The accompanying statutory financial statements are different in some respects from financial statements prepared in accordance with generally accepted accounting principles ("GAAP "). The more significant differences are as follows:
other investments include holdings in affiliated mutual funds at fair value and preferred stocks at cost,
We develop reserves for life insurance contracts using accepted actuarial methods computed principally on the net level premium, the Commissioners' Reserve Valuation Method and the California Method bases using the 1980 Commissioners' Standard Ordinary mortality tables with assumed interest rates ranging from 2.50 to 4.50 percent.
We develop reserves for individual annuities based on accepted actuarial methods at interest rates ranging from 6.25 to 9.00 percent.
The preparation of financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, as well as disclosures of contingent assets and liabilities, at the date of the financial statements. We must also make estimates and assumptions that affect the amounts of revenues and expenses during the reporting period. Future events, including changes in the levels of mortality, morbidity, interest rates, persistency, and asset valuations, could cause our actual results to differ from the estimates we used in the financial statements.
Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the audited Statutory Financial Statements, Notes to Statutory Financial Statements, and Selected Historical Financial Data. This Management’s Discussion and Analysis reviews our financial condition at December 31, 1999 and 1998, our results of operations for the past three years and, where appropriate, factors that may affect our future financial performance.
the adoption of efforts to improve persistency and retention levels, and
Premium income increased in 1999 and 1998 primarily due to increases in premiums of universal life, variable life and variable annuity products. The increase in premiums for life insurance products is largely attributable to continued growth in the in force of universal life products; the redesign of an existing variable universal life product and the issuance of a new variable universal life product in 1999; and the introduction of two new life products in 1998. Variable annuity premiums have increased primarily due to adding new fund options on existing products and the introduction of two new annuity products.
Net investment income increased in 1999 due to a 10% increase in average invested assets partially offset by a decrease in the gross yield for the investment portfolio to 7.4% in 1999 from 7.9% in 1998. Net investment income increased in 1998 due to an 8% increase in average invested assets and an increase in the gross yield for the investment portfolio to 7.9% in 1998 from 7.6% in 1997.
The increase in 1999 in gross investment income from bonds is due to increased investment levels, while yields stayed steady. The decrease in 1998 gross investment income from bonds is due to declines in portfolio yields partially offset by increased assets invested. Bond yields declined in 1998 as older, higher yielding bonds matured and were replaced with bonds that had lower yields. The increase in income from mortgage loans in 1999 and 1998 is due to an increase in the size of the mortgage portfolio caused by our strategy to increase mortgage acquisition activity.
The decrease in gross investment income on other investments in 1999 resulted primarily from decreased investments in affiliated mutual fund common stock and the receipt of an extraordinary dividend from an affiliated mutual fund in 1998.
Fees increased in 1999 and 1998 due to increases in fees collected from separate accounts as a result of increased variable life and variable annuity sales. In 1999 and 1998 we experienced decreases in commissions and expense allowances on reinsurance ceded and increases in the reserve adjustment on reinsurance ceded as a result of credits we received on our modified coinsurance agreement with MassMutual.
The primary driver of the $147 million increase in policyholders’ benefits and payments in 1999 from 1998 and $85 million increase in 1998 from 1997 was surrender benefits on individual annuity products and a $33 million 1999 surrender of one large corporate owned life insurance contract holder. Individual annuity surrenders increased $99 million, or 44%, during 1999 and $84 million, or 66%, during 1998 with the majority of the withdrawals coming from separate accounts. We believe this increased rate of individual annuity surrenders is primarily due to two factors: 1) the investment fund options currently offered with our annuity products use a “value” based investment philosophy that has temporarily fallen out of favor when compared to other investment options, such as “growth” funds, due to recent market conditions and, 2) a natural increase in the dollar amount of surrenders as business growth causes a higher level of annuity customer account values. Though it is not known if an increased level of surrenders will continue, we have and are taking steps that we believe will reduce surrender activity by enhancing product offerings through the addition of new fund options and other product features. Life insurance surrenders increased $3 million during both 1999 and 1998. The life insurance lapse rate, which is based upon the amount of insurance in force, increased to 7.9% for 1999 from 6.7% in 1998 and 6.5% in 1997. Death claims, net of reinsurance, increased $11 million, or 47%, to $35 million in 1999 compared to a decrease of $2 million, or 11%, in 1998. This increase was primarily due to unfavorable direct mortality experience in 1999 compared to 1998, partially offset by favorable reinsurance recoveries.
The increase in operating expenses, state taxes, licenses, and fees during 1999 and 1998 is primarily attributable to the increased production of new business that resulted in increased management fees. Management fees charged by MassMutual include increases in agency allowances associated with business growth. The growth in these expenses is consistent with our premium growth.
The decrease in federal income taxes during 1999 and 1998 is primarily attributable to the declining net gain (loss) from operations before federal income taxes, partially offset by the difference between statutory insurance reserves and tax reserves and the timing of the tax deductibility of acquisition costs and other items.
The increase in bonds during 1999 includes $475 million in purchases and $423 million of maturities and sales proceeds. There was a slight change in the mix of bonds at December 31, 1999, compared with December 31, 1998. Bond investments in U. S. Treasury and other government holdings increased to 12% of the total portfolio as of December 31, 1999, from 10% as of December 31, 1998. Mortgage-backed securities dropped from 8% to 7% and corporate debt securities dropped from 77% to
The increase in other assets is due primarily to a $25 million increase in transfers due from the separate accounts. Transfers due from separate accounts represents policyholders' account values in excess of statutory benefit reserves. This growth is consistent with the overall increase in separate account business in force.
a decrease of $4 million due to an increase in non-admitted assets,
an increase of $4 million primarily due to unrealized capital gains on bonds.
We utilize sophisticated asset/liability analysis techniques in order to set the investment policy for each liability class. Additionally, we test the adequacy of the projected cash flow provided by assets to meet all of our future policyholder and other obligations. We perform these studies using stress tests regarding future credit and other asset losses, market interest rate fluctuations, claim losses and other considerations. The result is a complete picture of the adequacy of our underlying assets, reserves, and capital.
A large portion of our operating expenses consist of administrative fees charged by MassMutual. The largest component of these fees is salaries, which are subject to wage increases that are at least partially affected by the rate of inflation. Our continuing efforts to control expenses may reduce the impact of inflation on operating expenses.
Inflation also indirectly affects us. New sales and surrenders of our insurance products, as well as investment income are influenced by inflation to the extent that the government's economic policy to control the level of inflation results in changes in interest rates.
We calculate the yield on each investment category, before federal income taxes as: (a) two times gross investment income divided by (b) the sum of assets at the beginning of the year and assets at the end of the year, less gross investment income. If investment expenses were deducted, our net yields would be 7.2%, 7.7%, and 7.5% for the years ended December 31, 1999, 1998 and 1997, respectively.
(1) Average life is 6.5 years, including securities guaranteed by the U.S. Government.
As of December 31, 1999, mortgage-backed securities in the bond portfolio consisted of $52 million of Government National Mortgage Association ( “GNMA”), and Federal National Mortgage Association (“FNMA ”) commitments, Federal Home Loan Mortgage Corporation (“FHLMC ”) and Federal Housing Authority (“FHA”) mortgage-backed pass-through securities, and $44 million of government agency-backed collateralized mortgage obligations.
The estimated fair value of bonds is based upon quoted market prices for actively traded securities. We subscribe to commercial pricing services providing estimated fair values of fixed income securities that are not actively traded. We generally determine estimated fair values for privately placed bonds by applying interest rate spreads based on quality and asset type to the appropriate duration on the Treasury yield curve.
Substantially all of our publicly traded and privately placed bonds are evaluated by the NAIC’s Securities Valuation Office (“SVO”), which assigns securities to one of six NAIC investment classes with Class 1 securities being the highest quality and Class 6 securities being the lowest quality. Classes 1 and 2 are investment grade, Class 3 is medium quality and Classes 4, 5 and 6 are non-investment grade. For securities which have not yet been rated by the NAIC, we use an internal rating system. We believe that our internal rating system is similar to that used by the SVO.
The table below sets forth the NAIC SVO ratings for our bond portfolio (including short-term securities) and, what we believe are the equivalent public rating agency designations. At December 31, 1999 and 1998, 91% and 88%, respectively, of the portfolio was invested in NAIC Classes 1 and 2 securities.
We utilize our investments in the privately placed bond portfolio to enhance the value of our overall portfolio, increase diversification, and obtain higher yields than are possible with comparable quality public market securities. To control risk when utilizing privately placed securities, we rely upon:
(1) These bonds are collateralized by mortgages backed by FNMA, GNMA or FHLMC and include collateralized mortgage obligations and pass-through securities. These amounts also include asset backed securities such as credit card, automobile, and residential mortgage securities.
The NAIC defines under-performing bonds as those whose deferral of interest and/or principal payments are deemed to be caused by the inability of the obligor to make such payments as called for in the bond contract. At December 31, 1999, we had $2 million in under-performing bonds. At December 31, 1998, we had no under-performing bonds.
As a result of our conservative monitoring process, we generate an internal watch list, which includes certain securities that would not be classified as under-performing under the SVO credit rating system. At December 31, 1999, bonds having a carrying value of $23 million, or 3% of the total bond portfolio including short-term securities, had been placed on our internal watch list. The internal watch list is comprised of bonds that have the following NAIC ratings:
Mortgage loans represented 17% and 11% of the total investments in the general account at December 31, 1999 and 1998, respectively. Mortgage loans consist of commercial mortgage loans and residential mortgage loan pools. At December 31, 1999 and 1998, commercial mortgage loans comprised 72% and 64%, respectively, of the mortgage loan portfolio. The following table provides certain information regarding the contractual maturity distribution of mortgage loans:
Our commercial mortgage loan portfolio consists of fixed and floating rate loans on completed, income producing properties. The majority of the portfolio is fixed rate mortgages.
During 1999 and 1998, all renewed bullet loans were performing assets prior to renewal and all loan renewals reflected market conditions. Past experience with regard to bullet maturities, however, is not necessarily indicative of future results.
We actively monitor, manage and directly service our commercial mortgage loan portfolio. Our personnel perform or review all aspects of loan origination and portfolio management, including:
The AVR contains a mortgage loan component, which totaled $7 million at December 31, 1999. In addition, at December 31, 1999, we held other investment reserves on commercial mortgage loans of $2 million. See "Investment Reserves".
We determine the net realizable value of bonds in accordance with principles established by the SVO using criteria such as:
Our total investment reserves at December 31, 1999, were $23 million, a 4% decrease from December 31, 1998, consisting of AVR of $21 million and GIR of $2 million.
(2) Amounts represent contributions calculated on a statutory formula and other amounts we deem necessary. The statutory formula provides for maximums that when exceeded cause a negative contribution. Additionally, these amounts represent the net impact on shareholder’s equity for investment gains and losses not related to changes in interest rates.
In our opinion, because of the effects of the matters discussed in the preceding paragraph, the 1999 financial statements referred to above do not present fairly, in conformity with generally accepted accounting principles, the financial position of C.M. Life Insurance Company as of December 31, 1999, or the results of its operations or its cash flows for the year then ended.
In our opinion, the 1999 statutory financial statements referred to above present fairly, in all material respects, the financial position of C.M. Life Insurance Company at December 31, 1999, and the results of its operations and its cash flows for the year then ended, on the statutory basis of accounting described in Note 1.
In our opinion, because of the effects of the matter discussed in the preceding paragraph, the financial statements audited by us do not present fairly, in conformity with generally accepted accounting principles, the financial position of C.M. Life Insurance Company as of December 31, 1998, or the results of its operations or its cash flows for each of the two years in the period ended December 31, 1998.
In our opinion, the financial statements audited by us, present fairly, in all material respects, the financial position of C.M. Life Insurance Company as of December 31, 1998, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 1998, on the basis of accounting described in Note 1.
The accompanying statutory financial statements have been prepared in conformity with the statutory accounting practices, except as to form, of the National Association of Insurance Commissioners (“NAIC”) and the accounting practices prescribed or permitted by the State of Connecticut Insurance Department and are different in some respects from financial statements prepared in accordance with generally accepted accounting principles (“GAAP”). The more significant differences are as follows: (a) acquisition costs, such as commissions and other costs directly related to acquiring new business, are charged to current operations as incurred, whereas GAAP would require these expenses to be capitalized and recognized over the life of the policies; (b) statutory policy reserves are based upon the commissioners reserve valuation methods and statutory mortality, morbidity and interest assumptions, whereas GAAP reserves would generally be based upon net level premium and estimated gross margin methods and appropriately conservative estimates of future mortality, morbidity and interest assumptions; (c) bonds are generally carried at amortized cost whereas GAAP generally requires they be reported at fair value; (d) deferred income taxes are not provided for book-tax timing differences as would be required by GAAP; and (e) payments received for universal and variable life products and variable annuities are reported as premium income and changes in reserves, whereas under GAAP, these payments would be recorded as deposits to policyholders’ account balances.
In March 1998, the NAIC adopted the Codification of Statutory Accounting Principles ( “Codification”). Codification provides a comprehensive guide of statutory accounting principles for use by insurers in all states and is expected to become effective January 1, 2001. The effect of adopting Codification shall be reported as an adjustment to surplus on the effective date. The Company is currently reviewing the impact of Codification; however, due to the nature of certain required accounting changes and their sensitivity to factors such as interest rates, the actual impact upon adoption cannot be determined at this time.
Assets designated as “non-admitted” include prepaid agent commissions, other prepaid expenses and the IMR, when in a net loss deferral position, and are excluded from the Statutory Statements of Financial Position. These amounted to $9.9 million and $5.5 million as of December 31, 1999 and 1998, respectively and changes therein are charged directly to surplus.
Provision for federal income taxes is based upon the Company’s estimate of its tax liability. No deferred tax effect is recognized for temporary differences that may exist between financial reporting and taxable income. Accordingly, the reporting of miscellaneous temporary differences, such as reserves and policy acquisition costs, resulted in effective tax rates which differ from the statutory tax rate.
The Board of Directors of MassMutual has authorized the contribution of funds to the Company sufficient to meet the capital requirements of all states in which the Company is licensed to do business. Substantially all of the statutory shareholder’s equity is subject to dividend restrictions relating to various state regulations, which limit the payment of dividends to the shareholder without prior approval. Under these regulations, $14.1 million of shareholder’s equity is available for distribution to the shareholder in 2000 without prior regulatory approval.
The carrying value and estimated fair value of bonds at December 31, 1999, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.
Investments in affiliated mutual funds had a cost of $17.4 million in 1999 and $62.4 million in 1998.
Options grant the purchaser the right to buy or sell a security or enter into a derivative transaction at a stated price within a stated period. The Company’s option contracts have terms of up to ten years. The amounts paid for options purchased are amortized into net investment income over the life of the contract on a straight-line basis. Unamortized costs are included in other investments on the Statutory Statements of Financial Position. Gains and losses on these contracts are recorded at the expiration or termination date and are deferred and amortized through the IMR over the remaining life of the option contract. At December 31, 1999 and 1998, the Company had option contracts with notional amounts of $944.5 million and $961.2 million, respectively. The Company’s credit risk exposure was limited to the unamortized costs of $7.0 million and $7.5 million at December 31, 1999 and 1998, respectively.
Interest rate cap agreements grant the purchaser the right to receive the excess of a referenced interest rate over a stated rate calculated by reference to an agreed upon notional amount. Interest rate floor agreements grant the purchaser the right to receive the excess of a stated rate over a referenced interest rate calculated by reference to an agreed upon notional amount. Amounts paid for interest rate caps and floors are amortized into net investment income over the life of the asset on a straight-line basis. Unamortized costs are included in other investments on the Statutory Statements of Financial Position. Amounts receivable and payable are accrued as adjustments to net investment income and included in the Statutory Statements of Financial Position as investment and insurance amounts receivable. Gains and losses on these contracts, including any unamortized cost, are recognized upon termination and are deferred and amortized through the IMR over the remaining life of the associated cap or floor agreement. At December 31, 1999 and 1998, the Company had agreements with notional amounts of $355.0 million. The Company ’s credit risk exposure on these agreements is limited to the unamortized costs of $0.2 million and $0.5 million at December 31, 1999 and 1998, respectively.
The Company utilizes asset swap agreements to reduce exposures, such as currency risk and prepayment risk, built into certain assets acquired. Cross-currency interest rate swaps allow investment in foreign currencies, increasing access to additional investment opportunities, while limiting foreign exchange risk. The net cash flows from asset and currency swaps are recognized as adjustments to the underlying assets’ net investment income. Gains and losses realized on the termination of these contracts adjusts the bases of the underlying assets. Notional amounts relating to asset and currency swaps totaled $3.6 million at December 31, 1999. As of December 31, 1998, the Company did not have any open asset swap agreements.
The Company enters into forward U.S. Treasury, Government National Mortgage Association ( “GNMA”) and Federal National Mortgage Association (“FNMA ”) commitments for the purpose of managing interest rate exposure. The Company generally does not take delivery on forward commitments. These commitments are instead settled with offsetting transactions. Gains and losses on forward commitments are recorded when the commitment is closed and deferred and amortized through the IMR over the remaining life of the asset. At December 31, 1999 and 1998, the Company had U. S. Treasury, GNMA and FNMA purchase commitments which will settle during the following year with contractual amounts of $15.4 million and $1.0 million, respectively.