We have prepared the accompanying statutory financial information, in conformity with the statutory accounting practices, except as to form, of the NAIC and the accounting practices prescribed or permitted by the State of Connecticut Insurance Department (“statutory accounting practices”).
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 GAAP would require these expenses to be capitalized and recognized over the life of the policies;
statutory policy reserves are based upon the Commissioners’ Reserve Valuation Methods and statutory mortality and interest assumptions, whereas GAAP reserves would generally be based upon net level premium or the estimated gross margin method with appropriate estimates of future mortality and interest assumptions;
bonds are generally carried at amortized cost, whereas GAAP generally requires reporting at fair value;
assets are reported at “admitted asset” value and “non-admitted assets” are excluded through a charge against shareholder’s equity, while under GAAP, “non-admitted assets” are recorded, net of any valuation allowance; and
We develop reserves for individual annuities based on account value or accepted actuarial methods, principally at interest rates ranging from 5.25 to 7.25 percent.
The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as well as disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during reporting periods. The most significant estimates include those used in determining investment valuation reserves, other than temporary impairments and the liabilities for future policyholders’ reserves and deposit fund balances. Future events, including, but not limited to, changes in the levels of mortality, interest rates, persistency and asset valuations, could cause actual results to differ from the estimates used in the financial statements. Although some variability is inherent in these estimates, management believes the amounts presented are appropriate.
Includes payable to MassMutual of $46.4 million in 2002, $45.0 million in 2001, $61.2 million in 2000, $49.9 million in 1999 and $28.8 million in 1998.
At December 31, 2002, we had approximately $6.1 billion in total statutory assets, over 280 thousand individual policyholders and $66.8 billion of direct individual life insurance in force. Our total adjusted capital, as defined by the National Association of Insurance Commissioners (“NAIC”), was $356.6 million at December 31, 2002.
Objective testimony to our strong performance and market position is reflected in our ratings, which at year-end 2002 were again among the highest enjoyed by any company in any industry. Our, and MassMutual’s, AAA (Extremely Strong) financial strength rating from Standard & Poor’s, A++ (Superior) financial strength rating from A.M. Best, and AAA (Exceptionally Strong) 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.
Certain information contained in this discussion is or may be considered forward-looking. Forward-looking statements are those not based on historical information, but rather, relate to future operations, strategies, financial results, or other developments, and contain terms such as “may,” “expects,” “should,” “believes,” “anticipates,” “intends,” “estimates,” “projects,” “goals,” “objectives,” or similar expressions.
The following table sets forth the components of our net income (loss):
The net income for 2002 is primarily attributable to increased realized capital gains resulting from an increase in the market value of hedging instruments, additional fee income from the new coinsurance agreement with MassMutual and increased net investment income, partially offset by earnings strain associated with the continued growth of the Company’s annuity and life insurance businesses, an increase in annuity reserves for guaranteed minimum death benefits, higher surrender benefits and higher death claims. 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.
Net losses increased in 2001 primarily due to earnings strain associated with continued growth of the Company’s life insurance business, higher death claims, and lower expense allowances 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.
Sales in 2002 of fixed annuity products increased to 45% of annuity sales from 16% in 2001. The decrease in variable annuity sales is a direct result of market performance and a reduction in premium received from variable annuity exchange programs with MassMutual.
Net investment income increased in 2002 primarily due to a 50% increase in average invested assets, partially offset by a decrease in the gross yield for the investment portfolio to 6.3% in 2002 from 7.5% in 2001. Net investment income increased in 2001 primarily due to a 21% increase in average invested assets, partially offset by a decrease in the gross yield for the investment portfolio to 7.5% in 2001 from 7.8% in 2000.
The increase in other investments’ gross investment income in 2002 is primarily due to increases in derivative instrument holdings. Average other investments increased 373% in 2002. See Portfolio risk management, footnote 5, Notes to Statutory Financial Statements, for further information. The increase in other investments’ gross investment income in 2001 is primarily due to an increase in income from interest rate swaps.
The increase in gross investment income from cash and short-term investments in 2002 is primarily due to an increase in average invested cash and short-term investments balances over the prior year. The decrease in gross investment income from cash and short-term investments in 2001 is primarily due to the declining interest rate environment, partially offset by an increase in average invested cash and short-term investment balances over 2000.
Fees and other income increased in 2002, as compared to 2001, primarily due to a new coinsurance agreement with MassMutual resulting in a $61.0 million increase in commissions and expense allowance on reinsurance ceded. This increase is enhanced by higher administrative fees collected from the management of investment accounts and lower reserve adjustments on reinsurance ceded. See “Related party transactions”, footnote 7, Notes to Statutory Financial Statements, for a more detailed description of the Company’s modified coinsurance agreements with MassMutual.
Fees increased in 2001 due to increases in fees collected from the administration of separate accounts as a result of variable life and variable annuity sales. Commissions and expense allowances on reinsurance ceded decreased in 2001 primarily due to lower first year commission allowance on annuity products.
Addition to policyholders’ reserves and funds includes transfers to and from the separate accounts, based upon policyholder elections, and the change in general account reserves. This increase during 2002 was primarily due to a $543.5 million increase in general account reserves, partially offset by a $305.3 million decrease in separate account withdrawals and other transfers and a $93.3 million increase in separate account deposits. The increase in 2002 in the change in general account reserves is primarily attributable to a $523.2 million increase in the change in annuity reserves and a $25.1 million increase in the change in life reserves. The increase in the change in annuity reserves is primarily due to increases in the reserves as a result of increased sales of fixed annuity products, the introduction of a new variable annuity product in 2001 and a 2002 increase in reserves for guaranteed minimum death benefits.
Commissions increased in 2002, primarily due to increased sales of annuity products. Annuity product commissions increased $26.1 million, or 60%, partially offset by a decrease in life insurance commissions of $12.0 million in 2002. The overall decrease in commissions as a percentage of sales is primarily due to a continued shift in the sales mix to annuity products, which have lower commission rates than life products. 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 non-traditional life insurance products are lower than commissions charged on traditional life insurance products. In 2001, life insurance commissions decreased $13.2 million while commissions on annuity products decreased $5.1 million. Annuity commissions include amounts due MassMutual for participation in various variable annuity exchange programs.
Realized capital gains, after the transfer to the IMR, increased $67.2 million for the year ended December 31, 2002. This increase is primarily due to increased mark to market adjustments for derivative instruments, partially offset by higher credit related losses from the sale of bonds. The increase in 2001 realized capital losses after transfers to the IMR, is primarily attributable to credit related losses from the sale of bonds.
General account assets increased $1,209.6 million or 62% from December 31, 2001, primarily due to increases in all categories of invested assets. These increases in investments were primarily the result of the Company’s continued growth, the investment of cash flow generated by the Company’s operations, derivative mark to market adjustments and the contribution of Bay State to the Company by MassMutual. The portfolio of general account invested assets is managed to support product liabilities in light of yield, liquidity and diversification considerations. The general investment account portfolio does not include the Company’s separate account invested assets. The Company’s separate account assets decreased $359.1 million or 11% primarily due to unfavorable market conditions and variable annuity surrenders.
Common stock-subsidiary is $194.0 million at December 31, 2002 due to the contribution of Bay State to the Company by MassMutual during the third quarter of 2002. See “Summary of significant accounting policies and practices”, Footnote 2c “Common stock-subsidiary”, for additional information on this transaction.
The Company’s cash and derivative positions are increasing primarily due to the increase in fixed annuity sales and a decrease in the supply of fixed income investments, such as bonds. The offerings of the public bond markets have become less attractive as bonds with lower credit risk are priced at very tight spreads over the Treasury rate. The Company uses a combination of derivatives and short-term investments to synthetically create temporary investment positions, which are highly liquid and of high quality. These synthetic investments perform like bonds and are held to improve the quality and performance of the general investment account until other suitable investments become available.
Other assets decreased by 26% from December 31, 2001. This decrease is primarily due to a $20.5 million decrease in amounts recoverable from reinsurance.
As with assets, most of the 2002 increase in liabilities occurred in general account liabilities, partially offset by a decrease in separate account liabilities. The growth in the general account is primarily attributable to growth in policyholders’ reserves and funds, lower transfers due from separate accounts, and an increase in other liabilities.
The increase in policyholders’ reserves and funds was primarily due to the new sales of fixed annuity products, sales of life insurance products, and interest credited.
Transfers due from separate accounts decreased by 24% from December 31, 2001. Transfers due from separate accounts represents policyholders’ account values in excess of statutory benefit reserves. This decrease is consistent with the decline in separate account liabilities, primarily attributable to market conditions, and the increase in statutory reserves as contracts mature. Management believes that this trend will continue.
The increase in other liabilities in 2002 is primarily due to increases in payables for securities purchased of $24.8 million and federal income taxes payable of $22.5 million.
an increase in additional paid-in capital of $191.5 million from the contribution of Bay State to the Company by MassMutual,
an increase of $2.9 million due to a change in deferred income taxes and
a decrease of $11.0 million due to a change in non-admitted assets.
Cash and short-term investments increased $512.9 million, or 245%, during 2002 primarily due to cash provided by operating activities partially offset by cash used in investing activities.
Loans and purchases of investments increased $315.5 million, or 44%, primarily due to a higher level of bond and mortgage purchase activity during 2002. Sales and maturities of investments and receipts from repayments of loans increased $214.8 million, or 60%, in 2002. We attribute this increase primarily to higher bond sales proceeds and maturities in 2002.
We have structured our investment portfolio to ensure a strong liquidity position in order to permit timely payment of policy and contract benefits without requiring an untimely sale of assets. We manage our liquidity position by matching our exposure to cash demands with adequate sources of cash and other liquid assets.
One of our primary liquidity concerns is the risk of early contract-holder and policyholder withdrawal. Life insurance policies are less susceptible to withdrawal than annuity contracts because annuities are primarily used as investment vehicles, while life policies are used to fulfill longer-term financial planning needs. We closely evaluate and manage our liquidity risk by, for example, including provisions in our products such as contingent deferred sales charges to discourage surrenders.
At December 31, 2002, we had $3,091.3 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 6.1%, 7.3% and 7.7% for the years ended December 31, 2002, 2001 and 2000, respectively.
The following table sets forth by industry category the total bond portfolio, including short-term securities, as of December 31, 2002:
During 2002 and 2001, 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.
The asset valuation reserve contains a mortgage loan component, which totaled $6.0 million at December 31, 2002. See “Investment Reserves”.
Our total investment reserves at December 31, 2002, are $15.8 million a decrease of $0.3 million, or 2%, from $16.1 million at December 31, 2001.
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, transfers among categories and changes in the general investment reserves.
We have audited the accompanying statutory statements of financial position of C.M. Life Insurance Company (the “Company”) as of December 31, 2002 and 2001, and the related statutory statements of income, changes in shareholder’s equity, and cash flows for the years ended December 31, 2002, 2001 and 2000. 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.
As described more fully in Note 2 to the financial statements, the Company has prepared these financial statements using statutory accounting practices prescribed or permitted by the State of Connecticut Insurance Department, which practices differ from accounting principles generally accepted in the United States of America. The effects on the financial statements of the variances between the statutory basis of accounting and accounting principles generally accepted in the United States of America, although not reasonably determinable, are presumed to be material.
In our opinion, because of the effects of the matters discussed in the preceding paragraph, the statutory financial statements referred to above do not present fairly, in conformity with accounting principles generally accepted in the United States of America, the financial position of C.M. Life Insurance Company as of December 31, 2002 and 2001, or the results of its operations or its cash flows for the years ended December 31, 2002, 2001 and 2000.
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, 2002 and 2001, and the results of its operations and cash flows for the years ended December 31, 2002, 2001 and 2000, on the basis of accounting described in Note 2.
Bonds are valued in accordance with rules established by the NAIC. Generally, bonds are valued at amortized cost, using the constant yield method.
For mortgage-backed securities included in bonds, 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.
This transaction was in the form of a related party capital contribution and is therefore considered a “non-economic transaction”. The transaction was recorded at existing book value and no realized capital gain or loss was recorded on this transaction.
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. Interest income earned on impaired loans is accrued on the net carrying value of the loan based on the loan’s effective interest rate; however, interest is not accrued for impaired loans more than 60 days past due. 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 the carrying value of the mortgage loan over its estimated fair value. The estimated fair value is based on the collateral value of the loan. Changes in the valuation reserves for mortgage loans are included in net unrealized capital gains and losses. When an event occurs resulting in an impairment that 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.
The Company uses derivative financial instruments in the normal course of business to manage its investment risks, primarily to reduce interest rate and duration imbalances determined in asset/liability analyses. The investment risk is assessed on a portfolio basis and derivative financial instruments are not designated as a hedge with respect to a specific risk; therefore, the criteria for hedge accounting is not met.
Common stocks are valued in accordance with rules established by the NAIC. Generally, common stocks are valued at fair value with unrealized gains and losses included in shareholder’s equity. The values of common stocks are adjusted for impairments in value deemed to be other than temporary.
The Company considers all highly liquid investments purchased with a maturity of twelve months or less to be short-term investments. Short-term investments are carried at amortized cost, which approximates fair value.
Accrued investment income is valued in accordance with rules established by the NAIC. Accrued investment income consists primarily of interest and dividends. Interest is recognized on an accrual basis and dividends are recorded as earned at the ex-dividend date. Due and accrued income is not recorded on: (a) unpaid interest on bonds in default, (b) interest on mortgage loans delinquent more than 90 days or where collection of interest is uncertain, (c) rent in arrears for more than three months, (d) policy loan interest due and accrued in excess of cash value, and (e) due and accrued interest on non-admitted assets.
Separate account assets and liabilities represent segregated funds administered and invested by the Company for the benefit of variable annuity and variable life insurance policyholders. Assets consist principally of marketable securities reported at fair value and are not available to satisfy liabilities that arise from any other business of the Company. Separate account liabilities represent segregated contract owner funds maintained in accounts with individual investment objectives. The Company receives administrative and investment advisory fees from these accounts.
Universal and variable life products use a formula that applies a weighted average credited rate to the mean average account value. Corporate owned life insurance products use a formula, which applies a weighted average credited rate to the mean account value. For single premium deferred annuities, basic data was used and for supplementary contracts, a formula was used based upon statutory regulations.
The Company waives deduction of deferred fractional premiums on death and returns any portion of the final premium beyond the date of death. Reserves are computed using continuous functions to reflect these practices. The Company reserves for any surrender value promised in excess of the reserve as legally computed.
Guaranteed minimum death benefit reserves (“GMDB”) on certain variable universal life and annuity products are also established by the Company. These reserves are largely a function of historical separate account returns and assumptions regarding future separate account returns as well as the contractual provisions of the issued GMDBs. The GMDB reserve balance at December 31, 2002 and 2001 was $22.8 million and $21.2 million, respectively.
During 2002, the Company reflected Actuarial Guideline XXXIV for minimum guaranteed death benefits included in variable annuity contracts, resulting in a $1.2 million increase in shareholder’s equity.
Net realized after tax capital losses of $8.9 million in 2002, $0.9 million in 2001 and $5.1 million in 2000 were deferred into the Interest Maintenance Reserve (“IMR”). Amortization of the IMR into net investment income amounted to $0.6 million in 2002, $(0.9) million in 2001 and $0.5 million in 2000. Realized capital gains and losses, net of taxes, not included in the IMR, are recognized in net income. Realized capital gains and losses, other than those related to separate accounts, 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.
In May 2002, the National Association of Insurance Commissioners issued Statement of Statutory Accounting Principles (“SSAP”) No. 86 “Accounting for Derivative Instruments and Hedging, Income Generation, and Replication (Synthetic Asset) Transactions” with an effective date of January 1, 2003. SSAP No. 86 supercedes SSAP No. 31 “Derivative Instruments” and establishes statutory accounting principles for derivative instruments and hedging, income generation, and replication (synthetic asset) transactions using selected concepts outlined in Financial Accounting Standards Board Statement No. 133 “Accounting for Derivative Instruments and Hedging Activities.” SSAP No. 86 requires that derivative instruments used in hedging transactions that meet the criteria of a highly effective hedge shall be valued and reported in a manner that is consistent with the hedged asset or liability. SSAP No. 86 also requires that derivative instruments used in hedging transactions that do not meet or no longer meet the criteria of an effective hedge shall be accounted for at fair value and the changes in fair value shall be recorded as unrealized gains or unrealized losses. Adoption of SSAP No. 86 by the Company will change the reporting of derivatives mark-to-market that do not qualify for hedge accounting from realized gains and losses to unrealized gains and losses.
The carrying value and estimated fair value of bonds were as follows:
Portions of realized gains and losses were deferred into the IMR. Other than temporary impairments on bonds during the years ended December 31, 2002 and 2001 were $6.3 million and $4.7 million, respectively, and were included in the gross realized capital losses noted above.
Summarized below is statutory financial information for Bay State as of and for the years ended December 31, 2002 and 2001:
The Company invests in mortgage loans collateralized principally by commercial real estate. During 2002, commercial mortgage loan lending rates ranged from 2.17% to 10.00%.
The maximum percentage of any one loan to the value of security at the time the loan was originated, exclusive of insured, guaranteed or purchase money mortgages, was 84% and 78% at December 31, 2002 and 2001, respectively.
Net investment income on derivative instruments was $14.5 million and $1.7 million for the years ended December 31, 2002 and 2001, respectively. There was no net investment income on derivative instruments for the year ended December 31, 2000.
The Company uses derivative financial instruments in the normal course of business to manage its investment risks, primarily to reduce interest rate and duration imbalances determined in asset/liability analyses. The investment risk is assessed on a portfolio basis and derivative financial instruments are not designated as a hedge with respect to a specific risk; therefore, the criteria for hedge accounting are not met. The Company’s derivative strategy employs a variety of instruments, including interest rate and currency swaps, options, forward commitments and asset and equity swaps.
The Company utilizes currency swaps for the purpose of managing currency exchange risks. Changes in the value of these contracts are recorded as realized capital gains and losses when contracts are closed and at each reporting date.
The Company utilizes certain other agreements including forward commitments, and asset and equity swaps to reduce exposures to various risks. The Company enters into forward U.S. Treasury, Government National Mortgage Association, Federal National Mortgage Association and other 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. Changes in the value of these contracts are recorded as realized capital gains and losses in the Statutory Statements of Income when contracts are closed and at each reporting date.
The following table summarizes the carrying value, fair value and notional amount of the Company’s derivative financial instruments:
The notional amounts described above do not represent amounts exchanged by the parties and, thus, are not a measure of the exposure of the Company. The amounts exchanged are calculated on the basis of the notional amounts and the other terms of the instruments, which relate to interest rates, exchange rates, security prices or financial or other indexes.
Fair values are based on quoted market prices, when available. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. These valuation techniques require management to develop a significant number of assumptions, including discount rates and estimates of future cash flow. Derived fair value estimates cannot be substantiated by comparison to independent markets or to disclosures by other companies with similar financial instruments. These fair value disclosures may not represent the amount that could be realized in immediate settlement of the financial instrument. The use of different assumptions or valuation methodologies may have a material effect on the estimated fair value amounts.
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.
Derivative financial instruments: Fair value for these instruments is based upon quotations obtained from independent sources.
The following table summarizes the carrying value and fair values of the Company’s financial instruments at December 31, 2002 and 2001:
The Company has a modified coinsurance quota-share reinsurance agreement with MassMutual whereby the Company cedes 75% of the premium 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 $23.2 million, $22.9 million and $26.7 million was ceded to MassMutual in 2002, 2001 and 2000, respectively. Fees and other income include a $7.5 million, $8.1 million and a $9.1 million expense allowance from MassMutual in 2002, 2001 and 2000, respectively. In addition, a modified coinsurance adjustment of $26.8 million, $30.2 million and $28.1 million was ceded to MassMutual in 2002, 2001 and 2000, respectively. Policyholders’ benefits of $37.4 million, $33.8 million and $38.4 million were ceded to MassMutual in 2002, 2001 and 2000, respectively.
The Company also has a stop-loss agreement with MassMutual under which the Company cedes claims which, in aggregate, exceed 0.32% of the covered volume for any year, with maximum coverage of $25.0 million above the aggregate limit. The aggregate limit was $66.0 million in 2002, $70.0 million in 2001, and $72.4 million in 2000 and it was not exceeded in any of the years. Premium income of $1.2 million in 2002 and $1.3 million in 2001 and 2000 was ceded to MassMutual.
MassMutual holds the assets and related reserves for payment of future benefits on the ceded policies. Premium income of $29.7 million, $47.4 million, and $47.3 million was ceded to MassMutual in 2002, 2001 and 2000, respectively. Fees and other income include a $7.3 million, $28.5 million and a $46.5 million expense allowance from MassMutual in 2002, 2001 and 2000, respectively. In addition, experience refunds of $2.8 million and $2.5 million were ceded to the Company from MassMutual in 2002 and 2001 respectively. There were no experience refunds from MassMutual to the Company in 2000. Policyholders’ benefits of $1.1 million, $11.3 million and $5.9 million were ceded to MassMutual in 2002, 2001 and 2000, respectively.
Effective January 1, 2002, the Company entered into an additional coinsurance agreement with MassMutual, whereby the Company cedes substantially 100% of the premium on new issues of certain universal life policies. In return, MassMutual pays to the Company a stipulated expense allowance and death and surrender benefits. MassMutual holds the assets and related reserves for payment of future benefits on the ceded policies. Premium income of $89.3 million was ceded to MassMutual in 2002. Fees and other income include an $82.8 million expense allowance from MassMutual in 2002. Policyholders’ benefits of $0.2 million were ceded to MassMutual in 2002.
Premium ceded to unaffiliated insurers was $52.8 million, $48.4 million and $46.2 million and reinsurance recoveries were $44.8 million, $71.6 million and $41.8 million for the years ended December 31, 2002, 2001 and 2000, respectively. Amounts recoverable from unaffiliated reinsurers were $12.1 million and $22.1 million as of December 31, 2002 and 2001, respectively. At December 31, 2002, five unaffiliated reinsurers accounted for 87% of the outstanding reinsurance recoverable.
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 shareholder’s equity. Accordingly, the reporting of miscellaneous temporary differences, such as reserves and policy acquisition costs, and of permanent differences such as tax credits, results in effective tax rates which differ from the federal statutory tax rate.
The components of the net deferred tax asset recognized in the Company’s assets, liabilities and shareholder’s equity at December 31, 2002 and 2001 are as follows (in millions):
The provision for incurred taxes on earnings for the years ended December 31, 2002 and 2001 are as follows (in millions):
In 2002, 2001 and 2000, federal income tax refunds were $15.7 million, $12.1 million and $14.6 million, respectively. As of December 31, 2002, federal income taxes paid in 2000 that will be available for recovery in the event of future net losses were $3.9 million.
The United States Internal Revenue Service has completed its examination of the Company’s income tax returns through the year 1997 and will begin examining the years 1998 through 2000 in early 2003. Management believes adjustments which may result from such examinations will not materially affect the Company’s financial position.
During 2002, MML Bay State Life Insurance Company (“Bay State”) became a wholly-owned stock life insurance subsidiary of the Company through the contribution of all of Bay State’s outstanding shares of common stock from MassMutual to the Company. This transaction was in the form of a related party capital contribution of $191.5 million. In 2001 and 2000, MassMutual contributed additional paid-in capital of $45.0 million and $85.0 million, respectively, to the Company.
The Company operates in a business environment subject to various risks and uncertainties. Such risks and uncertainties include, but are not limited to, interest rate risk and credit risk. Interest rate risk is the potential for interest rates to change, which can cause fluctuations in the value of investments. To the extent that fluctuations in interest rates cause the duration of assets and liabilities to differ, the Company controls its exposure to this risk by, among other things, asset/liability matching techniques that account for the cash flow characteristics of the assets and liabilities. Credit risk is the risk that issuers of investments owned by the Company may default or that other parties may not be able to pay amounts due to the Company. The Company manages its investments to limit credit risk by diversifying its portfolio among various security types and industry sectors. Management does not believe that significant concentrations of credit risk existed as of and for the years ended December 31, 2002 and 2001.
In the normal course of business, the Company enters into commitments to purchase certain investments. At December 31, 2002, the Company had outstanding commitments to purchase privately placed securities and mortgage loans, which totaled $27.4 million and $63.3 million, respectively. At December 31, 2002, the Company had no outstanding commitments to purchase real estate.
The relationship of the Company, MassMutual and affiliated companies as of December 31, 2002, is illustrated below. Subsidiaries are wholly owned by MassMutual, except as noted.