The following statutory information as of and for the years ended December 31, 2001, 2000, 1999, 1998, and 1997 has been derived from our audited statutory financial statements. The 2001, 2000 and 1999 statutory financial statements have been audited by Deloitte & Touche LLP, independent auditors’. The statutory financial statements for the years 1997 and 1998 were audited by other auditors.
acquisition costs, such as commissions and other variable costs that are directly related to acquiring new business, are charged to current operations as incurred, whereas United States GAAP would require these expenses to be capitalized and recognized over the life of the policies;
bonds are generally carried at amortized cost, whereas United States GAAP generally requires they be reported at fair value;
assets are reported at “admitted asset” value and “non-admitted assets” are excluded through a charge against surplus, while under United States GAAP, “non-admitted assets” are recorded, net of any valuation allowance; and
reinsurance recoverables on unpaid losses are reported as a reduction of policyholders’ reserves and funds, while under United States GAAP, they are reported as an asset.
We develop reserves for individual annuities based on accepted actuarial methods at interest rates ranging from 5.25 to 9.00 percent.
We maintain an Asset Valuation Reserve (“AVR”) and an Interest Maintenance Reserve (“IMR”), in compliance with regulatory requirements. The AVR and other investment reserves stabilize surplus against fluctuations in the value of mortgage loans and bonds. The IMR defers all interest related after-tax realized capital gains and losses. These interest related capital gains and losses are amortized into net investment income using the grouped method over the remaining life of the investment sold or over the remaining life of the underlying asset.
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, 2001 and 2000, our results of operations for the past three years and, where appropriate, factors that may affect our future financial performance.
At December 31, 2001, we had approximately $5.4 billion in total statutory assets, over 270 thousand individual policyholders and $66.9 billion of direct individual life insurance in force. Our total adjusted capital, as defined by the National Association of Insurance Commissioners (“NAIC”), was $203.5 million at December 31, 2001.
(1) Defined by the National Association of Insurance Commissioners as surplus plus asset valuation reserves.
Objective testimony to our strong performance and market position is reflected in our ratings, which at year-end 2001 were again among the highest enjoyed by any company in any industry. Our, and MassMutual’s, AAA financial strength rating from Standard & Poor’s, A++ (Superior) financial strength rating from A.M. Best, and AAA claims-paying rating from Fitch were the highest possible. Our, and MassMutual’s, Aa1 financial strength rating from Moody’s Investors Service was the highest in its “Excellent” category. Each rating agency independently assigns ratings based on its own separate review and takes into account a variety of factors, which are subject to change in making its decision. Accordingly, there can be no assurance of the ratings that will be afforded us in the future.
Net losses increased in 2001 primarily due to earnings strain associated with the continued growth of the Company’s life insurance business, higher death claims, and lower expense on reinsurance ceded; partially offset by an increase in net investment income, higher fees from the administration of separate investment funds and a higher tax benefit. It is generally expected that the increase in policyholders’ reserves and costs related to the production of new business will exceed the amount of premium earned in the first year of a policy, causing operating losses. We expect that a certain level of losses may continue in conjunction with future growth.
annuity and life insurance businesses, partially offset by improved mortality and higher fees received from separate accounts.
Premium income decreased in 2001 primarily due to decreases in premiums of annuity products. The overall decrease in premium income was primarily the result of a reduction in premium received from variable annuity exchange programs with MassMutual. Premium income increased in 2000 primarily due to increases in premiums from variable annuity, universal life and variable life products. The overall increase in premium income is primarily the result of a number of new and enhanced product offerings and increases in variable annuity exchange programs with MassMutual.
The components of fees and other income are set forth below:
The increase in policyholder’s benefits and payments in 2001 is primarily attributable to increased death benefits due to higher mortality, partially offset by lower annuity surrenders benefits. The increase in policyholders’ benefits and payments in 2000 is primarily attributable to surrender benefits on individual annuity products.
Individual annuity surrenders decreased $21.4 million, or 6%, in 2001 after an increase of $156.6 million, or 69%, during 2000. During 2000 the majority of the withdrawals came from separate accounts. The decrease in 2001 is primarily due to management's proactive conservation efforts and improved investment fund performance. We believe the 2000 increase in the rate of individual annuity surrenders is primarily due to two factors:
1) a natural increase in the dollar amount of surrenders as business growth causes a higher level of annuity customer account values and,
2) the investment fund options previously offered with our annuity products used a “value” based investment philosophy that had temporarily fallen out of favor when compared to other investment options, such as “growth” funds.
Annuity benefits and payments increased $6.6 million in 2001 and $12.4 million in 2000 primarily due to an increase in annuity death benefits.
Commissions decreased in 2001 primarily due to a decrease in sales of annuity products and an increase in the sale of non-traditional life insurance products. Commissions on these products are lower than commissions charged on traditional life insurance products. Commissions increased in 2000 primarily due to increases in sales of annuities and life insurance. Life insurance commissions decreased $13.2 million in 2001 after an increase of $33.5 million in 2000, while commissions on annuity products decreased $5.1 million in 2001 following an increase of $24.1 million in 2000. Annuity commissions include amounts due MassMutual for participation in various variable annuity exchange programs.
The decrease in operating expenses, state taxes, licenses, and fees during 2001 was primarily attributable to the decrease in sales of annuity products, while the increase in 2000 was 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 and other expenses associated with the production of new business.
The increase in 2001 realized capital losses after transfers to the IMR, is primarily attributable to credit related losses from the sale of bonds. The decrease in 2000 realized capital losses, after transfers to the IMR, is primarily due to a decline in losses from investments in affiliated mutual funds.
The increase in bonds during 2001 includes $550.3 million in purchases and $275.0 million of maturities and sales proceeds. There was a slight change in the mix of bonds at December 31, 2001, compared with December 31, 2000. Bond investments in U. S. Treasury and other government holdings increased to 10% of the total portfolio at December 31, 2001, from 8% as of December 31, 2000 while mortgage-backed securities
decreased from 10% to 9% during this same time period. Corporate debt securities decreased to 70% of the bond portfolio at December 31, 2001 from 76% as of December 31, 2000.
The decrease in other assets is due primarily to a $35.7 million decrease in commission and expense allowances due on reinsurance ceded and a $10.5 million decrease in life premiums and annuity considerations due, partially offset by a $15.2 million increase in amounts recoverable from reinsurers.
The decrease in other liabilities is primarily due to a $23.6 million decrease in amounts payable on reinsurance ceded. At December 31, 2000, we recorded accrued annuity commissions of $12.0 million due MassMutual for participation in the variable annuity exchange programs, which were paid in 2001.
Net cash provided by operating activities increased $334.4 million in 2001. We attribute this increase primarily to increased deposits into the fixed account options and decreased surrender benefits, partially offset by an increase in the net loss from operations.
At December 31, 2001, we had $1,860.9 million of invested assets in our general investment account. We manage the portfolio of invested assets to support the general account liabilities of the business in light of yield, liquidity, and diversification considerations.
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. After expenses and IMR amortization, net annualized yields were 7.3%, 7.7% and 7.2% for the years ended December 31, 2001, 2000 and 1999, respectively.
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
The following table sets forth by industry category the total bond portfolio, including short-term securities, as of December 31, 2001:
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, 2001, bonds having a carrying value of $30.5 million, or 2%, 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:
At December 31, 2001, 95.5% of our commercial mortgage loan portfolio consisted of bullet loans compared to 95.7% at December 31, 2000. Bullet loans are loans that do not fully amortize over their term.
During 2001 and 2000, 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 consider the maturities of commercial mortgage loans to be sufficiently diversified, and carefully monitor and manage maturities in light of our liquidity needs. In 2001, we added twenty-six new loans, twelve of which were office buildings. Additionally, in 2001, borrowers paid off six loans, which totaled $5.5 million.
The asset valuation reserve contains a mortgage loan component, which totaled $4.8 million at December 31, 2001. In addition, at December 31, 2001, we maintained a separate commercial mortgage loan investment reserve of $0.5 million for properties in the process of foreclosure and for other anticipated losses. See “Investment Reserves”.
(1) The balance is comprised of the AVR and other investment reserves which are recorded as liabilities on the statement of financial position as follows:
We have audited the accompanying statutory statements of financial position of C.M. Life Insurance Company (the “Company”) as of December 31, 2001 and 2000, and the related statutory statements of income, changes in shareholder’s equity, and cash flows for the years ended December 31, 2001, 2000 and 1999. 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.
In our opinion, the statutory financial statements referred to above present fairly, in all material respects, the financial position of C.M. Life Insurance Company at December 31, 2001 and 2000, and the results of its operations and its cash flows for the years ended December 31, 2001, 2000 and 1999 on the statutory basis of accounting described in Note 1.
C.M. Life Insurance Company (the “Company”) is a wholly-owned stock life insurance subsidiary of Massachusetts Mutual Life Insurance Company (“MassMutual”). The Company provides life insurance and annuities to individuals and group life insurance to institutions.
On January 1, 2001, the Company adopted the Codification of Statutory Accounting Principles (“Codification”). Codification provides a comprehensive guide of statutory accounting principles for use by insurers in the United States of America. See Note 2 for additional information with respect to the adoption of new accounting standards.
Bonds are valued in accordance with rules established by the NAIC. Generally, bonds are valued at amortized cost, using the constant yield method. The value of fixed maturity securities are adjusted for impairments in value deemed to be other than temporary. The Company considers the following factors in the evaluation of whether a decline in value is other than temporary: (a) the financial condition and near-term prospects of the issuer; (b) the Company’s ability and intent to retain the investment for a period of time sufficient to allow for an anticipated recovery in value; and (c) the period and degree to which the market value has been below cost. If the impairment is other than temporary, a direct write down is recognized in the Statutory Statements of Income as a realized capital loss, and a new cost basis is established.
For mortgage-backed securities included in fixed maturity securities, the Company recognizes income using a constant yield based on anticipated prepayments and the estimated economic life of the securities. When estimates of prepayments change, the effective yield is recalculated to reflect actual payments to date and anticipated future payments. The net investment in these securities is adjusted to the amount that would have existed had the new effective yield been applied since the acquisition of the securities. This adjustment is reflected in net investment income.
Mortgage loans are valued at amortized cost net of valuation reserves. The Company discontinues the accrual of interest on mortgage loans which are delinquent more than 90 days or when collection is uncertain. When it is probable that the Company will be unable to collect all amounts of principal and interest due according to the contractual terms of the mortgage loan agreement, a valuation reserve is established for the excess of carrying value of the mortgage loan over its estimated fair value.
The estimated fair value is based on the collateral value of the loan if the loan is collateralized. Any change to the valuation reserve for mortgage loans is included in net unrealized capital gains and losses. If the impairment is other than temporary, a direct write down is recognized in the Statutory Statements of Income as a realized capital loss, and a new cost basis is established. Collateral value is used as the measurement method if foreclosure becomes probable.
In compliance with regulatory requirements, the Company maintains an Asset Valuation Reserve (“AVR”) and an Interest Maintenance Reserve (“IMR”). The AVR and other investment reserves stabilize the shareholder’s equity against declines in the value of bonds and mortgage loan investments. The IMR defers all interest related after-tax realized capital gains and losses. These interest rate related gains and losses are amortized into net investment income using the grouped method over the remaining life of the investment sold or over the remaining life of the underlying asset.
Net realized after tax capital losses of $0.9 million in 2001, $5.1 million in 2000 and $1.4 million in 1999 were deferred into the IMR. Amortization of the IMR into net investment income amounted to $(0.9) million in 2001, $0.5 million in 2000 and $0.5 million in 1999. Realized capital gains and losses, less taxes, not included in the IMR, are recognized in net income. Realized capital gains and losses are determined using the specific identification method. All security transactions are recorded on a trade date basis. Unrealized capital gains and losses are recorded as a change in shareholder’s equity.
The Company enters into reinsurance agreements with MassMutual and other insurance companies in the normal course of business. Assets and liabilities related to reinsurance ceded contracts are reported on a net basis. Premiums, benefits to policyholders and reserves are stated net of reinsurance. Reinsurance premiums, commissions, expense reimbursements, benefits and reserves related to reinsured business are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. The Company remains liable to the insured for the payment of benefits if the reinsurer cannot meet its obligations under the reinsurance agreements.
On January 1, 2001, the Codification of Statutory Accounting Principles (“Codification”) became effective and was adopted by the Company. Codification provides a comprehensive guide of statutory accounting principles for use by insurers in the United States of America. The effect of adopting Codification was an increase to January 1, 2001 shareholder’s equity of $15.9 million. The primary components of this increase are the change in accounting for certain investments in derivatives of $4.7 million, the exclusion of cost of collection liability of $5.6 million and the admission of a net deferred tax asset of $5.1 million.
The Company believes that it has made a reasonable determination of the effect on shareholder’s equity based upon its interpretation of the principles outlined in Codification. However, future clarification of these principles by the State of Connecticut Insurance Department or the NAIC may have a material impact on this determination. In conformity with statutory accounting practices, prior year statements have not been restated to reflect the implementation of Codification. Certain 2000 and 1999 balances have been reclassified to conform to current year presentation.
The carrying value and estimated fair value of bonds at December 31, 2001, 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.
Excluding investments in United States governments and agencies, the Company is not exposed to any significant concentration of credit risk in its fixed maturities portfolio.
Mortgage loans, comprised primarily of commercial loans, amounted to $329.0 million and $270.1 million at December 31, 2001 and 2000, respectively. The Company’s mortgage loans finance various types of commercial properties throughout the United States. There were no valuation reserves or impairments on mortgage loans as of December 31, 2001 or 2000. The Company had restructured loans with book values of $2.8 million and $2.9 million at December 31, 2001 and 2000, respectively. These loans typically have been modified to defer a portion of the contractual interest payments to future periods. Interest deferred to future periods was immaterial in 2001 and 2000.
The geographic distributions of the mortgage loans at December 31, 2001 and 2000 were as follows:
The carrying value of investments which were non-income producing for the preceding twelve months was $0.2 million at December 31, 2001. There were no investments which were non-income producing for the preceding twelve months at December 31, 2000. Investments in joint ventures and partnerships were $0.9 million at December 31, 2001 and 2000. There was no net investment income on joint ventures and partnerships for the years ended December 31, 2001, 2000, and 1999, respectively. Net investment income on derivative instruments was $1.7 million for the year ended December 31, 2001, net investment losses were $0.3 million for the year ended December 31, 2000, while there was $0.3 million of net investment income for the year ended December 31, 1999.
Net realized capital gains and losses were comprised of the following:
The Company is exposed to credit-related losses in the event of nonperformance by counterparties to derivative financial instruments. This exposure is limited to contracts with a positive fair value. The amounts at risk in a net gain position were $12.5 million and $10.8 million at December 31, 2001 and 2000, respectively. The Company monitors exposure to ensure counterparties are credit worthy and concentration of exposure is minimized. Additionally, collateral positions are obtained with counterparties when considered prudent.
Bonds: Estimated fair value of bonds is based on quoted market prices when available. If quoted market prices are not available, fair values are determined by discounting expected future cash flows using current market rate applicable to yield, credit quality and maturity of the investment or using quoted market prices for comparable investments.
Mortgage loans: The fair value of mortgage loans is estimated by discounting expected future cash flows using current interest rates for similar loans with similar credit risk. For non-performing loans, the fair value is the estimated collateral value of the underlying real estate.
Policy loans, cash and short-term investments: Estimated fair values for these instruments approximate the carrying amounts reported in the Statutory Statements of Financial Position.
Other financial instruments: The estimated fair value for these instruments is determined based on quotations obtained from dealers or other reliable sources.
Investment-type insurance contracts: The estimated fair value for liabilities under investment-type insurance contracts is determined by discounted cash flow projections.
Federal income taxes are based upon the Company’s best estimate of its current and deferred tax liabilities. Deferred income taxes, which provide for book/tax temporary differences, are subject to limitation and are charged directly to policyholders’ contingency reserves. Accordingly, the reporting of miscellaneous temporary differences, such as reserves and policy acquisition costs, and of permanent differences such as tax credits, resulted in effective tax rates which differ from the federal statutory tax rate. For the years ending December 31, 2001 and 2000, the Company’s effective tax rate differs from the federal statutory tax rate of 35% for the following reasons:
The change in deferred tax assets of $2.2 million, net of non-admitted assets, less the change in deferred tax liabilities of $0.2 million resulted in the net change in deferred taxes of $2.0 million for the year ended December 31, 2001.
The Company plans to file a separate company 2001 federal income tax return.
The Internal Revenue Service has completed examining the Company’s income tax returns through the year 1995 and is currently examining the years 1996 and 1997. Management believes adjustments which may result from such examinations will not materially affect the Company’s financial position.
The Board of Directors of MassMutual has authorized the contribution of funds to the Company sufficient to meet the capital requirements of each state in the United States of America 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, $18.8 million of shareholder’s equity is available for distribution to the shareholder in 2002 without prior regulatory approval.
MassMutual and the Company have an agreement whereby MassMutual, for a fee, furnishes the Company, as required, operating facilities, human resources, computer software development and managerial services. Also, investment and administrative services are provided to the Company pursuant to a management services agreement with MassMutual. Fees incurred under the terms of these agreements were $171.6 million, $172.6 million and $124.5 million in 2001, 2000 and 1999, respectively. While management believes that these fees are calculated on a reasonable basis, they may not necessarily be indicative of the costs that would have been incurred on a stand-alone basis.
The Company participates in variable annuity exchange programs with its parent whereby certain MassMutual variable annuity contract holders can make a non-taxable exchange of their contract for an enhanced C.M. Life variable annuity contract. The Company received premiums of $295.6 million, $1,090.9 million and $117.8 million in 2001, 2000 and 1999, respectively, related to these exchange programs. The Company has an agreement with MassMutual to compensate MassMutual for the lost revenue associated with the exchange of these contracts. As a result of these exchanges, the Company has recorded commissions payable of $0.4 million as of December 31, 2001 and $12.0 million as of December 31, 2000, and has paid $15.0 million for the twelve month period ended December 31, 2001.
The Company cedes a portion of its life insurance business to MassMutual and other insurers in the normal course of business. The Company’s retention limit per individual insured is $15.0 million; the portion of the risk exceeding the retention limit is reinsured with other insurers, including MassMutual.
The Company has a modified coinsurance quota-share reinsurance agreement with MassMutual whereby the Company cedes 75% of the premiums on certain universal life policies. In return, MassMutual pays the Company a stipulated expense allowance, death and surrender benefits, and a modified coinsurance adjustment based upon experience. The Company retains the assets and related reserves for payment of future benefits on the ceded policies. Premium income of $22.9 million, $26.7 million and $29.8 million was ceded to MassMutual in 2001, 2000 and 1999, respectively. Policyholder benefits of $33.8 million, $38.4 million and $38.7 million were ceded to MassMutual in 2001, 2000 and 1999, respectively.
The Company also has a stop-loss agreement with MassMutual under which the Company cedes claims which, in aggregate, exceed .32% of the covered volume for any year, with maximum coverage of $25.0 million above the aggregate limit. The aggregate limit was $70.0 million in 2001, $72.4 million in 2000, and $45.4 million in 1999 and it was not exceeded in any of the years. Premium income of $1.3 million was ceded to MassMutual in 2001, 2000 and 1999, respectively.
The Company has conducted a review of the financial impact of the tragic events that occurred on September 11, 2001. These events have not materially impacted the Company’s financial position, results of operations, or liquidity for the period ended December 31, 2001 or foreseeable future periods.