10-Q 1 c58334e10-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 COMMISSION FILE NUMBER 333-1083 SEPTEMBER 30, 2000 -------------------------- VALLEY FORGE LIFE INSURANCE COMPANY (Exact name of registrant as specified in its charter) PENNSYLVANIA 23-6200031 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) CNA PLAZA CHICAGO, ILLINOIS 60685 (Address of principal executive offices) (Zip Code) (312) 822-5000 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes 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 NOVEMBER 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 16 2 VALLEY FORGE LIFE INSURANCE COMPANY INDEX

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) SEPTEMBER 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. As of September 30, 2000, 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, retirement services 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, premiums 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. 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 contracts, while the majority of accident and health insurance premiums are from short duration contracts. The effects of reinsurance on premium revenues are shown in the following table: 6 7 VALLEY FORGE LIFE INSURANCE COMPANY NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED

Transactions with Assurance, as part of the Pooling Agreement described in Note 1, are reflected in the above table. The table includes eight months of year 2000 premiums for the Federal Employee Health Benefit Plan which were transferred to another CNA entity September 1, 2000. Premium revenues ceded to non-affiliated companies were $344.5 million for the nine months ended September 30, 2000, and $283.8 million for the nine months ended September 30, 1999. Additionally, benefits and expenses for insurance claims and policyholder benefits are net of reinsurance recoveries from non-affiliated companies of $242.1 million for the period ended September 30, 2000, and $188.7 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 to 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. 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.

7 8 VALLEY FORGE LIFE INSURANCE COMPANY NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED 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, premiums 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 net premiums by product group for the nine month period ending September 30, 2000 and September 30, 1999. -------------------------------------------------------------------------------- NINE MONTHS ENDED SEPTEMBER 30 (In thousands of dollars) 2000 1999 -------------------------------------------------------------------------------- Life $ 60,293 $ 55,410 Accident and Health 161,458 177,186 -------------------------------------------------------------------------------- TOTAL $ 221,751 $ 232,596 ================================================================================ NOTE 6. ACCOUNTING PRONOUNCEMENTS 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." SOP 97-3 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. 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 nine months ended September 30, 1999. 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. Adoption of this bulletin, which occurred on October 1, 2000, will not have a significant impact on the results of operations or equity of VFL. The company is required to adopt Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (FAS 133), effective January 1, 2001. FAS 133 requires than an entity recognize all derivative instruments in the balance sheet and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as a hedge of the Company's (a) exposure to changes in the fair value of a recognized asset or liability or of an unrecognized firm commitment, (b) exposure to variable cash flows of a forecasted transaction, or (c) 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 8 9 VALLEY FORGE LIFE INSURANCE COMPANY NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)-CONCLUDED for changes in the fair value of a derivative depends on its intended use and the resulting hedge designation, if any. The transaction adjustment resulting from adoption of FAS 133 must be reported in net income or other comprehensive income, as appropriate, as the effect of a change in accounting principle. VFL does not expect adoption of FAS 133 to have a material impact on the results of operations or equity. Effective January 1, 2001, the Company is required to adopt statutory basis accounting changes related to the National Association of Insurance Commissioners codification of Statutory Accounting Practices. VFL does not expect these statutory accounting changes to have a significant impact on the Company's operations or statutory capital and surplus. NOTE 7. OTHER EVENTS The Federal Employee Health Benefit Plan (FEHBP) business formerly written by Assurance and assumed by VFL as part of the Reinsurance Pooling Agreement was transferred to another insurance entity owned by CNA on September 1, 2000. All assets and liabilities of this business were transferred through a novation agreement, and VFL was relieved of any ongoing direct or contingent liability with respect to this business. The transfer of this business resulted in no gain or loss to VFL in the transaction and did not have a material impact on results of its operations or equity. On October 6, 2000 CNAF, issued a press release announcing the sale of its life reinsurance business to Munich American Reassurance Company, the U.S. subsidiary of Munich RE. A portion of the life reinsurance business is conducted through VFL as part of a Reinsurance Pooling Agreement. The transfer of this business is not expected to have a material impact on results of operations or equity of VFL. The following table summarizes the premiums, income (loss) before income tax and total assets for FEHBP and life reinsurance business.

* FEHBP business transferred September 1, 2000. 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 to evaluate operating results and financial condition. Valley Forge Life Insurance Company (VFL), along with its parent, Continental Assurance Company (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 retirement services 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 nine months ended September 30, 2000 and 1999.

VFL's operating revenues decreased by 2.0% to $261.1 million for the first nine months of 2000 as compared to $266.3 million for the same time period in 1999 due to a 4.7% decrease in premiums, offset by increased net investment income. Premiums for the nine months of 2000 decreased $10.8 million or 4.7% to $221.8 million as compared to $232.6 million for the same period in 1999. The decrease in premiums for the first nine months of 2000 was a result of lower premiums in Federal Employee Health Benefit Plan (FEHBP). The FEHBP premiums were impacted by improved claim experience upon which the corresponding premiums are based. As stated in Note 7 to the Financial Statements, the FEHBP business was transferred to another CNA entity on September 1, 2000. Federal Employee Benefit Plan business 10 11 VALLEY FORGE LIFE INSURANCE COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED changes were partially offset by increases in life insurance premium revenues, primarily due to the premium growth for the ViaTerm product. Net investment income increased $5.2 million or 18.4% to $33.4 million for the nine months ended September 30, 2000 from $28.2 million for the same period in 1999. The increase in net investment income was due to an increase in average invested assets and improved investment yields within the portfolio as compared to the same period in 1999. On a pretax basis, operating income for the nine months of 2000 increased $10.4 million or 64.8% from the first nine months of 1999 primarily due to a 7.5% decrease in the first nine months claims and policyholder benefit expenses. Premium revenue decreased 4.7% for the first nine months of 2000. VFL's operating revenues, excluding net realized investment gains (losses), decreased by 5.1% to $80.4 million as compared to $84.7 million for the three months ending September 30, 1999 primarily due to decreased premium revenues of $6.7 million offset by an increase in net investment income of $1.2 million or 11.6%. The decrease in premium revenues was a result of the same factors as described above for the year-to-date results. For the three months ending September 30, 2000, investment income increased by $1.2 million to $11.3 million, as compared to investment income of $10.1 million for the three months ending September 30, 1999 due to the increase in average invested assets and improved investment yields within the portfolio. On a pretax basis, operating income for the third quarter of 2000 increased $3.1 million or 60.9% from the third quarter of 1999 primarily due to a $7.4 million or 9.4% decrease in the third quarter 2000 benefits and expenses offset by decreases in operating revenues of $4.3 million or 5.0% as compared to the third quarter of 1999. FINANCIAL CONDITION Assets totaled $4.1 billion at September 30, 2000, an increase of 17.2% over year-end 1999. Major factors that contributed to the increase in VFL assets were an increase in reinsurance receivables of 9.9% from December 31, 1999 due to insurance activity with Assurance and an increase in the variable separate account business. VFL separate account assets increased $278.4 million from year-end 1999 to $487.6 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 $760.7 million increased by $107.9 million, or 16.5%, over the December 31, 1999 level of $652.8 million. VFL's stockholder's equity was $273.7 million at September 30, 2000, compared to $252.2 million at December 31, 1999. INVESTMENTS The following table summarizes VFL's investments shown at cost or amortized cost and carrying value as of September 30, 2000 and December 31, 1999: 11 12 VALLEY FORGE LIFE INSURANCE COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED

* As reported in the Condensed Balance Sheets The operations, premiums 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 $517.5 million at September 30, 2000, compared with $530.5 million at December 31, 1999. At September 30, 2000, the net unrealized loss on fixed maturities amounted to approximately $3.8 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. The following table summarizes the ratings of VFL's fixed maturity portfolio at carrying value (market):

12 13 VALLEY FORGE LIFE INSURANCE COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONCLUDED The fair value of VFL's fixed maturities at September 30, 2000, includes $92.5 million of asset-backed securities, consisting of approximately 51% in collateralized mortgage obligations (CMOs), 39% in certain U.S. government agency issued pass-through certificates, 6% 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 1.5% and 0.6% of total assets as of September 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 September 30, 2000, VFL's operating activities provided cash of $100.8 million, compared with providing $101.7 million of operating cash flows for the same period in 1999. The net source of operating cash flows in the first nine months of 2000 are primarily the result of operating activities 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. 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 "believes," "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. 13 14 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 ---------------------- ------ ------ Financial Data Schedule 27 16 (b) REPORTS ON FORM 8-K: On October 10, 2000 Valley Forge Life Insurance Company filed a report on Form 8-K related to an announcement by CNA Financial Corporation, the parent company of Continental Assurance Company, the parent company of Valley Forge Life Insurance Company, issued a press release announcing the sale of its life reinsurance business to Munich American Reassurance Company, the U.S. subsidiary of Munich Re. A portion of the life reinsurance business is conducted through Valley Forge Life Insurance Company as part of a Reinsurance Pooling Agreement. 14 15 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: November 9, 2000 15

VALLEY FORGE LIFE INSURANCE CO 10-Q