
Assumptions used in determining the projected benefit
obligation (liability).................................. 7.25% 7.50% 7.25%
- ------------------------------------------------------------------------------------------
</TABLE>
The assumed health care cost trend rate used in measuring the accumulated
postretirement benefit obligation was 9% in 1997, declining to an ultimate rate
of 5% in 2002. The health care cost trend rate assumption has a significant
effect on the amount of the benefit obligation and periodic cost reported. An
increase in the assumed health care cost trend rate of 1% in each year would
increase CNAF's accumulated postretirement benefit obligation as of December 31,
1997 by $23.9 million and the aggregate net periodic postretirement benefit cost
for 1997 by $2.9 million.
SAVINGS PLAN
Casualty is included in the CNA Employees' Savings Plan which is a
contributory plan that allows employees to make regular contributions of up to
6% of their salary. VFL is allocated its proportionate share of CNA Employees'
Savings Plan expenses. CNAF contributes an additional amount equal to 70% of the
employee's regular contribution. Employees may also make an additional
contribution of up to 10% of their salaries for which there is no additional
contribution by CNAF. CNAF contributions allocated to and
65
<PAGE> 70
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--CONTINUED
NOTE 5.--(CONTINUED):
expensed by VFL for the Savings Plan were $.2 million, $1.0 million and $.7
million for the years ended December 31, 1997, 1996 and 1995, respectively.
NOTE 6. INCOME TAXES:
VFL is taxed under the provisions of the Internal Revenue Code, as
applicable to life insurance companies, and is included in the consolidated
Federal income tax return with CNAF and its eligible subsidiaries (CNA Tax
Group), which in turn is included in the consolidated Federal income tax return
of Loews and its eligible subsidiaries. The Federal income tax provision of VFL
is computed as if VFL were filing its own separate return.
VFL maintains a special tax memorandum account designated as the
"Shareholder's Surplus Account." Dividends from this account may be distributed
to the shareholder without resulting in any additional tax. The amount in the
Shareholder's Surplus Account was $121.8 million and $100.0 million at December
31, 1997 and 1996, respectively. Another tax memorandum account, defined as the
"Policyholders' Surplus Account," totaled $5.4 million at both December 31, 1997
and 1996. No further additions to this account are allowed. Amounts accumulated
in the Policyholders' Surplus Account are subject to income tax if distributed
to the stockholder. VFL has not provided for such a tax as VFL has no plans for
such a distribution.
Significant components of VFL's deferred tax assets and liabilities as of
December 31, 1997 and 1996 are shown in the table below:
<TABLE>
<CAPTION>
COMPONENTS OF DEFERRED TAX ASSETS AND LIABILITIES
- ---------------------------------------------------------------------------------
DECEMBER 31 1997 1996
- ---------------------------------------------------------------------------------
<S> <C> <C>
(In thousands of dollars)
Insurance reserves.......................................... $ 24,961 $ 17,166
Deferred acquisition costs.................................. (33,374) (22,078)
Investment valuation........................................ 6,129 5,411
Net unrealized gains........................................ (2,359) (530)
Receivables................................................. (2,486) (646)
Other, net.................................................. 3,031 989
- ---------------------------------------------------------------------------------
NET DEFERRED TAX (LIABILITIES) ASSETS $ (4,098) $ 312
=================================================================================
</TABLE>
At December 31, 1997, gross deferred tax assets and liabilities amounted to
$35.1 million and $39.2 million, respectively. Gross deferred tax assets and
liabilities, at December 31, 1996, amounted to $24.9 million and $24.6 million,
respectively. VFL has not established a valuation reserve at December 31, 1996
as it believes that all deferred tax assets are fully realizable.
The components of income tax expense are as follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31 1997 1996 1995
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(In thousands of dollars)
Current tax expense......................................... $4,716 $5,719 $11,747
Deferred tax expense........................................ 2,581 3,309 453
- ---------------------------------------------------------------------------------------------
TOTAL INCOME TAX EXPENSE $7,297 $9,028 $12,200
=============================================================================================
</TABLE>
66
<PAGE> 71
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--CONTINUED
NOTE 6.--(CONTINUED):
The components of total income tax expense are allocated between operating
income and realized capital gains and losses in the following table.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31 1997 1996 1995
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(In thousands of dollars)
Income tax expense on:
Operating income.......................................... $5,827 $7,358 $ 7,376
Realized investment gains................................. 1,470 1,670 4,824
- ---------------------------------------------------------------------------------------------
TOTAL INCOME TAX EXPENSE $7,297 $9,028 $12,200
=============================================================================================
</TABLE>
A reconciliation of the statutory federal income tax rate on income is as
follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
% OF % OF % OF
PRETAX PRETAX PRETAX
YEAR ENDED DECEMBER 31 1997 INCOME 1996 INCOME 1995 INCOME
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
(In thousands of dollars)
Income taxes at statutory rates............................ $7,219 35.0 $9,011 35.0 $12,149 35.0
Other...................................................... 78 0.4 17 0.1 51 0.2
- ---------------------------------------------------------------------------------------------------------------------------
INCOME TAX AT EFFECTIVE RATES $7,297 35.4 $9,028 35.1 $12,200 35.2
===========================================================================================================================
</TABLE>
NOTE 7. REINSURANCE:
The ceding of insurance does not discharge 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. Such
collateral totaled approximately $0.1 million at both December 31, 1997 and
1996.
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 are from short duration contracts. The effects of reinsurance on
premium revenues are shown in the following schedule:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
PREMIUMS
----------------------------------------- ASSUMED/NET
YEAR ENDED DECEMBER 31 DIRECT ASSUMED CEDED NET %
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
(In thousands of dollars)
1997
Life.................................................... $564,891 $81,502 $567,217 $ 79,176 103%
Accident and Health..................................... 2,776 252,996 2,776 252,996 100
-------- -------- -------- -------- ---
Total premiums........................................ $567,667 $334,498 $569,993 $332,172 101%
======== ======== ======== ======== ===
1996
Life.................................................... $422,700 $72,718 $424,907 $ 70,511 103%
Accident and Health..................................... 1,080 254,975 1,080 254,975 100
-------- -------- -------- -------- ---
Total premiums........................................ $423,780 $327,693 $425,987 $325,486 101%
======== ======== ======== ======== ===
1995
Life.................................................... $316,011 $75,053 $316,577 $ 74,487 101%
Accident and Health..................................... 422 222,166 422 222,166 100
-------- -------- -------- -------- ---
Total premiums........................................ $316,433 $297,219 $316,999 $296,653 100%
===================================================================================================================
</TABLE>
67
<PAGE> 72
VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--CONTINUED
NOTE 7.--(CONTINUED)
Transactions with Assurance, as part of the pooling agreement described in
Note 1, are reflected in the above table. Premium revenues ceded to
non-affiliated companies were $116.2 million, $43.0 million and $9.9 million for
the years ended December 31, 1997, 1996 and 1995, respectively. Additionally,
insurance claims and policyholder benefits are net of reinsurance recoveries
from non-affiliated companies of $77.8 million, $7.0 million and $6.1 million
for the years ended December 31, 1997, 1996 and 1995, respectively.
Reinsurance receivables reflected on the balance sheet are recoverables
from reinsurers related to insurance reserves. These balances were approximately
$1.6 billion and $1.3 billion at December 31, 1997 and 1996, respectively, are
principally due from Assurance pursuant to the Reinsurance Pooling Agreement.
The impact of reinsurance, including transactions with Assurance, on life
insurance in force is shown in the following schedule:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
LIFE INSURANCE IN FORCE
--------------------------------------- ASSUMED/NET
DIRECT ASSUMED CEDED NET %
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
(In thousands of dollars)
December 31, 1997.......................................... $166,308 $25,557 $168,353 $23,512 108.7%
December 31, 1996.......................................... 108,126 22,085 109,873 20,338 108.6
December 31, 1995.......................................... 57,138 16,996 58,442 15,692 108.3
==================================================================================================================
</TABLE>
NOTE 8. RELATED PARTIES:
As discussed in Note 1, VFL is party to a pooling agreement with its
parent, Assurance. In addition, VFL is party to the CNA Intercompany Expense
Agreement whereby expenses incurred by CNAF and each of its subsidiaries are
allocated to the appropriate company. All acquisition and underwriting expenses
allocated to VFL are further subject to the Reinsurance Pooling Agreement with
Assurance, so that acquisition and underwriting expenses recognized by VFL
approximate ten percent of the combined acquisition and underwriting expenses of
VFL and Assurance. Pursuant to the foregoing agreements, VFL recorded
amortization of deferred acquisition costs and other operating expenses totaling
$45.3 million, $37.2 million and $41.1 million for 1997, 1996 and 1995,
respectively. Expenses of VFL exclude $9.9 million, $12.3 million and $5.5
million of general and administrative expenses incurred by VFL and allocated to
CNAF for the years ended December 31, 1997, 1996 and 1995, respectively. VFL had
a $36.0 million and $67.5 million affiliated receivable at December 31, 1997 and
1996, respectively, for net cash settlements due from Assurance in the normal
course of operations related to pooling and general expense reimbursements.
There are no interest charges on intercompany receivables or payables.
NOTE 9. LEGAL:
VFL is party to litigation arising 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.
68
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VALLEY FORGE LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS -- CONCLUDED
NOTE 10. BUSINESS SEGMENTS:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31 1997 1996 1995
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(In thousands of dollars)
REVENUES
Individual................................................ $ 72,204 $ 70,208 $ 69,577
Group..................................................... 296,753 292,807 263,388
Realized gains............................................ 4,200 4,771 13,783
---------- ---------- ----------
Total............................................... $ 373,157 $ 367,786 $ 346,748
========== ========== ==========
INCOME BEFORE INCOME TAX
Individual................................................ $ 9,952 $ 12,752 $ 8,611
Group..................................................... 6,475 8,224 12,316
Realized gains............................................ 4,200 4,771 13,783
---------- ---------- ----------
Total............................................... $ 20,627 $ 25,747 $ 34,710
========== ========== ==========
NET INCOME
Individual................................................ $ 6,345 $ 8,209 $ 5,597
Group..................................................... 4,255 5,409 7,954
Realized gains............................................ 2,730 3,101 8,959
---------- ---------- ----------
Total............................................... $ 13,330 $ 16,719 $ 22,510
========== ========== ==========
ASSETS
Individual................................................ $1,824,854 $1,522,900 $1,360,942
Group..................................................... 543,572 457,902 280,496
---------- ---------- ----------
Total............................................... $2,368,426 $1,980,802 $1,641,438
======================================================================================================
</TABLE>
Assets and investment income are allocated to business segments based on
cash flows after attribution of separately identifiable assets. Income taxes
have been allocated on the basis of taxable operating income of the respective
insurance segments.
Group revenues include $211.5 million, $210.1 million and $187.0 million
for the years ended December 31, 1997, 1996 and 1995, respectively, under
contracts covering U.S. government employees and their dependents ("FEHBP").
* * * *
69
<PAGE> 74
TABLE OF CONTENTS FOR THE STATEMENT OF ADDITIONAL INFORMATION
<TABLE>
<CAPTION>
<S> <C>
PERFORMANCE INFORMATION..................................... 1
Money Market Subaccount Yields............................ 1
Other Subaccount Yields................................... 2
Average Annual Total Returns.............................. 2
Other Total Returns....................................... 3
Effect of the Annual Administration Fee on Performance
Data................................................... 4
VARIABLE ANNUITY PAYMENTS................................... 4
Annuity Unit Value........................................ 4
Illustration of Calculation of Annuity Unit Value......... 4
Illustration of Variable Annuity Payments................. 5
VALUATION DAYS.............................................. 5
OTHER INFORMATION........................................... 5
FINANCIAL STATEMENTS........................................ 5
</TABLE>
70
<PAGE> 75
APPENDIX A
The Market Value Adjustment is computed by multiplying the amount being
surrendered, withdrawn, transferred or applied to an Annuity Payment Option, by
the Market Value Adjustment factor. The Market Value Adjustment factor is
calculated as follows:
Market Value Adjustment = Amount multiplied by
F11+A2 (N/12) G
----------------------------------------
1+B -1
Where:
"Amount" is the amount being surrendered, withdrawn, transferred or
applied to an Annuity Payment Option less any applicable annual
administration fees or transfer processing fees;
"a" is the Guaranteed Interest Rate currently being credited to the
"Amount"; and
"b" is the Guaranteed Interest Rate that is currently being offered
for a Guarantee Period of duration equal to the time remaining to the
expiration of the Guarantee Period for the Guarantee Amount from which the
"Amount" is taken. Where the time remaining to the expiration of the
Guarantee Period is not 1, 3, 5, 7, or 10 years, "b" is the rate found by
linear interpolation of the rate for the Guarantee Period having the
duration closest to the time remaining or, if the time remaining is less
than 1 year, "b" is the rate for a 1 year period; and
"n" is the number of complete months remaining before the expiration
of the Guarantee Period for the Guarantee Amount from which the "Amount" is
taken.
As an example of calculating "b" by linear interpolation, if the time
remaining to the expiration of the Guarantee Period is 4.5 years, the
interpolated Guaranteed Interest Rate is equal to the sum of one-fourth of the
three-year Guaranteed Interest Rate and three-fourths of the five-year
Guaranteed Interest Rate. If the three-year Guaranteed Interest Rate is 3.6% and
the five-year Guaranteed Interest Rate is 4%, the interpolated Guaranteed
Interest Rate equals 3.9%--that is, 3.6% multiplied by 0.25 plus 4% multiplied
by 0.75.
The Market Value Adjustment is computed as in the following examples:
1. Assume that the Owner selects a 7 year Guarantee Period and that the
Company is crediting a 3.75% effective annual interest rate on the amount
allocated or transferred to such Guarantee Period. Assume also that 55 months
into the 7-year Period (seven months into the fifth year), the Owner withdraws
$7,500.
If at the time of the withdrawal the Company is offering a 3.4% effective
annual rate of interest on Guarantee Periods of 3 years and a 3.0% effective
annual rate of interest on Guarantee Periods of 1 year, then:
a = 0.03750
b = 0.03283 = (0.034 * 17/24) + (0.03 * 7/24) = linear interpolation
between the 3 year rate and the 1 year rate
The MVA factor = F(1.03750)G(29/12)-1 = 0.01096
-------------------------------
(1.03283)
MVA = $7,500.00 * 0.01096 = $82.20 Amount received = $7,500 + $82.20 =
$7,582.20
If at the time of the withdrawal the Company is offering a 5.75% effective
annual rate of interest on Guarantee Periods of 3 years and a 6.5% effective
annual rate of interest on Guarantee Periods of 1 year, then:
a = 0.03750
b = 0.05969 = (0.0575 * 17/24) + (0.065 * 7/24) = linear interpolation
between the 3 year rate and the 1 year rate
The MVA factor = F(1.03750)G(29/12)-1 = -0.04986
-------------------------------
(1.05969)
MVA = $7,500.00 * -0.04986 = -$373.95
Amount received = $7,500 - $373.95 = $7,126.05
A-1
<PAGE> 76
APPENDIX B
Assume that an Owner makes purchase payments on the first day of certain
Contract Years as shown in the table below. Assume also that the Owner withdraws
$7,500 during the seventh month of Contract Year five and $5,000 at the
beginning of Contract Years thirteen and fifteen. Assume that the Annuitant is
younger than age 76 for all twenty years. All "beginning of year death benefits"
are computed as of the first day of the Contract Year except for the figure for
Contract Year 5 which is computed as of the seventh month of that year (i.e., as
of the time of the $7,500 withdrawal).
EXPLANATIONS:
The Death Benefit at the beginning of Contract Years 1 through 4 is
determined from the Contract Value at the end of the prior Contract Year plus
the purchase payment made at the beginning of the year for which the computation
is being made.
The Death Benefit at the end of month 7 of Contract Year 5 is determined
from the prior year's Contract Value plus the purchase payment made at the
beginning of that year, minus the $7,500 withdrawn in the seventh month minus a
$318.75 surrender charge assessed in connection with the withdrawal.
The Death Benefit at the beginning of Contract Years 6 through 10 is
determined from the Contract Value at the end of the prior Contract Year plus
the purchase payment made at the beginning of the Year for which the computation
is being made. Since the first day of Contract Year 6 is a minimum death benefit
floor computation anniversary, a new death benefit floor amount is set at
$8,506.
The Death Benefit at the beginning of Contract Year 11 is determined solely
from the prior Year's Contract Value. Since this is a minimum death benefit
floor computation anniversary, a new death benefit floor amount is set at
$42,610.
The Death Benefit at the beginning of Contract Year 12 is determined from
the minimum death benefit which is the most recently reset death benefit floor
amount of $42,610. This is so because the Contract Value declined and no
purchase payments or withdrawals occurred since the prior reset of the death
benefit floor amount.
The Death Benefit at the beginning of Contract Year 13 is determined from
the minimum death benefit which is the most recently reset death benefit floor
amount of $42,610 adjusted for the $5,000 withdrawal. The $36,762 results from
$42,610 being multiplied by $31,432/$36,432.
The Death Benefit at the beginning of Contract Year 14 is the minimum death
benefit which is the most recently reset death benefit floor amount adjusted for
the $5,000 withdrawal made since that floor amount was set, or $36,762.
The Death Benefit at the beginning of Contract Year 15 is the minimum death
benefit which is the most recently reset death benefit floor amount of $42,610
adjusted for both $5,000 withdrawals made since that floor amount was set. The
$28,372 results from $42,610 being multiplied by $31,432/$36,432, and this
result multiplied by $16,908/$21,908.
The Death Benefit at the beginning of Contract Year 16 is the minimum death
benefit which is the most recently reset death benefit floor amount of $42,610
adjusted for both $5,000 withdrawals made since that floor amount was set. The
$28,372 results from $42,610 being multiplied by $31,432/$36,432, and this
result multiplied by $16,908/$21,908. Even though this is a death benefit floor
computation anniversary, the death benefit floor amount is not reset since the
Contract Value has not exceeded its previous high of $42,610 occurring in
Contract Year 10. No purchase payments or withdrawals were made.
The Death Benefit at the beginning of Contract Year 17 through 20 is the
minimum death benefit which is the most recently reset death benefit floor
amount of $42,610 adjusted for both $5,000 withdrawals made
B-1
<PAGE> 77
since that floor amount was set and adjusted further for the $10,000 purchase
payment made on the first day of Contract Year 17.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
ACCUMULATED
BEGINNING OF NET END OF YEAR BEGINNING YEAR
CONTRACT PURCHASE PURCHASE ACCUMULATION END OF YEAR DEATH
YEAR PAYMENTS WITHDRAWALS PAYMENTS UNIT VALUE CONTRACT VALUE BENEFIT
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1 $ 2,000 $ 0 $ 2,000 10.50000 $ 2,100 $ 2,000
- -------------------------------------------------------------------------------------------------------------
2 $ 2,000 $ 0 $ 4,000 11.23500 $ 4,387 $ 4,100
- -------------------------------------------------------------------------------------------------------------
3 $ 2,500 $ 0 $ 6,500 12.13380 $ 7,438 $ 6,887
- -------------------------------------------------------------------------------------------------------------
4 $ 3,000 $ 0 $ 9,500 13.34718 $11.482 $10.438
- -------------------------------------------------------------------------------------------------------------
5 $ 4,000 $7,500 $ 6,000 14.81537 $ 8,506 $ 7,663
- -------------------------------------------------------------------------------------------------------------
6 $ 5,000 $ 0 $11,000 16.59321 $15,127 $13,506
- -------------------------------------------------------------------------------------------------------------
7 $ 5,000 $ 0 $16,000 18.25254 $22,139 $20,127
- -------------------------------------------------------------------------------------------------------------
8 $ 5,000 $ 0 $21,000 19.71274 $29,310 $27,139
- -------------------------------------------------------------------------------------------------------------
9 $ 5,000 $ 0 $26,000 20.89550 $36,369 $34,310
- -------------------------------------------------------------------------------------------------------------
10 $ 5,000 $ 0 $31,000 21.52237 $42,610 $41,369
- -------------------------------------------------------------------------------------------------------------
11 $ 0 $ 0 $31,000 20.44625 $40,480 $42,610
- -------------------------------------------------------------------------------------------------------------
12 $ 0 $ 0 $31,000 18.40162 $36,432 $42,610
- -------------------------------------------------------------------------------------------------------------
13 $ 0 $5,000 $26,000 15.64138 $26,717 $36,762
- -------------------------------------------------------------------------------------------------------------
14 $ 0 $ 0 $26,000 12.82593 $21,908 $36,762
- -------------------------------------------------------------------------------------------------------------
15 $ 0 $5,000 $21,000 13.46723 $17,753 $28,372
- -------------------------------------------------------------------------------------------------------------
16 $ 0 $ 0 $21,000 14.14059 $18,641 $28,372
- -------------------------------------------------------------------------------------------------------------
17 $10,000 $ 0 $31,000 14.14059 $28,641 $38,372
- -------------------------------------------------------------------------------------------------------------
18 $ 0 $ 0 $31,000 13.43356 $27,209 $38,372
- -------------------------------------------------------------------------------------------------------------
19 $ 0 $ 0 $31,000 13.43356 $27,209 $38,372
- -------------------------------------------------------------------------------------------------------------
20 $ 0 $ 0 $31,000 13.97090 $28,297 $38,372
- -------------------------------------------------------------------------------------------------------------
</TABLE>
B-2
<PAGE> 78
STATEMENT OF ADDITIONAL INFORMATION
FLEXIBLE PREMIUM DEFERRED VARIABLE ANNUITY CONTRACT
ISSUED BY
VALLEY FORGE LIFE INSURANCE COMPANY
AND
VALLEY FORGE LIFE INSURANCE COMPANY VARIABLE ANNUITY
SEPARATE ACCOUNT
THIS STATEMENT OF ADDITIONAL INFORMATION, DATED MAY 1, 1998 IS NOT A
PROSPECTUS. THIS STATEMENT OF ADDITIONAL INFORMATION SHOULD BE READ IN
CONJUNCTION WITH THE PROSPECTUS DATED MAY 1, 1998 FOR THE VALLEY FORGE LIFE
INSURANCE COMPANY FLEXIBLE PREMIUM DEFERRED VARIABLE ANNUITY CONTRACT WHICH IS
REFERRED TO HEREIN.
THE PROSPECTUS SETS FORTH INFORMATION THAT A PROSPECTIVE INVESTOR SHOULD
KNOW BEFORE PURCHASING A CONTRACT. FOR A COPY OF THE PROSPECTUS, SEND A WRITTEN
REQUEST TO THE SERVICE CENTER AT P.O. BOX 305139, NASHVILLE, TENNESSEE
37230-5139 OR BY TELEPHONE 1-800-262-1755.
<PAGE> 79
TABLE OF CONTENTS
<TABLE>
<S> <C>
PERFORMANCE INFORMATION..................................... 1
Money Market Subaccount Yields............................ 1
Other Subaccount Yields................................... 2
Average Annual Total Returns.............................. 2
Other Total Returns....................................... 3
Effect of the Annual Administration Fee on Performance
Data................................................... 4
VARIABLE ANNUITY PAYMENTS................................... 4
Annuity Unit Value........................................ 4
Illustration of Calculation of Annuity Unit Value......... 4
Illustration of Variable Annuity Payments................. 5
VALUATION DAYS.............................................. 5
OTHER INFORMATION........................................... 5
FINANCIAL STATEMENTS........................................ 5
</TABLE>
i
<PAGE> 80
PERFORMANCE INFORMATION
From time to time, the Company may disclose yields, total returns, and
other performance data pertaining to the Contracts for a Subaccount. Such
performance data will be computed, or accompanied by performance data computed,
in accordance with the standards defined by the SEC.
Because of the charges and deductions imposed under a Contract, the yield
for the Subaccounts will be lower than the yield for their respective Funds. The
calculation of yields, total returns and other performance data do not reflect
the effect of any premium tax that may be applicable to a particular Contract.
Premium taxes currently range generally from 0% to 3.5% of the annuity
considerations (purchase payments) based on the jurisdiction is which the
Contract is sold.
MONEY MARKET SUBACCOUNT YIELDS
From time to time, sales literature or advertisements may quote the current
annualized yield of the Money Market Subaccount for a seven-day period in a
manner that does not take into consideration any realized or unrealized gains or
losses on shares of the Money Market Fund or on that Fund's portfolio
securities.
This current annualized yield is computed by determining the net change
(exclusive of realized gains and losses on the sale of securities and unrealized
appreciation and depreciation) at the end of the seven-day period in the value
of a hypothetical account under a Contract having a balance of one unit of the
Money Market Subaccount at the beginning of the period, dividing such net change
in account value by the value of the hypothetical account at the beginning of
the period to determine the base period return, and annualizing this quotient on
a 365-day basis. The net change in account value reflects: 1) net income from
the Subaccount attributable to the hypothetical account; and 2) charges and
deductions imposed under the Contract that are attributable to the hypothetical
account. The charges and deductions include the per unit charges for the
hypothetical account for: 1) the annual administration fee; 2) the mortality and
expense risk charge; and 3) the asset-based administration charge. For purposes
of calculating current yields for a Contract, an average per unit annual
administration fee is used based on the $30 annual administration fee deducted
for the prior Contract Year of the Contract Anniversary. Current Yield is
calculated according to the following formula:
Current Yield = ((NCS - ES)/UV) X (365/7)
Where:
NCS = the net change in the value of the Money Market Subaccount
(exclusive of realized gains or losses on the sale of
securities and unrealized appreciation and depreciation) for the
seven-day period attributable to a hypothetical account having a
balance of 1 Subaccount unit.
ES = Per unit expenses attributable to the hypothetical account
for the seven-day period.
UV = The unit value for the first day of the seven-day period.
Effective Yield = (1 + (NCS - ES)/UV) 365/7 - 1
Where:
NCS = the net change in the value of the Money Market Subaccount
(exclusive of realized gains or losses on the sale of securities and
unrealized appreciation and depreciation) for the seven-day
period attributable to a hypothetical account having a balance of 1
Subaccount unit.
ES = per unit expenses attributable to the hypothetical account
for the seven-day period.
UV = the unit value for the first day of the seven-day period.
Because of the charges and deductions imposed under the Contract, the yield for
the Money Market Subaccount is lower than the yield for the Money Market Fund.
1
<PAGE> 81
The current and effective yields on amounts held in the Money Market
Subaccount normally fluctuate on a daily basis. THEREFORE, THE DISCLOSED YIELD
FOR ANY GIVEN PAST PERIOD IS NOT AN INDICATION OR REPRESENTATION OF FUTURE
YIELDS OR RATES OF RETURN. The Money Market Subaccount's actual yield is
affected by changes in interest rates on money market securities, average
portfolio maturity of the Money Market Fund, the types and quality of portfolio
securities held by the Fund and the Fund's operating expenses. Yields on amounts
held in the Money Market Subaccount may also be presented for periods other than
a seven-day period.
Yield calculations do not take into account the surrender charge under the
Contract equal to 4% to 7% of certain purchase payments during the five full
years between the date of receipt of the purchase payment and the date of
surrender or withdrawal.
OTHER SUBACCOUNT YIELDS
From time to time, sales literature or advertisements may quote the current
annualized yield of one or more of the Subaccounts (except the Money Market
Subaccount) for a Contract for 30-day or one-month periods. The annualized yield
of a Subaccount refers to income generated by the Subaccount during a 30-day or
one-month period and is assumed to be generated each period over a 12-month
period.
The yield is computed by 1) dividing the net investment income of the Fund
attributable to the Subaccount units less Subaccount expenses for the period; by
2) the maximum offering price per unit on the last day of the period times the
daily average number of units outstanding for the period; by 3) compounding that
yield for a six-month period; and by 4) multiplying that result by 2. Expenses
attributable to the Subaccount include the annual administration fee, the
asset-based administration charge and the mortality and expense risk charge. The
yield calculation assumes an annual administration fee of $30 per year per
Contract deducted for the prior Contract Year as of the Contract Anniversary.
For purposes of calculating the 30-day or one-month yield, an average
administration fee based on the average Variable Account Value is used to
determine the amount of the charge attributable to the Subaccount for the 30-day
or one-month period. The 30-day or one-month yield is calculated according to
the following formula:
Yield = 2 X (((NI - ES)/(U X UV) + 1) 6 - 1)
Where:
NI = net income of the Fund for the 30-day or one-month period
attributable to the Subaccount's units.
ES = expenses of the Subaccount for the 30-day or one-month
period.
U = the average number of units outstanding.
UV = the unit value at the close (highest) of the last day in the
30-day or one-month period.
Because of the charges and deductions imposed under the Contracts, the yield for
the Subaccount is lower than the yield for the corresponding Fund.
The yield on the amounts held in the Subaccounts normally fluctuates over
time. THEREFORE, THE DISCLOSED YIELD FOR ANY GIVEN PAST PERIOD IS NOT AN
INDICATION OR REPRESENTATION OF FUTURE YIELDS OR RATES OF RETURN. A subaccount's
actual yield is affected by the types and quality of the securities held by the
corresponding Fund and that Fund's operating expenses.
Yield calculations do not take into account the surrender charge under the
Contract equal to 4% to 7% of certain purchase payments during the five full
years between the date of receipt of the purchase payment and the date of
surrender or withdrawal.
AVERAGE ANNUAL TOTAL RETURNS
From time to time, sales literature or advertisements may quote standard
average annual total returns for one or more of the Subaccounts for Various
periods of time.
2
<PAGE> 82
When a Subaccount or Fund has been in operation for 1, 5, and 10 years,
respectively, the standard average annual total return for these periods will be
provided. Average annual total returns for other periods of time may, from time
to time, also be disclosed.
Standard average annual total returns represent the average annual
compounded rates of return that would equate an initial investment of $1,000
under a Contract to the redemption value of that investment as of the last day
of each of the periods. The ending date for each period for which total return
quotations are provided will be for the most recent calendar quarter-end
practicable, considering the type of the communication and the media through
which it is communicated.
Standard average annual total returns are calculated using Subaccount unit
values which the Company calculates on each Valuation Day based on the
performance of the Subaccount's underlying Fund, the deductions for the
mortality and expense risk charge, and the deductions for the asset-based
administration charge and the annual administration fee. The calculation assumes
that the annual administration fee is $30 per year per Contract deducted for the
prior Contract Year as of the Contract Anniversary. For purposes of calculating
standard average annual total return, an average per-dollar per-day annual
administration fee attributable to the hypothetical account for the period is
used. The calculation also assumes surrender of the Contract at the end of the
period for the return quotation. Standard average annual total returns will
therefore reflect a deduction of the surrender charge for any period less than
six years. The standard average annual total return is calculated according to
the following formula:
TR = ((ERV/P 1/N) - 1
Where:
TR = the average annual total return net of Subaccount recurring
charges.
ERV = the ending redeemable value (net of any applicable surrender
charge) of the hypothetical account at the end of the period.
P = a hypothetical initial payment of $1,000.
N = the number of years in the period.
From time to time, sales literature or advertisements any quote standard average
annual total returns for periods prior to the date the Variable Account
commenced operations. Such performance information for the Subaccounts is
calculated based on the performance of the various Funds and the assumption that
the Subaccounts were in existence for the same periods as those indicated for
the Funds, with the level of Contract charges that were in effect at the
inception of the Subaccounts.
Fund total return information used to calculate the standard average annual
total returns of the Subaccounts for periods prior to the inception of the
Subaccounts has been provided by the Funds. The Funds are not affiliated with
the Company. While the Company has no reason to doubt the accuracy of these
figures provided by the Funds, the Company has not independently verified the
accuracy of these figures.
OTHER TOTAL RETURNS
From time to time, sales literature or advertisements may also quote
average annual total returns that do not reflect the surrender charge. These are
calculated in exactly the same way as standard average annual total returns
described above, except that the ending redeemable value of the hypothetical
account for the period is replaced with an ending value for the period that does
not take into account any charges on amounts surrendered or withdrawn.
3
<PAGE> 83
The company may disclose cumulative total returns in conjunction with the
standard formats described above. The cumulative total returns will be
calculated using the following formula:
CTR = (ERV/P) - 1
Where:
CTR = The cumulative total return net of Subaccount recurring
charges for the period.
ERV = The ending redeemable value of the hypothetical investment
at the end of the period.
P = A hypothetical single payment of $1,000.
EFFECT OF THE ANNUAL ADMINISTRATION FEE ON PERFORMANCE DATA
The Contract provides for a $30 annual administration fee to be deducted
annually for each prior Contract Year as of the Contract Anniversary, from the
Subaccount Values and Guarantee Amounts based on the proportion that each bears
to the Contract Value. For purposes of reflecting the change in yield and total
return quotations, the charge is converted into a per-dollar per-day charge
based on the average Subaccount Value and Guarantee Amount of all Contracts on
the last day of the period for which quotations are provided. The per-dollar
per-day average charge will then be adjusted to reflect the basis upon which the
particular quotation is calculated.
VARIABLE ANNUITY PAYMENTS
ANNUITY UNIT VALUE
The value of an Annuity Unit is calculated at the same time that the value
of an Accumulation Unit is calculated and is based on the same values for Fund
shares and other assets and liabilities. (See "Annuity Payments" in the
Prospectus.) The Annuity Unit Value for each Subaccount's first Valuation Period
was set at $10. The Annuity Unit Value for a Subaccount for each subsequent
Valuation Period is equal to (a) multiplied by (b) divided by (c) where:
(a) is the Net Investment Factor for the Valuation Period for which the
Annuity Unit Value is being calculated;
(b) is the Annuity Unit Value for the preceding Valuation Period; and
(c) is a daily Benchmark Rate of Return factor (for the 3% benchmark rate
of return) adjusted for the number of days in the Valuation Period.
The Benchmark Rate of Return factor is equal to one plus 3%, or 1.03. The
annual factor can be translated into a daily factor of 1.00008098.
The following illustrations show, by use of hypothetical examples, the
method of determining the Annuity Unit Value and the amount of several Variable
Annuity Payments based on one Subaccount.
ILLUSTRATION OF CALCULATION OF ANNUITY UNIT VALUE
<TABLE>
<C> <S> <C>
1. Annuity Unit Value for immediately preceding Valuation
Period...................................................... 10.00000000
2. Net Investment factor....................................... 1.00036164
3. Daily factor to compensate for Benchmark Rate of Return of
3%.......................................................... 1.00008099
4. Adjusted Net Investment Factor (2)/(3)...................... 1.00028063
5. Annuity Unit Value for current Valuation Period (4)X(1)..... 10.00280630
</TABLE>
4
<PAGE> 84
ILLUSTRATION OF VARIABLE ANNUITY PAYMENTS
(ASSUMING NO PREMIUM TAX IS APPLICABLE)
<TABLE>
<C> <S> <C>
1. Number of Accumulation Units at Annuity Date................ 1,000.00
2. Accumulation Unit Value..................................... 12.55548000
3. Adjusted Contract Value (1)X(2)............................. $ 12,555.48
4. First monthly Annuity Payment per $1,000 of adjusted
Contract Value.............................................. 9.63
5. First monthly Annuity Payment (3)X(4)/1,000................. $ 120.91
6. Annuity Unit Value.......................................... 10.00280630
7. Number of Annuity Units (5)/(6)............................. 12.08760785
8. Assume Annuity Unit value for second month equal to......... 10.04000000
9. Second Monthly Annuity Payment (7)X(8)...................... $ 121.36
10. Assume Annuity Unit Value for third month equal to.......... 10.05000000
11. Third Monthly Annuity Payment (7)X(10)...................... $ 121.48
</TABLE>
VALUATION DAYS
As defined in the prospectus, for each Subaccount a Valuation Day is each
day on which the New York Stock Exchange is open for business, except for
certain holidays listed in the prospectus and days that a Subaccount's
corresponding Fund does not value its shares.
OTHER INFORMATION
A registration statement has been filed with the SEC under the Securities
Act of 1933, as amended, with respect to the Contracts discussed in this
Statement of Additional Information. Not all the information set forth in the
registration statement, amendments and exhibits thereto has been included in
this Statement of Additional Information. Statements contained in this Statement
of Additional Information concerning the content of the Contracts and other
legal instruments are summaries. For a complete statement of the terms of these
documents, reference should be made to the instruments filed with the SEC.
FINANCIAL STATEMENTS
Financial statements of the Company are presented in the prospectus. The
following financial statements are of the Valley Forge Life Insurance Company
Variable Annuity Separate Account.
5
<PAGE> 85
[THIS PAGE INTENTIONALLY LEFT BLANK]
6
<PAGE> 86
- --------------------------------------------------------------------------------
Dear Contractholder:
- --------------------------------------------------------------------------------
Thank you for including the CNA Capital Select family of products in your
portfolio of long-range financial planning vehicles. Enclosed is the Annual
Report for the CNA Capital Select Variable Annuity, which is issued by Valley
Forge Life Insurance Company, one of the CNA insurance companies. This report
summarizes investments (from inception through December 31, 1997) under each of
the 18 variable fund subaccounts available through the CNA Capital Select
Variable Annuity.* The subaccounts are offered by six widely recognized fund
managers:
- Federated Advisors
- Fidelity Management & Research Company
- Fred Alger Management, Inc.
- Massachusetts Financial Services Company (MFS)
- Societe Generale Asset Management Corporation (SoGen)
- Van Eck Associates Corporation
The full list of subaccounts is found in the Notes to Financial Statements,
Note 1. Organization, included within this report.
This year we will be adding (at no additional cost to contractholders)
enhancements that make our variable annuity an even more attractive product.
These will include an improved Guaranteed Minimum Death Benefit, a Dollar Cost
Averaging interest bonus and a more flexible free partial withdrawal schedule.**
And you still get the full complement of benefits that have helped distinguish
our annuity from the beginning:
- Tax deferral allows all of your money to work for you (instead of just an
after-tax portion);
- Free transfer (up to a total of 12 per year) are available among
subaccounts and fixed accounts (four of the 12 free transfers can apply
to fixed accounts);
- Product flexibility that allows you to change the amount and frequency of
premium payments according to your changing needs -- plus there's a low
minimum of just $100 for subsequent contributions;
- Features like Automatic Subaccount Rebalancing and Dollar Cost Averaging
allow you to maintain the kind of fund mix you prefer.
If you need more information, please refer to your prospectus. If you can't
find it or need additional copy, your agent will be happy to order one for you.
If you have other needs, as well as questions or suggestions, call your agent --
or let us hear from you directly. We'll do everything we can to help, because we
want our ongoing relationship to be as positive for you as it is for us. Again,
thank you for purchasing a CNA Capital Select Variable Annuity, one of the many
quality products available through the CNA family of products.
Sincerely,
ALAN S. LURTY
Alan S. Lurty, FLMI
Senior Vice President and
Chief Operating Officer, Annuities
* Although guaranteed-interest options are available in connection with the CNA
Capital Select Variable Annuity financial reports regarding these fixed-interest
funds are not included in this report.
** It's important to remember that any withdrawals prior to age 59 1/2 can
result in government-imposed taxes and tax penalties.
7
<PAGE> 87
STATEMENT OF ASSETS AND LIABILITIES
VALLEY FORGE LIFE INSURANCE COMPANY
VARIABLE ANNUITY SEPARATE ACCOUNT
================================================================================
<TABLE>
<CAPTION>
FEDERATED FEDERATED FEDERATED FIDELITY FIDELITY
PRIME MONEY UTILITY HIGH INCOME EQUITY- ASSET FIDELITY FIDELITY
DECEMBER 31, 1997 FUND II FUND II BOND FUND II INCOME MANAGER INDEX 500 CONTRAFUND
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS:
Investments, at market value:
Federated Insurance Series $861,084 $50,683 $190,479
Variable Insurance Products Fund $495,969
Variable Insurance Products Fund II $267,366 $562,885 $329,066
The Alger American Fund
MFS Variable Insurance Trust
SoGen Variable Funds, Inc.
Van Eck Worldwide Insurance Trust
-------- ------- -------- -------- -------- -------- --------
TOTAL INVESTMENTS 861,084 50,683 190,479 495,969 267,366 562,885 329,066
-------- ------- -------- -------- -------- -------- --------
TOTAL ASSETS 861,084 50,683 190,479 495,969 267,366 562,885 329,066
-------- ------- -------- -------- -------- -------- --------
LIABILITIES - - - - - - -
- ---------------------------------------------------------------------------------------------------------------------------------
PARTICIPANTS' EQUITY--NET ASSETS $861,084 $50,683 $190,479 $495,969 $267,366 $562,885 $329,066
=================================================================================================================================
</TABLE>
See accompanying Notes to Financial Statements
8
<PAGE> 88
STATEMENT OF ASSETS AND LIABILITIES
VALLEY FORGE LIFE INSURANCE COMPANY
VARIABLE ANNUITY SEPARATE ACCOUNT
================================================================================
<TABLE>
<CAPTION>
MFS SOGEN VAN ECK VAN ECK
ALGER ALGER MFS GROWTH MFS MFS OVERSEAS WORLDWIDE WORLDWIDE
SMALL ALGER MID-CAP EMERGING MFS WITH LIMITED TOTAL VARIABLE HARD EMERGING
CAP GROWTH GROWTH GROWTH RESEARCH INCOME MATURITY RETURN FUND ASSETS MARKETS
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$195,731 $249,383 $42,427
$141,648 $156,415 $219,017 $81,706 $259,844
$752,892
$9,037 $16,890
- -------- -------- ------- -------- -------- -------- ------- -------- -------- ------ -------
195,731 249,383 42,427 141,648 156,415 219,017 81,706 259,844 752,892 9,037 16,890
- -------- -------- ------- -------- -------- -------- ------- -------- -------- ------ -------
195,731 249,383 42,427 141,648 156,415 219,017 81,706 259,844 752,892 9,037 16,890
- -------- -------- ------- -------- -------- -------- ------- -------- -------- ------ -------
- - - - - - - - - - -
- -------- -------- ------- -------- -------- -------- ------- -------- -------- ------ -------
$195,731 $249,383 $42,427 $141,648 $156,415 $219,017 $81,706 $259,844 $752,892 $9,037 $16,890
========================================================================================================================
<CAPTION>
TOTAL
- ----------
<S><C>
$1,102,246
495,969
1,159,317
487,541
858,630
752,892
25,927
- ----------
4,882,522
- ----------
4,882,522
- ----------
-
- ----------
$4,882,522
</TABLE>
See accompanying Notes to Financial Statements
9
<PAGE> 89
STATEMENT OF OPERATIONS
VALLEY FORGE LIFE INSURANCE COMPANY
VARIABLE ANNUITY SEPARATE ACCOUNT
================================================================================
<TABLE>
<CAPTION>
FEDERATED FEDERATED FEDERATED HIGH FIDELITY
FOR THE PERIOD FROM INCEPTION TO PRIME MONEY UTILITY INCOME BOND FIDELITY ASSET FIDELITY FIDELITY
DECEMBER 31, 1997 FUND II FUND II FUND II EQUITY-INCOME MANAGER INDEX 500 CONTRAFUND
<S> <C> <C> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
MAR. 4, MAR. 17, MAY 1, FEB. 21, FEB. 21, MAR. 17, FEB. 21,
INCEPTION DATE 1997 1997 1997 1997 1997 1997 1997
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Investment income:
Dividend income $21,053 $ 82 $1,192 $- $ - $ - $-
------- ------ ------ ------- ------- ------- ------
21,053 82 1,192 - - - -
------- ------ ------ ------- ------- ------- ------
Expenses:
Mortality and expense risk
and administration charges 5,938 150 647 1,842 1,397 1,805 917
------- ------ ------ ------- ------- ------- ------
5,938 150 647 1,842 1,397 1,805 917
------- ------ ------ ------- ------- ------- ------
NET INVESTMENT INCOME
(LOSS) 15,115 (68) 545 (1,842) (1,397) (1,805) (917)
------- ------ ------ ------- ------- ------- ------
Investment gains (losses):
Net realized gains (losses) - 85 1,461 18,226 11,160 9,302 3,732
Net unrealized gains (losses) - 4,190 3,915 6,272 1,593 19,813 4,074
------- ------ ------ ------- ------- ------- ------
NET REALIZED AND
UNREALIZED INVESTMENT
GAINS (LOSSES) - 4,275 5,376 24,498 12,753 29,115 7,806
- ------------------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN
PARTICIPANTS' EQUITY RESULTING
FROM OPERATIONS $15,115 $4,207 $5,921 $22,656 $11,356 $27,310 $6,889
==============================================================================================================================
</TABLE>
See accompanying Notes to Financial Statements
10
<PAGE> 90
STATEMENT OF OPERATIONS
VALLEY FORGE LIFE INSURANCE COMPANY
VARIABLE ANNUITY SEPARATE ACCOUNT
================================================================================
<TABLE>
<CAPTION>
MFS SOGEN VAN ECK VAN ECK
ALGER ALGER MFS GROWTH MFS MFS OVERSEAS WORLDWIDE WORLDWIDE
SMALL ALGER MID-CAP EMERGING MFS WITH LIMITED TOTAL VARIABLE HARD EMERGING
CAP GROWTH GROWTH GROWTH RESEARCH INCOME MATURITY RETURN FUND ASSETS MARKETS TOTAL
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
APR. 3, JUN. 17, FEB. 21, FEB. 21, FEB. 21, MAR. 13, MAY 1, FEB. 21, FEB. 3, APR. 3, APR. 11,
1997 1997 1997 1997 1997 1997 1997 1997 1997 1997 1997
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
51
$ $ - $ 89 $ - $ - $ 5,132 $ 3,140 $ - $ - $- $ - $30,739
- -------- ------- ------- ------ ------ ------- ------- ------- -------- ----- ------- -------
51 - 89 - - 5,132 3,140 - - - - 30,739
- -------- ------- ------- ------ ------ ------- ------- ------- -------- ----- ------- -------
661 621 199 692 969 792 470 1,259 8,364 20 94 26,837
- -------- ------- ------- ------ ------ ------- ------- ------- -------- ----- ------- -------
661 621 199 692 969 792 470 1,259 8,364 20 94 26,837
- -------- ------- ------- ------ ------ ------- ------- ------- -------- ----- ------- -------
(610) (621) (110) (692) (969) 4,340 2,670 (1,259) (8,364) (20) (94) 3,902
- -------- ------- ------- ------ ------ ------- ------- ------- -------- ----- ------- -------
5,548 732 1,490 122 3,145 2,986 1,202 5,264 7,592 11 (404) 71,654
(13,637) (8,997) (1,453) 3,958 5,519 5,310 (1,986) 11,648 (34,846) (189) (4,665) 519
- -------- ------- ------- ------ ------ ------- ------- ------- -------- ----- ------- -------
)
(8,089 (8,265) 37 4,080 8,664 8,296 (784) 16,912 (27,254) (178) (5,069) 72,173
- ---------------------------------------------------------------------------------------------------------------------------------
$(8,699) $(8,886) $ (73) $3,388 $7,695 $12,636 $ 1,886 $15,653 $(35,618) $(198) $(5,163) $76,075
=================================================================================================================================
</TABLE>
See accompanying Notes to Financial Statements
11
<PAGE> 91
STATEMENT OF CHANGES IN NET ASSETS
VALLEY FORGE LIFE INSURANCE COMPANY
VARIABLE ANNUITY SEPARATE ACCOUNT
================================================================================
<TABLE>
<CAPTION>
FEDERATED FEDERATED FEDERATED FIDELITY FIDELITY
FOR THE PERIOD FROM INCEPTION TO PRIME MONEY UTILITY HIGH INCOME EQUITY- ASSET FIDELITY FIDELITY
DECEMBER 31, 1997 FUND II FUND II BOND FUND II INCOME MANAGER INDEX 500 CONTRAFUND
<S> <C> <C> <C> <C> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
MAR. 4, MAR. 17, MAY 1, FEB. 21, FEB. 21, MAR. 17, FEB. 21,
INCEPTION DATE 1997 1997 1997 1997 1997 1997 1997
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
From operations:
Net investment income (loss) $ 15,115 $ (68) $ 545 $ (1,842) $ (1,397) $ (1,805) $ (917)
Net realized gains (losses) - 85 1,461 18,226 11,160 9,302 3,732
Net unrealized gains (losses) - 4,190 3,915 6,272 1,593 19,813 4,074
----------- -------- --------- --------- --------- -------- ---------
Change in net assets resulting from
operations 15,115 4,207 5,921 22,656 11,356 27,310 6,889
From capital transactions:
Net premiums 3,534,379 22,534 116,421 427,889 186,728 444,865 146,548
Withdrawals (6,610) - (507) (701) (12) (704) -
Transfers among sub-accounts and with
the Guaranteed Interest Option
Separate Account -- net (2,681,800) 23,942 68,644 46,125 69,294 91,414 175,629
----------- -------- --------- --------- --------- -------- ---------
Change in net assets resulting from
capital transactions 845,969 46,476 184,558 473,313 256,010 535,575 322,177
Increase in net assets during period 861,084 50,683 190,479 495,969 267,366 562,885 329,066
Net assets at beginning of period - - - - - - -
- ---------------------------------------------------------------------------------------------------------------------------------
NET ASSETS AT END OF PERIOD $ 861,084 $ 50,683 $ 190,479 $ 495,969 $ 267,366 $562,885 $ 329,066
- ---------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE PER UNIT AT END OF
PERIOD $ 1.00 $ 14.29 $ 10.95 $ 24.28 $ 18.01 $ 114.39 $ 19.94
=================================================================================================================================
UNITS OUTSTANDING AT END OF PERIOD 861,083.8 3,546.7 17,395.3 20,427.1 14,845.4 4,920.8 16,502.8
=================================================================================================================================
</TABLE>
See accompanying Notes to Financial Statements
12
<PAGE> 92
STATEMENT OF CHANGES IN NET ASSETS
VALLEY FORGE LIFE INSURANCE COMPANY
VARIABLE ANNUITY SEPARATE ACCOUNT
================================================================================
<TABLE>
<CAPTION>
MFS SOGEN VAN ECK VAN ECK
ALGER ALGER MFS GROWTH MFS MFS OVERSEAS WORLDWIDE WORLDWIDE
SMALL ALGER MID-CAP EMERGING MFS WITH LIMITED TOTAL VARIABLE HARD EMERGING
CAP GROWTH GROWTH GROWTH RESEARCH INCOME MATURITY RETURN FUND ASSETS MARKETS
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
APR. 3, JUN. 17, FEB. 21, FEB. 21, FEB. 21, MAR. 13, MAY 1, FEB. 21, FEB. 3, APR. 3, APR. 11,
1997 1997 1997 1997 1997 1997 1997 1997 1997 1997 1997
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ (610) $ (621) $ (110) $ (692) $ (969) $ 4,340 $ 2,670 $ (1,259) $ (8,364) $ (20) $ (94)
5,548 732 1,490 122 3,145 2,986 1,202 5,264 7,592 11 (404)
(13,637) (8,997) (1,453) 3,958 5,519 5,310 (1,986) 11,648 (34,846) (189) (4,665)
- -------- -------- ------- --------- --------- --------- --------- --------- ---------- ------ -------
(8,699) (8,886) (73) 3,388 7,695 12,636 1,886 15,653 (35,618) (198) (5,163)
186,908 203,646 38,097 99,654 121,533 124,921 75,938 186,723 819,873 4,326 19,999
- - - - - - (960) (786) (959) - -
17,522 54,623 4,403 38,606 27,187 81,460 4,842 58,254 (30,404) 4,909 2,054
- -------- -------- ------- --------- --------- --------- --------- --------- ---------- ------ -------
204,430 258,269 42,500 138,260 148,720 206,381 79,820 244,191 788,510 9,235 22,053
195,731 249,383 42,427 141,648 156,415 219,017 81,706 259,844 752,892 9,037 16,890
- - - - - - - - - - -
- ------------------------------------------------------------------------------------------------------------------------------
$195,731 $249,383 $42,427 $ 141,648 $ 156,415 $ 219,017 $ 81,706 $ 259,844 $ 752,892 $9,037 $16,890
- ------------------------------------------------------------------------------------------------------------------------------
$ 43.75 $ 42.76 $24.18 $ 16.14 $ 15.79 $ 16.44 $ 10.01 $ 16.63 $ 9.77 $15.72 $ 11.00
==============================================================================================================================
4,473.8 5,832.2 1,754.7 8,776.2 9,906.0 13,322.2 8,162.4 15,625.0 77,061.7 574.9 1,535.5
==============================================================================================================================
<CAPTION>
TOTAL
- ----------
<S><C>
$ 3,902
71,654
519
- ----------
76,075
6,760,982
(11,239)
(1,943,296)
- ----------
4,806,447
4,882,522
-
- ----------
$4,882,522
- ----------
</TABLE>
See accompanying Notes to Financial Statements
13
<PAGE> 93
NOTES TO FINANCIAL STATEMENTS
VALLEY FORGE LIFE INSURANCE COMPANY
VARIABLE ANNUITY SEPARATE ACCOUNT
PERIOD FROM INCEPTION TO DECEMBER 31, 1997
================================================================================
NOTE 1. ORGANIZATION
- --------------------------------------------------------------------------------
Valley Forge Life Insurance Company Variable Annuity Separate Account
("Variable Account"), a unit investment trust registered with the Securities and
Exchange Commission under the Investment Company Act of 1940, is a separate
account of Valley Forge Life Insurance Company ("VFL"). The Variable Account
began operations on February 3, 1997. The assets of the Variable Account are
segregated from VFL's general account and its other separate accounts. VFL is a
wholly-owned subsidiary of Continental Assurance Company ("Assurance").
Assurance is a wholly-owned subsidiary of Continental Casualty Company
("Casualty"), which is wholly-owned by CNA Financial Corporation ("CNA"). Loews
Corporation owns approximately 84% of the outstanding common stock of CNA.
The Variable Account currently offers 18 sub-accounts each of which invests
in shares of a corresponding fund (i.e., investment portfolios), wherein the
contractholders bear all of the investment risk. Each fund is either an open-end
diversified management investment company or a separate investment portfolio of
such a company and is managed by a registered investment advisor. The
sub-accounts are as follows:
FEDERATED INSURANCE SERIES:
Federated Prime Money
Fund II
Federated Utility Fund II
Federated High Income
Bond Fund II
FIDELITY VARIABLE INSURANCE
PRODUCTS FUND (VIP):
Fidelity VIP Equity-
Income Portfolio
FIDELITY VARIABLE INSURANCE
PRODUCTS FUND II (VIP II):
Fidelity VIP II Asset
Manager Portfolio
Fidelity VIP II Index 500
Portfolio
Fidelity VIP II Contrafund
Portfolio
ALGER AMERICAN FUND:
Alger American Small
Capitalization Portfolio
Alger American Growth
Portfolio
Alger American Mid-Cap
Growth Portfolio
MFS VARIABLE INSURANCE TRUST:
MFS Emerging Growth
Series
MFS Research Series
MFS Growth With Income
Series
MFS Limited Maturity
Series
MFS Total Return Series
SOGEN VARIABLE FUNDS, INC.:
SoGen Overseas Variable Fund
VAN ECK WORLDWIDE INSURANCE
TRUST:
Van Eck Worldwide Hard
Assets Fund
Van Eck Worldwide
Emerging Markets Fund
The Guaranteed Interest Option Separate Account ("GIO Account") is also a
separate account of VFL, that supports the values and benefits under the
Guaranteed Interest Option. Through the Guaranteed Interest Option, VFL offers
specified effective annual rates of interest that are credited daily and
available for specified periods of time. Contractholders choosing the Guaranteed
Interest Option do not participate in the investment performance of the GIO
Account and this performance does not determine the Guaranteed Interest Option
value or benefits relating thereto. The assets of the GIO Account are held
separately from other VFL assets and from the General Account of VFL. The GIO
Account, however, unlike the Variable Account, is not registered as an
investment company under the 1940 Act. As a result, the accompanying financial
statements do not reflect amounts invested in the GIO Account.
14
<PAGE> 94
NOTES TO FINANCIAL STATEMENTS
VALLEY FORGE LIFE INSURANCE COMPANY
VARIABLE ANNUITY SEPARATE ACCOUNT
PERIOD FROM INCEPTION TO DECEMBER 31, 1997
================================================================================
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- --------------------------------------------------------------------------------
VALUATION OF INVESTMENTS -- Investments in the Variable Account consist of
shares in the portfolios of the funds and are stated at fair value based on
quoted market prices.
RECOGNITION OF INVESTMENT INCOME -- Investment income consists of dividends
declared by the portfolio managers of the funds which are recognized on the date
of record.
REALIZED GAINS AND LOSSES -- Realized investment gains and losses in the
Variable Account represent the difference between the proceeds from sales of
shares by the Variable Account and the cost of such shares, which are determined
using the average cost method.
CONTRACTHOLDER VARIABLE ACCOUNT ACTIVITY -- Variable Account activity is
reflected in individual contractholder accounts on a daily basis.
FEDERAL INCOME TAXES -- Net investment income and realized gains and losses
on investments of the Variable Account are taxable to contractholders generally
upon distribution. Accordingly, no provision for income taxes has been recorded.
USE OF ESTIMATES -- The preparation of financial statements in conformity
with generally accepted accounting principles ("GAAP") 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.
15
<PAGE> 95
NOTES TO FINANCIAL STATEMENTS
VALLEY FORGE LIFE INSURANCE COMPANY
VARIABLE ANNUITY SEPARATE ACCOUNT
PERIOD FROM INCEPTION TO DECEMBER 31, 1997
================================================================================
NOTE 3. INVESTMENTS
- --------------------------------------------------------------------------------
At December 31, 1997, the investments of the respective subaccounts of the
Variable Annuity Separate Account are as follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MARKET
SHARES COST VALUE
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
INSURANCE SERIES:
Federated Prime Money Fund II 861,084 $861,084 $861,084
Federated Utility Fund II 3,547 46,493 50,683
Federated High Income Bond Fund II 17,395 186,564 190,479
VARIABLE INSURANCE PRODUCTS FUND:
Equity-Income 20,427 489,697 495,969
VARIABLE INSURANCE PRODUCTS FUND II:
Asset Manager 14,845 265,773 267,366
Index 500 4,921 543,072 562,885
Contrafund 16,503 324,992 329,066
THE ALGER AMERICAN FUND:
Small Capitalization 4,474 209,368 195,731
Growth 5,832 258,380 249,383
MidCap Growth 1,755 43,880 42,427
MFS VARIABLE INSURANCE TRUST:
Emerging Growth 8,776 137,690 141,648
Research 9,906 150,896 156,415
Growth With Income 13,322 213,707 219,017
Limited Maturity 8,162 83,692 81,706
Total Return 15,625 248,196 259,844
SOGEN VARIABLE FUNDS, INC.:
Overseas 77,062 787,738 752,892
VAN ECK WORLDWIDE INSURANCE TRUST:
Hard Assets 575 9,226 9,037
Emerging Markets 1,536 21,555 16,890
</TABLE>
16
<PAGE> 96
NOTES TO FINANCIAL STATEMENTS
VALLEY FORGE LIFE INSURANCE COMPANY
VARIABLE ANNUITY SEPARATE ACCOUNT
PERIOD FROM INCEPTION TO DECEMBER 31, 1997
================================================================================
- --------------------------------------------------------------------------------
NOTE 4. INVESTMENT TRANSACTIONS
- --------------------------------------------------------------------------------
The aggregate cost of purchases and proceeds from sales of Insurance
Series, VIP Fund, VIP Fund II, Alger American Fund, MFS Variable Insurance
Trust, SoGen Variable Funds, Inc. and Van Eck Worldwide Insurance Trust shares
from the date of inception to December 31, 1997, were as follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PURCHASES SALES
- -------------------------------------------------------------------------------------
<S> <C> <C>
INSURANCE SERIES:
Federated Prime Money Fund II $3,550,031 $2,710,000
Federated Utility Fund II 131,884 85,557
Federated High Income Bond Fund II 226,400 42,489
VARIABLE INSURANCE PRODUCTS FUND:
Equity-Income 675,097 203,626
VARIABLE INSURANCE PRODUCTS FUND II:
Asset Manager 429,770 175,157
Index 500 646,677 112,906
Contrafund 366,624 45,364
THE ALGER AMERICAN FUND:
Small Capitalization 327,651 123,882
Growth 391,931 134,284
MidCap Growth 55,923 13,622
MFS VARIABLE INSURANCE TRUST:
Emerging Growth 319,665 182,097
Research 181,534 33,784
Growth With Income 231,099 25,510
Limited Maturity 135,099 55,749
Total Return 466,510 223,577
SOGEN VARIABLE FUNDS, INC.:
Overseas 994,765 214,619
VAN ECK WORLDWIDE INSURANCE TRUST:
Hard Assets 10,106 892
Emerging Markets 26,885 4,925
</TABLE>
17
<PAGE> 97
NOTES TO FINANCIAL STATEMENTS
VALLEY FORGE LIFE INSURANCE COMPANY
VARIABLE ANNUITY SEPARATE ACCOUNT
PERIOD FROM INCEPTION TO DECEMBER 31, 1997
================================================================================
NOTE 5. CHARGES AND DEDUCTIONS
- --------------------------------------------------------------------------------
VFL deducts a daily charge from the assets of the Variable Account to
compensate it for mortality and expense risks that it assumes under the
Contract. The daily charge is approximately equal to an annual rate of 1.25% of
the net assets of the Variable Account.
An annual administration fee of $30 is deducted from contracts in both the
Variable and GIO Accounts if the contract value is below $50,000 at the time of
the deduction. This fee is to cover a portion of VFL's administrative expenses
related to the contracts.
VFL deducts a daily administration charge from the assets of the Variable
Account to compensate it for a portion of the expenses it incurs in
administering the contracts. The daily charge is approximately equal to an
annual rate of 0.15% of the net assets of the Variable Account.
VFL permits 12 free transfers among and between the sub-accounts within the
Variable Account (four of which can be applied to the GIO Account) per contract
year. For each additional transfer, VFL charges $25 at the time each such
transfer is processed. The fee is deducted from the amount being transferred.
- --------------------------------------------------------------------------------
NOTE 6. DIVERSIFICATION REQUIREMENTS
- --------------------------------------------------------------------------------
Under the provisions of Section 817(h) of the Internal Revenue Code of 1986
(the Code), a variable annuity contract, other than a contract issued in
connection with certain types of employee benefit plans, will not be treated as
an annuity contract for Federal tax purposes for any period for which the
investments of the segregated asset account on which the contract is based are
not adequately diversified. The Code provides that the "adequately diversified"
requirement may be met if the underlying investments satisfy either a statutory
safe harbor test or diversification requirements set forth in regulations issued
by the Secretary of the Treasury. VFL believes, based on the funds'
prospectuses, that the funds satisfy the requirement of the regulations.
18
<PAGE> 98
- --------------------------------------------------------------------------------
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
The Contractholders of Valley Forge Life Insurance Company Variable Annuity
Separate Account and
The Board of Directors of Valley Forge Life Insurance Company:
We have audited the accompanying statement of assets and liabilities of
Valley Forge Life Insurance Company Variable Annuity Separate Account (a
separate account of the Valley Forge Life Insurance Company, which is a
wholly-owned subsidiary of Continental Assurance Company, which is a
wholly-owned subsidiary of Continental Casualty Company, which is wholly-owned
by CNA Financial Corporation, an affiliate of Loews Corporation) as of December
31, 1997, and the related statements of operations and changes in net assets for
the period from inception through December 31, 1997. These financial statements
are the responsibility of management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. Our procedures included
confirmation of securities held at December 31, 1997. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of the Valley Forge Life
Insurance Company Variable Annuity Separate Account as of December 31, 1997, and
the results of its operations and the changes in its net assets for the period
from inception through December 31, 1997, in conformity with generally accepted
accounting principles.
DELOITTE & TOUCHE LLP
Chicago, Illinois
February 23, 1998
19
