10-Q 1 e10-q.txt QUARTERLY REPORT 1 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------------------- FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000 COMMISSION FILE NUMBER 333-1083 -------------------------- VALLEY FORGE LIFE INSURANCE COMPANY (Exact name of registrant as specified in its charter) PENNSYLVANIA 23-6200031 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) CNA PLAZA CHICAGO, ILLINOIS 60685 60685 (Address of principal executive offices) (Zip Code) (312) 822-5000 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No |X| --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. CLASS OUTSTANDING AT AUGUST 1, 2000 ------------------------------ ----------------------------- Common Stock, Par value $50.00 50,000 THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION H (1) (a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM 10-Q WITH THE REDUCED DISCLOSURE FORMAT. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- Page 1 of 25 2 VALLEY FORGE LIFE INSURANCE COMPANY INDEX PART I. FINANCIAL INFORMATION (UNAUDITED) PAGE NO. ------ --------------------- -------- ITEM 1. CONDENSED FINANCIAL STATEMENTS: CONDENSED BALANCE SHEETS June 30, 2000 (Unaudited) AND DECEMBER 31, 1999.......... 3 CONDENSED STATEMENTS OF OPERATIONS (Unaudited) FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2000 AND 1999. 4 CONDENSED STATEMENTS OF CASH FLOWS (Unaudited) FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 1999........... 5 NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited) JUNE 30, 2000...................... 6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.......................10 PART II. OTHER INFORMATION -------- ----------------- ITEM 5. OTHER INFORMATION..................................................15 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K...................................15 SIGNATURES..................................................................16 EXHIBIT 10(k) DEPARTMENT HEAD SEVERANCE AGREEMENT...........................17 EXHIBIT 27 FINANCIAL DATA SCHEDULE..........................................25 2 3 VALLEY FORGE LIFE INSURANCE COMPANY CONDENSED BALANCE SHEETS

See accompanying Notes to Condensed Financial Statements (Unaudited). 3 4 VALLEY FORGE LIFE INSURANCE COMPANY CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)

See accompanying Notes to Condensed Financial Statements (Unaudited). 4 5 VALLEY FORGE LIFE INSURANCE COMPANY CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)

See accompanying Notes to Condensed Financial Statements (Unaudited). 5 6 VALLEY FORGE LIFE INSURANCE COMPANY NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) June 30, 2000 NOTE 1. BASIS OF PRESENTATION Valley Forge Life Insurance Company (VFL) was incorporated under the laws of the Commonwealth of Pennsylvania on August 9, 1956. 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). CNAF is a holding company whose primary subsidiaries consist of property/casualty and life insurance companies, collectively CNA. Loews Corporation owns approximately 87% 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 insurance, pension products and accident and health insurance consisting primarily of major medical and hospitalization. VFL also markets a portfolio of variable separate account products, including annuity and universal life products. These products offer policyholders the option of allocating payments to one or more variable separate accounts or to a guaranteed income account or both. Payments allocated to the variable separate 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 for one year for life products. The operations, assets and liabilities of VFL and its parent, Assurance, are managed on a combined basis. Pursuant to a Reinsurance Pooling Agreement, as amended on July 1, 1996, VFL cedes all of its business, excluding its separate account business, to its parent, Assurance. This ceded 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 condensed financial statements are unaudited and have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). Certain financial information that is normally included in annual financial statements, including financial statement footnotes, prepared in accordance with GAAP, but that is not required for interim reporting purposes, has been condensed or omitted. These statements should be read in conjunction with the financial statements and notes thereto included in VFL's Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 1999. In the opinion of management, these statements include all adjustments (consisting of normal recurring accruals) that are necessary for the fair presentation of the financial position, results of operations and cash flows. The operating results for the interim periods are not necessarily indicative of the results to be expected for the full year. Certain amounts applicable to prior periods have been reclassified to conform to classifications followed in 2000. In the first quarter of 2000, VFL adopted the American Institute of Certified Public Accountants' Statement of Position (SOP) 98-7, "Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." Adoption of the SOP did not have a material impact on the financial position or results of operations of VFL. In the first quarter of 1999, VFL adopted the American Institute of Certified Public Accountants' Statement of Position (SOP) 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments." This SOP requires that insurance companies recognize liabilities for insurance-related assessments when an assessment is probable and will be imposed, when it can be reasonably estimated, and when the event obligating an entity to pay an imposed or probable assessment has occurred on or before the date of the financial statements. Adoption of the SOP resulted in an after tax charge of $234,000 ($360,000, pretax) as a cumulative effect of a change in accounting principle for the six months ended June 30, 1999. 6 7 VALLEY FORGE LIFE INSURANCE COMPANY NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED NOTE 2. REINSURANCE The ceding of insurance does not discharge the primary liability of VFL. 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. For carriers that are not authorized reinsurers in VFL's state of domicile, VFL receives collateral, primarily in the form of bank letters of credit. In the table below, the majority of life premium revenue is from long duration type contracts, while the majority of accident and health insurance premiums is from short duration contracts. The effects of reinsurance on premium revenues are shown in the following table:

Transactions with Assurance, as part of the Pooling Agreement described in Note 1, are reflected in the above table. Premium revenues ceded to non-affiliated companies were $226.0 million for the six months ended June 30, 2000, and $187.4 million for the six months ended June 30, 1999. Additionally, benefits and expenses for insurance claims and policyholder benefits are net of reinsurance recoveries from non-affiliated companies of $150.1 million for the period ended June 30, 2000, and $139.2 million for the same period in 1999. Reinsurance receivables reflected on the balance sheets are amounts recoverable from reinsurers who have assumed a portion of the Company's insurance reserves. These balances are principally due from Assurance pursuant the Reinsurance Pooling Agreement. NOTE 3. LEGAL PROCEEDINGS 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 stockholder's equity of VFL. 7 8 VALLEY FORGE LIFE INSURANCE COMPANY NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED NOTE 4. COMPREHENSIVE INCOME Comprehensive income is comprised of all changes to stockholder's equity, including net income, except those changes resulting from contributions from and distributions to the stockholder. The components of comprehensive income are shown below.

NOTE 5. BUSINESS SEGMENTS VFL operates in one reportable segment, the business of which is to market and underwrite insurance products designed to satisfy the life, health and retirement needs of individuals and groups. VFL products are distributed primarily in the United States. Premium revenues earned outside the United States are not material. The operations, assets and liabilities of VFL and its parent, Assurance, are managed on a combined basis. Pursuant to a Reinsurance Pooling Agreement, as amended, VFL cedes all of its business, excluding its separate account business, to Assurance which is then pooled with the business of Assurance, excluding Assurance's participating contracts and separate account business, and 10% of the combined pool is assumed by VFL. The following presents premiums by product group for the six month period ending June 30, 2000 and June 30, 1999.

8 9 VALLEY FORGE LIFE INSURANCE COMPANY NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)-CONCLUDED NOTE 6. OTHER EVENTS On March 8, 2000, CNA announced that it was exploring the sale of the individual life insurance and reinsurance businesses. On August 8, 2000 CNA announced that it had completed exploring the sale of the individual life insurance and life reinsurance businesses and that it would retain the individual life, long term care and retirement services businesses. CNA announced that it would continue to explore the separate sale of its life reinsurance business. A portion of the life reinsurance business is conducted through VFL and as part of the Reinsurance Pooling Agreement, VFL also assumes 10% of the life reinsurance business of Assurance. The Federal Employee Health Benefit Plan (FEHBP) business currently written by Assurance and assumed by VFL as part of the Reinsurance Pooling Agreement is being transferred to another insurance entity indirectly owned by CNA. Subject to final regulatory approvals it is expected that the transfer will be effective September 1, 2000. All assets and liabilities of this business will be transferred through a novation agreement, and VFL will be relieved of any ongoing direct or contingent liability with respect to this business. The transfer of this business is not expected to have a material impact on results of operations or equity of VFL. The FEHBP business contributed premiums of $48.9 million and $100.1 million, and net operating income of $0.4 million and $0.6 million for the three and six month periods ended June 30, 2000, respectively. 9 10 VALLEY FORGE LIFE INSURANCE COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the condensed financial statements (unaudited) and notes thereto found on pages 3 to 9, which contain additional information helpful in evaluating operating results and financial condition. VFL, along with its parent, Assurance, markets and underwrites products designed to satisfy the life insurance, health insurance and retirement needs of individuals and groups. The individual products consist primarily of term and universal life insurance policies and individual annuities. Group products include life, accident and health insurance, consisting primarily of major medical and hospitalization insurance and pension products. VFL and Assurance also market a portfolio of variable separate account products, including annuity and universal life products. These variable separate account products offer policyholders the option of allocating payments to one or more variable separate accounts or to a guaranteed income account or both. Payments allocated to the variable separate accounts are invested in corresponding investment portfolios where the investment risk is borne by the policyholder. 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. RESULTS OF OPERATIONS The following table summarizes key components of VFL's operating results for the three months and six months ended June 30, 2000 and 1999.

VFL's operating revenues, excluding net realized investment gains/losses, decreased 0.5% to $180.8 million for the first six months of 2000 as compared to $181.7 million for the same time period in 1999. Premiums for the first six months of 2000 decreased $4.1 millions or 2.6% to $154.2 million as compared to $158.3 million for the same period in 1999. The decrease in premiums for the first six months of 2000 was a result of lower premiums in the Federal Employee Health Benefit Plan (FEHBP) resulting from improved claim experience upon which the premiums are based. 10 11 VALLEY FORGE LIFE INSURANCE COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED On a pretax basis, operating income for the second quarter of 2000 increased $3.8 million or 78.3% from the second quarter of 1999 primarily due to a $10.1 million or 11.1% decrease in the second quarter 2000 benefits and expenses offset by decreases in operating revenues of $6.3 million or 6.5% as compared to the second quarter of 1999. On a pretax basis, operating income for the first six months of 2000 increased $7.3 million or 66.6% from the first six months of 1999 primarily due to a 5.0% decrease in the first six months claims and policyholder benefit expenses. Other operating expenses decreased 12.8% while premium revenue decreased 2.6% for the first half of 2000. VFL's operating revenues, excluding net realized investment gains/losses, decreased by 6.5% to $90.0 million as compared to $96.3 million for the three months ending June 30, 1999 primarily due to decreased premium revenues of $6.6 million offset by an increase in net investment income of $2.0 million or 22.7%. Premium revenues decreased due to lower premiums in Federal Employee Health Benefit Plan (FEHBP) which are impacted by improved claim experience upon which the corresponding premiums are based and was partially offset by increases in life insurance premium revenues, primarily due to the premium growth for the ViaTerm product. For the three months ending June 30, 2000, investment income increased by $2.0 million to $11.0 million, as compared to investment income of $9.0 million for the three months ending June 30, 1999 due to the increase in average invested assets. VFL's operating revenues decreased by 0.5% to $180.8 million for the first six months of 2000 as compared to $181.7 million for the same time period in 1999 due to decreased premiums and other revenues, offset by increased net investment income. Premiums for the first six months of 2000 decreased $4.1 million or 2.6% to $154.2 million as compared to $158.3 million for the same period in 1999. The decrease in premiums for the first six months of 2000 was a result of the factors described above for the quarterly results. Net investment income increased $4.0 million or 22.2% to $22.1 million for the six months ended June 30, 2000 from $18.1 million for the same period in 1999 due to the increase in average invested assets as compared to the same period in 1999. FINANCIAL CONDITION Assets totaled $3.9 billion at June 30, 2000, an increase of 9.8% over year-end 1999. Major factors that contributed to the increase in VFL assets were, reinsurance receivables up 7.0% from December 31, 1999 due to insurance activity with Assurance and an increase in the variable separate account business. VFL separate account assets increased $170.4 million from year-end 1999 to $379.6 million primarily due to increased marketing efforts coupled with product enhancements and an increase in the available investment options. VFL's cash and invested assets of $631.6 million decreased by $21.2 million, or 3.2%, over the December 31, 1999 level of $652.8 million. VFL's stockholder's equity was $263.3 million at June 30, 2000, compared to $252.2 million at December 31, 1999. 11 12 VALLEY FORGE LIFE INSURANCE COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED INVESTMENTS The following table summarizes VFL's investments shown at cost or amortized cost and carrying value as of June 30, 2000 and December 31, 1999:

* As reported in the Condensed Balance Sheets The operations and liabilities of VFL and Assurance are managed on a combined basis. The investment portfolios of VFL and Assurance are managed to maximize total after-tax investment return while minimizing credit risks, with investments concentrated in high quality securities to support insurance underwriting operations. The investment portfolios are segregated for the purpose of supporting policy liabilities for universal life, annuities and other interest sensitive products. VFL has the ability 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. VFL's investments in fixed maturities are carried at a fair value of $472.5 million at June 30, 2000, compared with $530.5 million at December 31, 1999. At June 30, 2000, the net unrealized loss on fixed maturities amounted to approximately $8.0 million on an after tax basis resulting from rising interest rates. At December 31, 1999, net unrealized losses for the fixed maturities were approximately $11.6 million after tax. Fluctuations from period to period are primarily due to changes in interest rates in the market and the mix of instruments within the portfolio. 12 13 The following table summarizes the ratings of VFL's fixed maturity portfolio at carrying value (market):

VALLEY FORGE LIFE INSURANCE COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED The fair value of VFL's fixed maturities at June 30, 2000, includes $96.0 million of asset-backed securities, consisting of approximately 56% in collateralized mortgage obligations (CMOs), 32% in certain U.S. government agency issued pass-through certificates, 8% in corporate mortgage-backed pass-through certificates and 4% in corporate asset-backed obligations. The majority of the asset-backed securities held are actively traded in liquid markets and are priced by broker-dealers. Below investment grade bonds are high yield securities rated below BBB by bond rating agencies, as well as other unrated securities which, in the opinion of management, are below investment grade. High yield securities generally involve a greater degree of risk than that of investment grade securities. However, expected returns should compensate for the added risk. This risk is also considered in the interest rate assumptions in the underlying insurance products. VFL's concentration in high yield bonds was approximately 0.5% and 0.6% of total assets as of June 30, 2000 and December 31, 1999, respectively. LIQUIDITY AND CAPITAL RESOURCE 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. For the period ended June 30, 2000, VFL's operating activities used cash of $7.1 million, compared with providing $11.4 million of operating cash flows for the same period in 1999. The net use of operating cash flows in the first six months of 2000 are primarily the result of increased commissions and other payables occurring in the normal course of business. Management believes that future liquidity needs will be met 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. ACCOUNTING STANDARDS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard 133, "Accounting for Derivative Instruments and Hedging Activities." This statement requires that an entity recognize all derivative instruments as either assets or liabilities in the balance sheet and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. This Statement is effective for fiscal years beginning after June 15, 2000. VFL is currently evaluating the effects of this Statement on its accounting and reporting for derivative securities and hedging activities. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 101. "Revenue Recognition in Financial Statements". This bulletin summarizes certain of the SEC Staff's view in applying generally accepted accounting principles to revenue recognition in financial statements. This bulletin, through its subsequent revised releases SAB No. 101A and No. 101B, is effective for registrants no later than the fourth fiscal quarter of fiscal years beginning after December 15, 1999. VFL does not expect the implementation of this bulletin to have a significant impact on the results of operations or equity of the company. 13 14 VALLEY FORGE LIFE INSURANCE COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONCLUDED FORWARD-LOOKING STATEMENTS The statements contained in this management discussion and analysis, which are not historical facts, are forward-looking statements. When included in this management discussion and analysis, the words "believe," "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, the impact of competitive products, policies and pricing; product and policy demand and market responses; development of claims and the effect on loss reserves; the performance of reinsurance companies under reinsurance contracts with VFL; general economic and business conditions; changes in financial markets (interest rate, credit, currency, commodities and stocks); changes in foreign, political, social and economic conditions; regulatory initiatives and compliance with governmental regulations; judicial decisions and rulings; the effect on VFL of changes in rating agency policies and practices; the results of financing efforts; changes in VFL's composition of operating segments; the actual closing of contemplated transactions and agreements and various other matters and risks (many of which are beyond VFL's control) detailed in VFL's Securities and Exchange Commission filings. These forward-looking statements speak only as of the date of this management discussion and analysis. 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. 14 15 VALLEY FORGE LIFE INSURANCE COMPANY PART II - OTHER INFORMATION ITEM 5. OTHER INFORMATION - NONE ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS: Exhibit Page Description of Exhibit Number Number ----------------------- ------- ------ Department Head Severance Agreement 10 (k) 17 Financial Data Schedule 27 25 (b) REPORTS ON FORM 8-K: There were no reports on Form 8-K for the three months ended June 30, 2000. 15 16 VALLEY FORGE LIFE INSURANCE COMPANY SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Valley Forge Life Insurance Company By /s/ Robert V. Deutsch ----------------------------- Robert V. Deutsch Director, Senior Vice President And Chief Financial Officer Date: August 14, 2000 16

VALLEY FORGE LIFE INSURANCE CO 10-Q