(a) acquisition costs, such as commissions and other costs directly related to acquiring new business, are charged to current operations as incurred, whereas GAAP would capitalize, these expenses and recognize them over the life of the policies;
(b) statutory policy reserves are based upon the commissioners’ reserve valuation methods and statutory mortality, morbidity, and interest assumptions, whereas GAAP reserves would generally be based upon net level premium and estimated gross margin methods and appropriately conservative estimates of future mortality, morbidity, and interest assumptions;
(c) bonds are generally carried at amortized cost whereas GAAP generally reports them at fair value;
(d) deferred income taxes are not provided for book-tax temporary differences as would be required by GAAP; and
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, 2000 and 1999, our results of operations for the past three years and, where appropriate, factors that may affect our future financial performance.
continued commitment to the high credit quality of our general account investment portfolio.
Objective testimony to our strong performance and market position is reflected in our ratings, which at year-end 2000 were again among the highest enjoyed by any company in any industry. Our, and MassMutual’s, year-end 2000 ratings 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.
Costs related to the production of new business are impacted by commissions and other variable producer compensation, management fees to MassMutual and business issuance and processing costs, which include policy assembly and other customer service activities including fluctuations in the market value of variable funds during the processing of deposits. During 2000, costs related to the production of new business as a percentage of premiums were lower, primarily because a larger portion of new business was generated through variable annuity exchange programs with MassMutual contract owners. See Related Party Transactions, footnote 7, Notes to Statutory Financial Statements, for further information on the annuity exchange programs with MassMutual.
Premium income increased in 2000 and 1999 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.
These product development efforts included the redesign of an existing variable universal life product, the introduction of two new annuity products in 1999, the introduction of one new variable universal life product in 1999, and the addition of new fund options on existing annuity products.
Our business mix has shifted as a result of increasing sales of annuity products. Annuity products comprised 84% of total net premium income during 2000, compared to 74% in 1999 and 64% in 1998. In contrast, universal and other life products were 16% of total net premium income in 2000, compared to 26% in 1999, and 36% in 1998.
Net investment income increased in 2000 primarily due to a 12% increase in average invested assets and an increase in the gross yield for the investment portfolio to 7.8% in 2000 from 7.4% in 1999. Net investment income increased in 1999 due to a 10% increase in average invested assets partially offset by a decrease in the gross yield for the investment portfolio to 7.4% in 1999 from 7.9% in 1998.
The decrease in other investments gross investment income in 2000 is primarily due to a reduction in dividends received from affiliated mutual funds. In 1999, the decrease in gross investment income on other investments resulted primarily from decreased investments in affiliated mutual fund common stock and the receipt of an extraordinary dividend from an affiliated mutual fund in 1998.
2) the investment fund options currently offered with our annuity products use a “value” based investment philosophy that has temporarily fallen out of favor when compared to other investment options, such as “growth” funds, due to market conditions over the last few years.
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. The increase during 2000 was primarily due to a $1,383.7 million increase in separate account deposits, partially offset by a $222.7 million increase in separate account withdrawals and other transfers. The increase during 1999 is primarily attributable to a $329.8 million increase in separate account deposits, partially offset by a $109.4 million increase in separate account withdrawals and other transfers. The change in general account reserves was relatively level in 2000 whereas in 1999 these expenses grew due to an increase in annuity deposits into the general account.
Commissions increased in 2000 and 1999 primarily due to increases in sales of annuities and life insurance. Life insurance commissions increased $33.5 million in 2000 and $21.1 million in 1999, while commissions on annuity products increased $24.1 million in 2000 and $11.9 million in 1999. Annuity commissions include amounts due MassMutual for participation in various variable annuity exchange programs. Throughout the last several years, overall commissions as a percentage of sales decreased due to a shift in the sales mix from life products to annuity products, which have lower commission rates than life products.
The increase in operating expenses, state taxes, licenses, and fees during 2000 and 1999 is primarily attributable to the increased production of new business that resulted in increased management fees. Management fees charged by MassMutual include increases in agency allowances and other expenses associated with the production of new business.
The following table sets forth our more significant assets, liabilities and shareholder’s equity:
Total assets at December 31, 2000, increased by $1,573.6 million, from December 31, 1999. We attribute this increase primarily to continued growth in our separate accounts, as the result of continued growth in deposits of variable products, partially offset by withdrawals.
General account assets increased $263.6 million, or 19%, to $1,666.2 million as of December 31, 2000, from $1,402.6 million as of December 31, 1999. We attribute this increase primarily to increases in bonds, mortgage loans and other assets, partially offset by a reduction in cash and short-term investments. These increases in investments were primarily the result of our continued growth and the investment of cash flow generated by our operations, as well as a capital contribution from our parent, MassMutual.
The increase in bonds during 2000 includes $485.7 million in purchases and $319.9 million of maturities and sales proceeds. There was a slight change in the mix of bonds at December 31, 2000, compared with December 31, 1999. Bond investments in U. S. Treasury and other government holdings
The increase in mortgage loans is primarily attributed to a continuation of our strategy of increasing our investments in mortgage loans due to favorable market conditions. For the year ended December 31, 2000, $82.7 million of new loans were issued and $38.7 million was received on outstanding accounts.
Other investments consisting of financial options, interest rate caps and floors, affiliated common stocks and preferred stocks increased in 2000 due to market appreciation.
The increase in other assets is due primarily to a $79.6 million increase in transfers due from separate accounts. Transfers due from separate accounts represents policyholders’ account values in excess of statutory benefit reserves. This growth is consistent with the overall increase in separate account business in force.
The increase in policyholders’ reserves and funds, primarily attributable to growth from new sales in annuity products and interest credited, was partially offset by transfers to separate accounts and withdrawals.
The increase in other liabilities is primarily due to increases in federal income tax payable driven by federal tax expenses and a $11.3 million increase in payable to parent. In 2000, we recorded accrued annuity commissions of $12.0 million as an estimate of compensation due MassMutual for participation in the variable annuity exchange programs. On March 13, 2001, we paid $5 million of the $12.0 million due MassMutual.
a decrease of $9.0 million due to a change in the valuation of policyholders’ reserves,
Cash and short-term investments decreased $66.6 million, or 37%, during 2000 as a result of cash used in investment activities exceeding funds provided by operating activities.
In 2000, MassMutual made capital contributions that totaled $85.0 million. The Board of Directors of MassMutual authorized the contribution of funds to meet the capital requirements of all states in which we are licensed to do business.
We proactively manage our liquidity position on an ongoing basis to meet cash needs while minimizing adverse impacts on investment returns. We analyze a variety of scenarios modeling potential demands on liquidity, taking into account the provisions of our policies and contracts in force, our cash flow position, and the volume of cash and readily marketable securities in our portfolio.
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 assessed against withdrawals to discourage surrenders.
As of December 31, 2000, our total adjusted capital as defined by the NAIC was $167.5 million. The NAIC developed the Risk Based Capital (“RBC”) model to compare the total adjusted capital with a standard design in order to reflect an insurance company’s risk profile. Although we believe that there is no single appropriate means of measuring RBC needs, we feel that the NAIC approach to RBC measurement is reasonable, and we manage our capital position with significant attention to maintaining adequate total adjusted capital relative to RBC. Our total adjusted capital was well in excess of all RBC standards at December 31, 2000 and 1999. We believe we enjoy a strong capital position in light of our risks and that we are well positioned to meet policyholder and other obligations.
As directed by our policyholders, the majority of our assets are policyholders’ investments in our separate accounts. We record the assets in our separate accounts at market value, and we pass all investment risks on to our policyholders. The following discussion focuses on the general investment account portfolio, which does not include our separate account assets.
At December 31, 2000, we had $1,436.2 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.
(1) Average life is 4.8 years, including securities guaranteed by the U.S. Government.
As of December 31, 2000, mortgage-backed securities in the bond portfolio consisted of $90.5 million of Government National Mortgage Association (“GNMA”), and Federal National Mortgage Association (“FNMA”) commitments, Federal Home Loan Mortgage Corporation (“FHLMC”) and Federal Housing Authority (“FHA”) mortgage-backed pass-through securities, and $55.4 million of government agency-backed collateralized mortgage obligations.
(1) Excludes GNMA’s which are categorized as obligations of the U.S. Government corporations and agencies.
The estimated fair value of bonds is based upon quoted market prices for actively traded securities. We subscribe to commercial pricing services providing estimated fair values of fixed income securities that are not actively traded. We generally determine estimated fair values for privately placed bonds by applying interest rate spreads based on quality and asset type to the appropriate duration on the U.S. Treasury yield curve.
Substantially all of our publicly traded and privately placed bonds are evaluated by the NAIC’s Securities Valuation Office (“SVO”), which assigns securities to one of six NAIC investment classes with Class 1 securities being the highest quality and Class 6 securities being the lowest quality. Classes 1 and 2 are investment grade, Class 3 is medium quality, and Classes 4, 5 and 6 are non-investment grade. For securities which have not yet been rated by the NAIC, we use an internal rating system. We believe that our internal rating system is similar to that used by the SVO.
The following table sets forth by industry category the total bond portfolio, including short-term securities, as of December 31, 2000:
(1)These bonds are collateralized by mortgages backed by FNMA, GNMA or FHLMC and include collateralized mortgage obligations and pass-through securities. These amounts also include asset backed securities such as credit card, automobile, and residential mortgage securities.
We actively review the bond portfolio to estimate the likelihood and amount of financial defaults or write-downs in the portfolio and to make timely decisions as to the potential sale or renegotiation of terms of specific investments.
The following table provides certain information regarding the contractual maturity distribution of mortgage loans:
At December 31, 2000, 96% of our commercial mortgage loan portfolio consisted of bullet loans compared to 97% at December 31, 1999. Bullet loans are loans that do not fully amortize over their term.
The following tables set forth by property type and geographic distribution, the carrying value of commercial mortgage loan balances:
The AVR contains a mortgage loan component, which totaled $7.6 million at December 31, 2000. See “Investment Reserves”.
In the case of real estate and commercial mortgage loans, we make borrower and property-specific assessments as well.
In compliance with regulatory requirements, we maintain the AVR. The AVR stabilizes surplus against non-interest rate related fluctuations in the value of stocks and bonds. We maintain other reserves which are not mandated by regulation, in anticipation of future losses on specific mortgage loans, particularly mortgage loans in the process of foreclosure.
The following table presents the change in total investment reserves for the years 2000 and 1999:
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.
These amounts offset realized capital gains (losses), 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 and mortgage loan foreclosures.
We have audited the accompanying statutory statements of financial position of C.M. Life Insurance Company (the “Company”) as of December 31, 2000 and 1999, and the related statutory statements of income, changes in shareholder’s equity, and cash flows for the years then ended. 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, because of the effects of the matters discussed in the preceding paragraph, the 2000 and 1999 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, 2000 and 1999, or the results of its operations or its cash flows for the years then ended.
In our opinion, the 2000 and 1999 statutory financial statements referred to above present fairly, in all material respects, the financial position of C.M. Life Insurance Company at December 31, 2000 and 1999, 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.
As described in Note 1, these financial statements were prepared in conformity with accounting practices prescribed or permitted by the Department of Insurance of the State of Connecticut, 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 generally accepted accounting principles, although not reasonably determinable, are presumed to be material.
In our opinion, the financial statements of C.M. Life Insurance Company audited by us, present fairly, in all material respects, the results of its operations and its cash flows for the year ended December 31, 1998, on the 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 is primarily engaged in the sale of flexible premium universal and variable life insurance and variable annuity products distributed through career agents. The Company is licensed to sell life insurance and annuities in Puerto Rico, the District of Columbia and 49 states of the United States of America (excluding New York).
In March 1998, the NAIC adopted the Codification of Statutory Accounting Principles (“Codification”). Codification provides a comprehensive guide of statutory accounting principles for use by insurers in the United States of America and is effective January 1, 2001. The effect of adopting Codification will be reported as an adjustment to shareholder’s equity on the effective date. The Company has initially estimated the impact as of January 1, 2001, to be an increase of $11.0 million. Included in this total adjustment to shareholder’s equity is the change in accounting for certain investments and the admission of net deferred tax assets. The Company believes that it has made a reasonable estimate based upon its interpretation of the principles outlined in Codification. However, future clarification of these principles by the State of Connecticut Department of Insurance or the NAIC may have a material impact on these estimates.
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 shareholder’s equity against fluctuations in the value of stocks, as well as declines in the value of bonds and mortgage loans. The IMR defers 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 and interest related hedging activities. 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 $5.1 million in 2000 and $1.4 million in 1999, and realized after-tax capital gains of $2.6 million in 1998 were deferred into the IMR. Amortization of the IMR into net investment income amounted to $0.5 million in 2000, $0.5 million in 1999 and $0.3 million in 1998. At December 31, 1999, the unamortized IMR deferred was in a net loss position, which in accordance with the regulations, was recorded as a reduction of surplus. Realized capital gains and losses, less taxes, not includable in the IMR, are recognized in net income. Realized capital gains and losses are determined using the specific identification method. Unrealized capital gains and losses are included in shareholder’s equity.
Separate account assets and liabilities represent segregated funds administered and invested by the Company for the benefit of variable life and annuity contractholders. The Company receives administrative and investment advisory fees from these accounts. Separate accounts reflect two categories of risk assumption; non-guaranteed separate accounts for which the contractholder assumes the investment risk; and guaranteed separate accounts for which the Company contractually guarantees a minimum return to the contractholder. Assets consist principally of marketable securities reported at fair value. Transfers receivable from separate accounts represent 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. Investment income and realized and unrealized gains and losses on the assets of separate accounts accrue directly to contractholder’s and, accordingly, are not reflected in the Statutory Statement of Income.
Assets designated as “non-admitted” include prepaid agent commissions, other prepaid expenses and the IMR, when in a net loss deferral position, and are excluded from the Statutory Statements of Financial Position. These amounted to $13.5 million and $9.9 million as of December 31, 2000 and 1999, respectively and changes therein are charged directly to shareholder’s equity.
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. In the normal course of business, the Company enters into commitments to purchase certain investments. At December 31, 2000, the Company has outstanding commitments to purchase privately placed securities and mortgage loans, which totaled $5.9 million and $10.7 million, respectively.
Investments in affiliated mutual funds had a cost of $13.7 million in 2000 and $17.4 million in 1999.
The Company utilizes interest rate swap agreements, options, and purchased caps and floors to reduce interest rate exposures arising from mismatches between assets and liabilities and to modify portfolio profiles to manage other risks. Under interest rate swaps, the Company agrees to an exchange, at specified intervals, between streams of variable rate and fixed rate interest payments calculated by reference to an agreed-upon notional principal amount. Gains and losses realized on the termination of contracts are deferred and amortized through the IMR over the remaining life of the associated contract. Net amounts receivable and payable are accrued as adjustments to net investment income and included in investment and insurance amounts receivable on the Statutory Statements of Financial Position. At December 31, 2000 and 1999, the Company had swaps with notional amounts of $315.0 million and $226.5 million, respectively.
Options grant the purchaser the right to buy or sell a security or enter into a derivative transaction at a stated price within a stated period. The Company’s option contracts have terms of up to ten years. The amounts paid for options purchased are amortized into net investment income over the life of the contract on a straight-line basis. Unamortized costs are included in other investments on the Statutory Statements of Financial Position. Gains and losses on these contracts are recorded at the expiration or termination date and are deferred and amortized through the IMR over the remaining life of the option contract. At December 31, 2000 and 1999, the Company had option contracts with notional amounts of $809.5 million and $944.5 million, respectively. The Company’s credit risk exposure was limited to the unamortized costs of $6.1 million and $7.0 million at December 31, 2000 and 1999, respectively.
The Company utilizes asset swap agreements to reduce exposures, such as currency risk and prepayment risk, built into certain assets acquired. Cross-currency interest rate swaps allow investment in foreign currencies, increasing access to additional investment opportunities, while limiting foreign exchange risk. The net cash flows from asset and currency swaps are recognized as adjustments to the underlying assets’ net investment income. Gains and losses realized on the termination of these contracts adjusts the bases of the underlying assets. Notional amounts relating to asset and currency swaps totaled $6.6 million and $3.6 million at December 31, 2000 and 1999, respectively. As of December 31, 1998, the Company did not have any open asset swap agreements.
The Company enters into forward U.S. Treasury, Government National Mortgage Association (“GNMA”) and Federal National Mortgage Association (“FNMA”) commitments for the purpose of managing interest rate exposure. The Company generally does not take delivery on forward commitments. These commitments are instead settled with offsetting transactions. Gains and losses on forward commitments are recorded when the commitment is closed and deferred and amortized through the IMR over the remaining life of the asset. At December 31, 1999, the Company had U. S. Treasury, GNMA and FNMA purchase commitments which will settle during the following year with contractual amounts of $15.4 million. As of December 31, 2000, the Company did not have any open U. S. Treasury, GNMA and FNMA purchase commitments.
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 $10.8 million and $3.8 million at December 31, 2000 and 1999, 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.
In 1999, the Company began participating 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 $1,090.9 million and $117.8 million in 2000 and 1999, respectively, related to these exchange programs. The Company is currently negotiating with MassMutual, to compensate MassMutual for the lost revenue associated with the exchange of these contracts. As of December 31, 2000, the Company has recorded accrued commissions of $12.0 million as an estimate of compensation due MassMutual.
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 is contingently liable with respect to ceded reinsurance in the event any reinsurer is unable to fulfill its contractual obligations.
Effective January 1, 2000, the Company entered into a coinsurance agreement with MassMutual, whereby the Company cedes substantially 100% of the premiums 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 $47.3 million was ceded to MassMutual in 2000. Policyholders’ benefits of $5.9 million was ceded to MassMutual in 2000.
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 is involved in litigation arising in and out of the normal course of business, including class action and purported class action suits which seek both compensatory and punitive damages. While the Company is not aware of any actions or allegations which should reasonably give rise to any material adverse effect, the outcome of litigation cannot be foreseen with certainty. It is the opinion of management, after consultation with legal counsel, that the ultimate resolution of these matters will not materially affect its financial position, results of operations or liquidity.