C.M. Life's principal office is located at 140 Garden Street, Hartford, Connecticut.
(1) Defined by the NAIC as surplus plus Asset Valuation Reserve ("AVR").
Certain prior year amounts have been reclassified to conform with current year presentation. The preceding selected financial data of C.M. Life should be read in conjunction with the statutory financial statements notes thereto and the related management's discussion and analysis.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS - -------------------------------------------------------------------------------- OF OPERATIONS - -------------
Premium income, net of reinsurance ceded, increased $16.9 million to $331.3 million in 1997 from $314.4 million in 1996. The 5.4% growth in premiums is attributable to increased sales of Universal and other life products partially offset by a decrease in variable annuity products of 5.7% from the prior year. The result reflects a change in CM Life's business mix in which Universal and other life products comprised 35.5% of total premium income during 1997 compared to 27.9% in 1996, while annuity products were 64.5% in 1997 compared to 72.1% in 1996. Variable annuity premiums have declined due to lower sales through the brokerage distribution channel and a shift in sales through MassMutual's distribution channels from variable annuity products issued by CM Life to variable annuity products issued by C.M. Life's affiliate, MML Bay State Life Insurance Company.
The decrease in gross investment income from bonds and the increase in mortgage loans reflects a shift in the investments in those assets. The increase in gross investment income on common stock reflects enhanced yields on investments in affiliated mutual funds.
Policy benefits and payments increased $1.4 million to $100.4 million in 1997 from $99.0 million in 1996. Surrender and annuity benefits increased $0.5 million and $0.9 million, respectively, essentially due to increased variable and fixed annuity withdrawals and contract surrenders. The life insurance lapse rate, which is based upon amount of insurance in force, decreased to 6.5% for 1997 compared to 7.1% for 1996. Death claims, net of reinsurance, remained consistent between years at $25.1 million and $25.2 million for 1997 and 1996, respectively.
Operating expenses, commissions and state taxes, licenses and fees, increased $12.9 million to $86.5 million in 1997 from $73.6 million in 1996. The increase is attributable to increased expenses and commissions associated with the production of new business and the modification of C.M. Life's variable annuity underwriting agreements with its affiliates, G.R. Phelps and MML Distributors, discussed above, which also increased commissions.
Federal income tax expense increased $12.7 million to $19.0 million in 1997 from $6.3 million in 1996. Taxable income increased $31.2 million to $49.7 million in 1997 from $18.5 million in 1996. The increase in taxable income is primarily attributable to the difference between statutory insurance reserves and tax reserves and the timing of the tax deductibility of acquisition costs and other items.
investments. The 1997 gain of $3.4 million from bonds were primarily interest related and was transferred to IMR net of tax.
As a result of the foregoing factors, net income for 1997 was $7.6 million compared to $2.2 million in 1996, representing an increase of $5.4 million or 245.5% increase over prior year.
Policy benefits and payments increased $40.1 million to $99.0 million in 1996 from $58.9 million in 1995. Surrender benefits increased by $22.7 million, essentially due to increased variable and fixed annuity withdrawals and contract surrenders. The life insurance lapse rate, which is based upon amount of insurance in force, remained at 7.1% for both 1996 and 1995. Death claims, net of reinsurance, grew to $25.2 million in 1996 from $16.3 million in 1995, which is due to an increase in the life insurance in force and worse than expected mortality. Although mortality experience declined during 1996, C.M. Life does not believe this is an indication of future trends.
Federal income tax expense decreased $3.1 million to $6.3 million from $9.4 million as a result of decreased taxable income. Taxable income decreased $9.2 million to $18.5 million in 1996 from $27.7 million in 1995. The change in taxable income is primarily attributable to the $15.8 million decrease in net gain from operations offset by book tax differences of $6.6 million. These book tax differences include the timing of the deductibility of acquisition costs and other items.
Realized capital gains, after the transfer to the Interest Maintenance Reserve ("IMR"), which captures after tax realized capital gains and losses due to changes in interest rates for all types of fixed income investments, increased $1.2 million to $0.7 million in 1996 from a realized loss of $0.5 million in 1995. The increase is primarily attributable to gains generated during the first quarter of 1996 on the sale of common stock investments.
Total assets at December 31, 1997 were $2,219.2 million, representing an increase of $352.6 million or 18.9%, from $1,866.6 million at December 31, 1996. Much of this increase was due to continued growth in C.M. Life's separate investment accounts, which increased by $316.7 million, or 40.6% to $1,096.5 million at December 31, 1997 from $779.8 million at December 31, 1996. Invested assets in C.M. Life's general account portfolio at December 31, 1997 increased by $38.1 million, or 3.7% to $1,060.6 million from $1,022.5 million at December 31, 1996.
Total liabilities at December 31, 1997 were $2,106.0 million, representing an increase of $349.2 million, or 19.9%, from $1,756.8 million at December 31, 1996. As with assets, most of this growth occurred in the separate investment accounts as discussed above.
Policyholders' reserves and funds at December 31, 1997 were $951.0 million, representing an increase of $43.5 million, or 4.8%, from $907.5 million at December 31, 1996. The increase, primarily attributable to universal and other life products, is consistent with increased sales of these products. Policy loans at December 31, 1997 were $142.5 million, representing an increase of $9.6 million, or 7.2%, from $132.9 million at December 31, 1996.
C.M. Life's liquid assets include substantial Treasury holdings, short-term money market investments, stocks, and marketable long-term fixed income securities. Cash and short-term investments totaled $88.4 million at December 31, 1997.
The liquidity position of C.M. Life is proactively managed on an ongoing basis to meet cash needs while minimizing adverse impacts on investment returns. A variety of scenarios are analyzed by modeling potential demands on liquidity, taking into account the provisions of C.M. Life's policies and contracts in force, C.M. Life's cash flow position and the volume of cash and readily marketable securities in C.M. Life's portfolio.
A primary liquidity concern for C.M. Life is the risk of early contractholder and policyholder withdrawal. The most affected products are individual life insurance and individual deferred annuities. Personal life insurance policies are less susceptible to withdrawal than annuity contracts because annuities are primarily used as investment vehicles, while personal life policies are used to fulfill longer-term financial planning needs. C.M. Life closely evaluates and manages its liquidity risk.
Like other businesses and governments around the world, C.M. Life could be adversely affected if the computer systems used by the company and those with which it does business do not properly recognize the year 2000. This is commonly known as the "Year 2000 issue." In 1996, C.M. Life's parent company, MassMutual, began an enterprise wide process of identifying, evaluating and implementing changes to computer systems and applications software to address the Year 2000 issue on its own behalf and on behalf of its insurance subsidiaries, including C.M. Life.
MassMutual is addressing the Year 2000 issue internally with modifications to existing programs and conversions to new programs. C.M. Life's costs related to the Year 2000 issue are being currently expensed by C.M. Life and when measured against C.M. Life's net gain from operations, are not material to C.M. Life. MassMutual is also seeking assurances from vendors, customers, service providers and others with which MassMutual and its subsidiaries conducts business, in order to identify and resolve the Year 2000 issue
In accordance with the life insurance laws and regulations under which C.M. Life operates, it is obligated to carry on its books, as liabilities, actuarially determined reserves to meet its obligations on outstanding contracts.
The C.M. Life's operating expenses are affected by inflation. A large portion of C.M. Life's operating expenses consists of administrative fees charged by MassMutual, the largest component of which is salaries, which are subject to wage increases, at least partially affected by the rate of inflation. C.M. Life's and MassMutual's continuing efforts to control expenses may reduce the impact of inflation on operating expenses.
The following table sets forth C.M. Life's invested assets in the general investment account and gross investment yield:
The yield on total investments before indirect expenses was 7.6%, 7.9% and 7.9% for the years ended December 31, 1997, 1996 and 1995, respectively. If investment expenses were deducted, net yields would be 7.5%, 7.8% and 7.7%, respectively. The yield on each investment category, before federal income taxes, is calculated 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. This is the formula which was specified by the NAIC for calculating investment yield when this information was last required to be included in the annual statement filed with the Connecticut Department of Insurance.
C.M. Life carries its investments in accordance with methods and values prescribed by the NAIC and adopted by state insurance authorities. Generally, bonds are valued at amortized cost, preferred stocks in good standing at cost, and common stocks at fair value. Mortgage loans are valued at principal less impairments and unamortized discount. Real estate is valued at cost less accumulated depreciation, impairments, and mortgage encumbrances. Depreciation on investment real estate is calculated using the straight-line method. Policy loans are carried at the outstanding loan balance less amounts unsecured by the cash surrender value of the policy. Short-term investments are stated at amortized cost, which approximates fair value.
C.M. Life periodically uses standard derivative financial instruments such as options, and futures to hedge certain risks associated with anticipated purchases and sales of investments and certain payments denominated in foreign currencies. These derivative financial instruments are used to protect C.M. Life from market fluctuations in interest and exchange rates between the contract date and the date on which the hedged transaction occurs. C.M. Life is subject to off-balance sheet risk that the counterparties of the transactions will fail to perform as contracted. C.M. Life manages this risk by only entering into contracts with highly rated institutions and listed exchanges. C.M. Life does not hold or issue derivative financial instruments for trading purposes.
The following table provides certain information regarding the maturity distribution of bonds (excluding short-term securities):
C.M. Life invests a significant portion of its investment funds in high quality publicly traded bonds in order to maintain and manage liquidity and reduce the risk of default in the portfolio. As of December 31, 1997, 95.9% of the publicly traded bonds were rated as NAIC Categories 1 and 2, as illustrated by the following chart:
(1) Includes short-term securities. 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 tables below set forth the carrying value, gross unrealized gains and losses, net unrealized gains and losses and estimated fair value of the bond portfolio (excluding short-term securities) at December 31, 1997 and 1996.
The common stock portfolio comprised 5.8% and 5.4% of C.M. Life's investments at December 31, 1997 and 1996, respectively. Common stock had a cost of $50.2 million in 1997 and $47.2 million in 1996; the fair value was $61.4 million and $55.6 million at December 31, 1997 and 1996, respectively.
Mortgage loans represented 9.6% and 3.2% of the total investments in the general account at December 31, 1997 and 1996, respectively. Mortgage loans consist of commercial mortgage loans and residential mortgage loan pools. At December 31, 1997 and 1996, commercial mortgage loans comprised 69.4% and 100.0% of the mortgage loan portfolio.
Total gross investment income on mortgage loans for the year ended December 31, 1997 was $5.0 million, a 36.7% increase from $3.9 million at December 31, 1996. This increase was due to a shift in investment philosophy from bonds to residential mortgage loans. Net realized capital losses were $0.2 and $2.2 million for the years ended December 31, 1997 and 1996.
At December 31, 1997, 99.9% of the commercial mortgage loan portfolio consisted of bullet loans (loans that do not fully amortize over their term) compared to 99.6% at December 31, 1996. Scheduled bullet maturities at December 31, 1997 of $5.8 million, $10.5 million, $2.8 million and $14.6 million in 1998, 1999, 2000 and 2001 and represent 8.3%, 14.9%, 3.9% and 20.7%, respectively, of the commercial mortgage loan portfolio. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.
The maturities of commercial mortgage loans are considered by C.M. Life to be sufficiently diversified and are carefully monitored and managed in light of C.M. Life's liquidity needs.
As of December 31, 1997 and 1996, C.M. Life's policy loans were $142.5 million and $132.9 million, respectively. Policy loans, as a percentage of invested assets, were 13.4% and 13.0% at December 31, 1997 and 1996, respectively. Variable interest rate policy loans were 100% of total policy loans at December 31, 1997 and 98.6% in 1996. For loans with variable interest rates, the rates are adjusted annually based upon changes in a corporate bond index.
C.M. Life does not accrue interest income on bonds delinquent more than 90 days or when management believes the collection of interest is uncertain. Interest not accrued on bonds totaled $0.1 million and zero million for the years ended December 31, 1997 and 1996.
C.M. Life actively monitors, manages and directly services its commercial mortgage loan portfolio. C.M. Life's personnel perform or review all aspects of loan origination and portfolio management, including lease analysis, property transfer analysis, economic and financial reviews, tenant analysis and oversight of default and bankruptcy proceedings. All properties are re-valued each year and re-inspected either each
year or every other year based on internal quality ratings. C.M. Life uses the following criteria to determine whether a current or potential problem exists: (i) borrower bankruptcies, (ii) major tenant bankruptcies, (iii) requests for restructuring, (iv) delinquent tax payments, (v) late payments, (vi) loan-to- value or debt service coverage deficiencies and (vii) overall vacancy levels.
The AVR contains a commercial mortgage loan component which totaled $2.2 million at the end of 1997. In addition, at December 31, 1997, C.M. Life maintained a GIR of $3.9 million for properties in the process of foreclosure and for other anticipated losses. See "Investment Reserves."
When C.M. Life determines that it is probable that the net realizable value of an invested asset is less than its carrying value, appropriate write-downs or investment reserves are established and recorded in accordance with statutory practice.
In the case of bonds, the net realizable value is determined in accordance with principles established by the SVO using criteria such as the net worth and capital structure of the borrower, the value of the collateral, the presence of additional credit support and C.M. Life's evaluation of the borrower's ability to compete in a relevant market.
(2) Amounts represent contributions calculated on a statutory formula plus amounts deemed necessary by C.M. Life. Represents the net impact on Policyholders' Contingency Reserves for investment gains and losses not related to changes in interest rates. (3) These amounts offset realized capital gains (loss), net of tax, that have been recorded as a component of net income. Amounts include realized capital gains and losses, net of tax, on sales not related to interest fluctuations, such as repayments of mortgage loans at a discount, mortgage loan foreclosures and real estate permanent write-downs. (4) These amounts offset unrealized capital gains (loss), recorded as a change in Policyholders' Contingency Reserves (Surplus). Amounts include unrealized losses due to market value reductions of securities with a NAIC quality rating of 6 and net changes in the undistributed earnings of subsidiaries. (5) Amounts represent the reserve contribution (note 2) less amounts already recorded (notes 3 and 4). This net change in reserves is recorded as a charge to Policyholders' Contingency Reserves.
Financial statements, in the form required by Regulation S-X, are set forth below. The Registrant is not required to file supplementary financial data specified by Item 302 of Regulation S-K.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of C.M. Life Insurance Company at December 31, 1997 and 1996, and the results of its operations and its cash flows for the years then ended, on the statutory basis of accounting described in Note 1.
The accompanying statutory financial statements, except as to form, have been prepared in conformity with the statutory accounting practices of the National Association of Insurance Commissioners ("NAIC") and the accounting practices prescribed or permitted by the Insurance Department of the State of Connecticut.
The NAIC is currently engaged in an extensive project to codify statutory accounting principles ("Codification") with a goal of providing a comprehensive guide of statutory accounting principles for use by insurers in all states. This comprehensive guide, which has not been approved by the NAIC or any state insurance department includes seventy-two Statements of Statutory Accounting Principles ("SSAPs") and is expected to be effective no earlier than January 1, 1999. The effect of adopting these SSAPs shall be reported as an adjustment to surplus on the effective date. Management is currently reviewing the impact of Codification. However, since the SSAPs have not been finalized, the ultimate impact cannot be determined at this time.
The preparation of financial statements requires management 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. Management 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 and asset valuations, could cause actual results to differ from the estimates used in the financial statements.
2. Summary of Significant Accounting Policies The following is a description of the Company's principal accounting policies and practices.
Bonds and stocks are valued in accordance with rules established by the National Association of Insurance Commissioners. Generally, bonds are valued at amortized cost, preferred stocks in good standing at cost, and common stocks at fair value.
Short-term investments are stated at amortized cost, which approximates fair value.
The Interest Maintenance Reserve captures after-tax realized capital gains and losses which result from changes in the overall level of interest rates for all types of fixed income investments, as well as other financial instruments, including financial futures, U. S. Treasury purchase commitments, options and interest rate swaps. This reserve is amortized into 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 gains of $2.0 million in 1997 and $0.4 million in 1996 and net realized after tax capital losses of $0.9 million in 1995 were transferred to the Interest Maintenance Reserve. Amortization of the Interest Maintenance Reserve into net investment income amounted to $0.1 million in 1997, 1996 and 1995. At December 31, 1997, 1996 and 1995, the Interest Maintenance Reserve consisted of a net loss deferral which was recorded as a reduction of surplus.
Separate account assets and liabilities represent segregated funds administered and invested by the Company for the benefit of variable annuity contract holders. The assets consist principally of marketable securities reported at fair value. Transfers due from separate account represents the policyholders' account values in excess of statutory benefit reserves. Premiums, benefits and expenses of the separate accounts are reported in the Statutory Statement of Income. Reserves for these life and annuity contracts have been established using assumed interest rates and valuation methods that will provide reserves at least as great as those required by law and contract provisions. The Company receives administrative and investment advisory fees from these accounts.
Policyholders' reserves for life contracts are developed using accepted actuarial methods computed principally on the net level premium and the Commissioners' Reserve Valuation Method bases using the American Experience and 1980 Commissioners' Standard Ordinary mortality tables with assumed interest rates ranging from 4.0 to 4.5 percent.
Federal tax payments were $6.8 million in 1997, $17.6 million in 1996 and $10.7 million in 1995.
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 capital stock and surplus is subject to dividend restrictions relating to various state regulations which limit the payment of dividends without prior approval. Under these regulations, $10.7 million of capital stock and surplus is available for distribution to the shareholder in 1998 without prior regulatory approval.
Prior to March 1, 1996, the Company had an underwriting agreement with its affiliates GR Phelps and MML Distributors. Under this agreement, the affiliates paid commissions and received the cash flows from variable annuity contract fees. Effective March 1, 1996, this agreement was cancelled, and the Company began paying all commissions and retained the right to the related future cash flows from contract fees.
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 $4 million; the portion of the risk exceeding the retention limit is reinsured with other insurers. The Company is contingently liable with respect to ceded reinsurance in the event any reinsurer is unable to fulfill its contractual obligations.
The Company has a modified coinsurance quota-share reinsurance agreement with Mass Mutual 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. Reserves for payment of future benefits for the ceded policies are retained by the Company.
6. Investments The Company maintains a diversified investment portfolio. Investment policies limit concentration in any asset class, geographic region, industry group, economic characteristic, investment quality or individual investment.
The carrying value and estimated fair value of bonds at December 31, 1997, 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.
Proceeds from sales of investments in bonds were $388.8 million during 1997, $162.9 million during 1996, and $380.6 million during 1995. Gross capital gains of $3.8 million in 1997, $1.6 million in 1996, and $3.6 million in 1995 and gross capital losses of $0.5 million in 1997, $0.9 million in 1996, and $4.7 million in 1995 were realized on those sales, portions of which were included in the Interest Maintenance Reserve. Estimated fair value of non-publicly traded bonds is determined by the Company using a pricing matrix.
The fair value of mortgage loans, as determined from a pricing matrix for performing loans and the estimated underlying real estate value for non-performing loans, approximated carrying value.
The carrying value of investments which were non-income producing for the preceding twelve months was $0.4 million and $2.8 million at December 31, 1997 and 1996, respectively.
It is not practicable to determine the fair value of policy loans as they do not have a stated maturity.
The Company manages its investment risks primarily to reduce interest rate and duration imbalances determined in asset/liability analyses. The fair values of these instruments, which are not recorded in the financial statements, are based upon market prices or prices obtained from brokers. The Company does not hold or issue these financial instruments for trading purposes.
The Company utilizes interest rate swap agreements and options to reduce interest rate exposures arising from mismatches between assets and liabilities and to modify portfolio profiles to manage other risks identified. Under interest rate swaps, the Company agrees to exchange, at specified intervals, the difference between fixed and floating interest rates calculated by reference to an agreed-upon notional principal amount. Net amounts receivable and payable are accrued as adjustments to interest income and included in investment and insurance amounts receivable on the Statutory Statement of Financial Position. Gains and losses realized on the termination of contracts are amortized through the Interest Maintenance Reserve over the remaining life of the associated contract. At December 31, 1997 and 1996, the Company had swaps outstanding with notional amounts of $46.5 million and $13.0 million, respectively. The fair value of these instruments was $0.2 million at December 31, 1997 and $0.1 million at December 31, 1996.
9. Business Risks and Contingencies The Company is subject to insurance guaranty fund laws in the states in which it does business. These laws assess insurance companies amounts to be used to pay benefits to policyholders and claimants of insolvent insurance companies. Many states allow these assessments to be credited against future premium taxes. The Company believes such assessments in excess of amounts accrued will not materially affect its financial position, results of operations or liquidity. The Company elected not to admit $1.3 million and $1.6 million of guaranty fund premium tax offset receivable relating to prior assessments in 1997 and 1996, respectively.
11. Affiliated Companies The relationship of the Company, its parent and affiliated companies as of December 31, 1997 is illustrated below. Subsidiaries are wholly-owned by the parent, except as noted.
Subsidiaries of MassMutual International ---------------------------------------- MassLife Seguros de Vida (Argentina) S. A. MassMutual International (Bermuda) Ltd. Mass Seguros de Vida (Chile) S. A. MassMutual International (Luxembourg) S. A.
MassMutual Holding MSC, Incorporated ------------------------------------- MassMutual/Carlson CBO N. V. - 100% MassMutual Corporate Value Limited - 46% 9048 - 5434 Quebec, Inc.
We have audited the accompanying statutory statements of income, changes in capital stock and surplus and cash flows of C.M. Life Insurance Company (a Connecticut corporation and a wholly owned subsidiary of Connecticut Mutual Life Insurance Company) for the year ended December 31, 1995. These financial statements and the schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financials statements and schedules based on our audit.
In our originally issued report dated February 15, 1996, we expressed an opinion that the 1995 financial statements, prepared using accounting practices prescribed or permitted by the Insurance Department of the State of Connecticut, presented fairly, in all material respects, the financial position of C.M. Life Insurance Company as of December 31, 1995, and the results of its operations and its cash flows for the year ended December 31, 1995 in conformity with generally accepted accounting principles. Pursuant to the provisions of Statement of Financial Accounting Standards No. 120 (SFAS No. 120), Accounting and Reporting by Mutual Life Insurance Enterprises and by Insurance Enterprises for Certain Long-Duration Contracts, financial statements of mutual life insurance enterprises for periods ending on or before December 15, 1996, prepared using accounting practices prescribed or permitted by insurance regulators (statutory financial statements) are no longer considered presentations in conformity with generally accepted accounting principles when presented for comparative purposes with the enterprise's financial statements for periods subsequent to the effective date of SFAS No. 120. Accordingly our present opinion, on the presentation of the 1995 financial statements in accordance with generally accepted accounting principles, as present herein, is different from that expressed in our previous report.
Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. Schedules III and IV are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic financial statements, and in our opinion, fairly state in all material respects the financial data required to be set forth therein for the year ended December 31, 1995 in relation to the basic financial statements taken as a whole.