The net income from U.S. operations in 1998 of $1.5 million compared to a net loss in 1997 of $0.8 million was primarily a result of increased fee income earned in 1998 compared to 1997. The higher net
Fee income for 1998 was $54.5 million, compared to $38.7 million in 1997 ($40.4 million in 1996). The increase in fee income in 1998 is attributable to: i) higher cost of insurance charges resulting from a larger inforce block of business in 1998 compared to 1997 and 1996; ii) increased mortality and expense risk charges earned as a percentage of the value of invested assets in the separate account portfolios which have grown significantly in 1998 and 1997 compared to 1996 due to continued strong investment performance, and; iii) higher surrender charges earned due mainly to a larger inforce block of business. Cost of insurance charges for 1998, 1997 and 1996 were $28.3 million, $21.3 million and $19.3 million, respectively; mortality and expense risk charges earned on separate account assets for 1998, 1997 and 1996 were $8.5 million, $7.0 million and $5.2 million, respectively, and; surrender charges for 1998, 1997 and 1996 were $5.1 million, $3.2 million and $3.0 million, respectively. The variable universal life and annuity business accounted for 81% of the fee income earned by the
Company in 1998 compared to 82% in 1997 and 85% in 1996. The remainder of the fee income is primarily derived through asset-based distribution fees which have increased to $7.6 million in 1998 compared to $5.1 million in 1997 ($1.6 million in 1996).
The DAC amortization expense was $9.3 million for 1998 compared to $4.9 million for 1997 ($13.2 million for 1996). In 1997, there was significant DAC unlocking due to assumption changes in the DAC model and re-pricing of the Company's variable products. This was partially offset by amounts written-off relating to DAC in the Taiwan operations due to high reported lapses in 1997.
The following table outlines, by type of investment, the carrying value of the general account investment portfolio of the Company:
General account investments decreased by $14.6 million or 14% from 1997. This change is due to a decrease in fixed maturities of $18.6 million, an increase in policy loans of $4.6 million and a decrease in short-term investments of $1.7 million. The Company manages its investment portfolio to provide liquidity to meet new business strain on increased variable life insurance sales.
The Company's equity portfolio of $20.5 million represents 23% of investments at the end of 1998, compared to 19% at the end of 1997. The equities consist entirely of investments in the portfolios of the MIT.
Policy loans represented 22% of investments at December 31, 1998, compared to 12% in 1997. Most individual life insurance policies provide the individual policyholder with the right to obtain a policy loan from the Company. Such loans are made in accordance with the terms of the respective policies, are carried at the unpaid balance, and are fully secured by the cash surrender value of the policies on which the respective loans are made.
Allowances for losses on investments are established when an asset or portfolio of assets becomes impaired as a result of deterioration in credit quality to the extent that there is no longer assurance of timely realization of the carrying value of assets and related investment income. The carrying value of an impaired asset is reduced to the net realizable value of the asset at the time of recognition of impairment.
DAC increased from $130.4 million at the end of 1997 to $163.5 million as at the end of 1998. This increase is due mainly to deferrable acquisition costs associated with the sale of the COLI product introduced in 1997.
Taiwan reserves increased in 1998 due to increased business and lower lapses and surrenders.
The general account liabilities consist of traditional insurance whose liquidity requirements do not fluctuate significantly from one year to the next. The majority of the Company's cash flows arise from policyholder transactions related to the separate accounts, and, as such, the assets and liabilities of these products are exactly matched.
The Company maintains a prudent amount invested in cash and short term investments. At the end of 1998, this amounted to $24 million or 21% of total investments, including cash and cash equivalents, compared to $22 million in 1997 or 17.7%. In addition, the Company's liquidity is managed by maintaining an easily marketable portfolio of fixed maturities. Because of the excess of expense over income, which arises from the cost of new policy issues, the continued success in generating sales will not only result in losses in the results from operations, but will create a cash flow strain as well. The Company's consolidated statements of cash flows indicate this in that operating activities used cash of $69.3 million and $24.7 million in 1998 and 1997, respectively, compared to $20.5 million in 1996. Included in the 1998 total for cash used in operating activities is the consideration paid of $41.0 million on the termination of the reinsurance agreement with ManUSA. As a result, the Company looks to its parent, ManUSA, for the necessary capital to support its operations. In 1996, a $15 million contribution of capital was made to the Company by ManUSA to provide further liquidity. In 1998, the surplus debenture for $8.5 million issued to the Company from ManUSA in 1995 was discharged and recorded as a capital contribution. Also in 1998, the promissory note in the amount of $33 million issued by the Company to ManUSA in 1997 was discharged and the amount of $34.3 million ($33 million plus interest of $1.3 million) was recorded as a capital contribution. In addition, in 1998, a further $51.7 million contribution of capital was made to the Company by ManUSA to offset the payment of $41.0 million made by the Company to ManUSA on the termination of the reinsurance agreement between the two companies discussed previously. The Company and Manulife Financial have entered into an agreement whereby Manulife Financial provides a claims paying guarantee to the Company's U.S. policyholders. This claims paying guarantee does not apply to the Company's separate account contract holders.
The key risks faced by the Company and how they are managed is explained in the following sections.
Interest rate risk is the risk that the Company will incur economic losses due to adverse changes in interest rates. The Company manages its interest rate risk through an asset/liability management program. The Company has established a target portfolio mix which takes into account the risk attributes of the liabilities supported by the assets, expectations of market performance, and a generally conservative investment philosophy. Preservation of capital and maintenance of income flows are key objectives of this program.
The Company's policy of matching assets with related liabilities by currency limits its exposure to foreign currency movements to a minimal level. The currency exposure on surplus is proportional to the underlying liabilities, thus insulating the Company's "surplus to liability" ratios from changes in foreign currency exchange rates.
The process of pricing products includes the estimation of many factors including future investment yields, mortality and morbidity experience, expenses, rates of policy surrender, and taxes. Pricing risk is the risk that actual experience in the future will not develop as estimated in pricing. Some products are designed such that adjustments to premiums or benefits can be made for experience variations, while for other products no such changes are possible.
The Company has coordinated its operational compliance departments under the supervision of its corporate legal function. This structure ensures compliance with all legal and regulatory requirements in all jurisdictions in which the Company does business. All customer-related communications, product brochures and selling tools, and procedures for compliance therewith, are subject to review by the compliance function. Compliance is monitored on an ongoing basis.
The Company makes extensive use of information systems in the operations of its various businesses, including for the exchange of financial data and other information with customers, suppliers and other counterparties. The Company also uses software and information systems provided by third parties in its accounting, business and investment systems.
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 WITH REPORT OF INDEPENDENT AUDITORS
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Manufacturers Life Insurance Company of America at December 31, 1998 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles.
The Manufacturers Life Insurance Company of America (the "Company") is a wholly-owned subsidiary of The Manufacturers Life Insurance Company (U.S.A.) ("ManUSA"), which is in turn an indirectly wholly-owned subsidiary of The Manufacturers Life Insurance Company ("Manulife Financial"), a Canadian-based mutual life insurance company. The Company markets variable annuity and variable life products in the United States and traditional insurance products in Taiwan.
On December 31, 1996, ManUSA transferred to the Company all of the common and preferred shares of Manulife Holding Corporation ("Holdco"), an investment holding company. The Company then transferred all the common and preferred shares of Manufacturers Adviser Corporation ("MAC") to Holdco for two shares of $1 common stock of Holdco. Holdco has primarily three wholly-owned subsidiaries, ManEquity Inc., a registered broker/dealer, MAC, an investment fund management company, and Manulife Capital Corporation ("MCC"), an investment holding company.
These transfers have been accounted for using the pooling-of-interests method of accounting. Under this method, the assets, liabilities, capital and surplus, revenues and expenses of each separate entity are combined retroactively at their historical carrying values to form the financial statements of the Company for all periods presented to give effect to the reorganization as if the structure in place at December 31, 1996 had been in place as of the earliest period presented in these consolidated financial statements. The accounts of all subsidiary companies are therefore combined and all significant intercompany balances and transactions are eliminated on combination. In addition, the capital and surplus of the Company has been restated retroactively to reflect the capital structure in place at December 31, 1996.
The accompanying consolidated financial statements of the Company have been prepared in conformity with generally accepted accounting principles ("GAAP").
The Company classifies all of its fixed maturity and equity securities as available-for-sale and records these securities at fair value. Realized gains and losses on sales of securities classified as available-for-sale are recognized in net income using the specific identification method. Changes in the fair value of securities available-for-sale are reflected directly in accumulated other comprehensive income after adjustments for deferred taxes and deferred acquisition costs. Discounts and premiums on investments are amortized using the effective interest method.
The Company considers all highly liquid debt instruments purchased with an original maturity date of three months or less to be cash equivalents. Cash equivalents are stated at cost plus accrued interest, which approximates fair value.
Commissions and other expenses which vary with and are primarily related to the production of new business are deferred to the extent recoverable and included as an asset. DAC associated with variable annuity and variable life insurance contracts is charged to expense in relation to the estimated gross profits of those contracts. The amortization is adjusted retrospectively when estimates of current or future gross profits are revised. DAC associated with traditional life insurance policies is charged to expense over the premium paying period of the related policies. DAC is adjusted for the impact on estimated future gross profits assuming the unrealized gains or losses on securities had been realized at year-end. The impact of any such adjustments is included in net unrealized gains (losses) in accumulated other comprehensive income. DAC is reviewed annually to determine recoverability from future income and, if not recoverable, it is immediately expensed.
The Company is routinely involved in reinsurance transactions in order to minimize exposure to large risks. Life reinsurance is accomplished through various plans including yearly renewable term, co-insurance and modified co-insurance. Reinsurance premiums, policy charges for cost of insurance and claims are accounted for on a basis consistent with that used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums, fees and claims are reported net of reinsured amounts. Amounts paid with respect to ceded reinsurance contracts are reported as reinsurance receivables in other assets.
The Company's wholly-owned subsidiary, Manufacturers Life Mortgage Securities Corporation, has historically invested amounts received as repayments of mortgage loans in annuities issued by ManUSA. These annuities were collateral for the 8 1/4 % mortgage-backed bonds payable. On March 1, 1997 the annuities matured and the proceeds were used to repay the bonds payable.
At December 31, 1998, the consolidated group has utilized all available operating loss carryforwards and net capital loss carryforwards. The losses of the Company, MRC and ManUSA may be used to offset the ordinary and capital gain income of MRL. However, losses of MRL may not be used to offset the income of the other members of the consolidated group.
a) On June 15, 1998, the outstanding promissory note in the amount of $33,000 plus interest at 6.95% issued on December 5, 1997 payable to ManUSA was discharged and the amount due of $34,318 ($33,000 plus interest of $1,318) was recorded as a capital contribution.
During 1996, the Company issued two common shares to its Parent Company in return for a capital contribution of $15,000.
The aggregate statutory capital and surplus of the Company at December 31, 1998 was $121,799 (1997 $56,598). The aggregate statutory net loss of the Company for the year ended 1998 was $23,491 (1997 $2,550; 1996 $5,961). State regulatory authorities prescribe statutory accounting practices that differ in certain respects from generally accepted accounting principles followed by stock life insurance companies. The significant differences relate to investments, deferred acquisition costs, deferred income taxes, non-admitted asset balances and reserve calculation assumptions.
(a) On December 31, 1998, the coinsurance treaties under which the Company had assumed two blocks of insurance from ManUSA were terminated. The Company's risk under these treaties was limited to $100,000 of initial face amount per claim plus a pro-rata share of any increase in face amount. Upon the termination of the treaties, the Company paid consideration in the amount of approximately $41.0 million to ManUSA and policyholder reserves totaling $41.0 million were recaptured by ManUSA. No gain or loss resulted from the termination of these treaties.
In the normal course of business, the Company assumes and cedes reinsurance as a party to several reinsurance treaties with major unrelated insurance companies. The Company remains liable for amounts ceded in the event that reinsurers do not meet their obligations.
Reinsurance recoveries on ceded reinsurance contracts with unrelated insurance companies were $1,362, $909 and $357 during 1998, 1997 and 1996 respectively.
The Company reports two business segments: Traditional Life Insurance sold in Taiwan and Variable Life and Annuities sold in the U.S. The Company's reportable segments have been determined based on geography, differences in product features, and distribution; the segments are also consistent with the Company's management structure. Segmented information for the Company is as follows:
A full discussion of the Company's Year 2000 program and Year 2000 review will be contained in the Company's Management Discussion and Analysis.
The Board Of Directors The Manufacturers Life Insurance Company Of America
We have audited the financial statements of The Manufacturers Life Insurance Company of America as of December 31, 1998 and 1997 and 1996 and for each of the three years in the period ended December 31, 1998 and have issued our report thereon dated March 15, 1999 (included elsewhere in this Annual Report on Form 10-K). Our audits also included the financial statement schedules listed in this Annual Report on Form 10-K. These schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits.
THE MANUFACTURERS LIFE INSURANCE COMPANY OF AMERICA SCHEDULE I -- SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES