- Management's Discussion and Analysis of Financial Condition and Results of Operation
The following analysis of the consolidated results of operations and financial condition of The Manufacturers Life Insurance Company of America, (hereafter referred to as "ManAmerica" or the "Company") should be read in conjunction with the Consolidated Financial Statements and the related Notes to Consolidated Financial Statements.
The Company reported a consolidated net loss in 1998 of $0.8 million, compared to the 1997 net loss of $3.6 million ($8.4 million net loss in 1996). The main contributors to these losses were as follows:
loss in 1997 compared to 1996 was directly attributable to new business strain on dramatically increased variable universal life contract sales for which deposits increased 28% over 1996 levels.
The net loss from Taiwan operations decreased to $2.3 million in 1998 from $2.8 million in 1997 (a $17.5 million net loss in 1996). The lower net loss in 1998 was a result of higher premiums and lower operating costs which were partially offset by higher policyholder benefits due to increased business and lower surrenders. The increased net loss in 1997 compared to 1996 was a result of significant start-up costs incurred in Taiwan, particularly associated with producer recruitment. In 1997, as discussed earlier, improvements were made in the Taiwan branch operations to rationalize the operations, slow the sales growth and related production costs, and to instead focus on strategic growth. Lower sales in 1998 and 1997 compared to 1996 have significantly reduced the level of commissions and expenses incurred.
Premium revenue for 1998 was $9.3 million compared to $8.6 million in 1997 ($12.9 million in 1996). Of the total, premiums related to sales of traditional life insurance contracts in Taiwan in 1998, 1997 and 1996 were $9.2 million, $8.1 million and $12.2 million respectively. The increase in premiums for Taiwan in 1998 compared to 1997 reflects the focused growth strategy adopted in 1997 as discussed previously. The decrease in premiums for Taiwan in 1997 from 1996 reflects this same shift in strategy. In 1998, $0.1 million of premiums were reported for U.S. operations, compared to $0.5 million in 1997 and $0.7 million in 1996. The U.S. premiums relate solely to a block of Corporate-owned life insurance business assumed from ManUSA for which the initial premium assumed of $25.4 million was received in 1994, with very little renewal premium received thereafter. On December 31, 1998, this agreement was terminated and the Company transferred premiums and reserves totaling $41.0 million related to this block of business to ManUSA. This transaction is reported as consideration paid on reinsurance terminated of $41.0 million along with a corresponding reduction of reserves on reinsurance terminated.
The growth in variable life insurance deposits continued while single premium variable annuity premiums continued to decrease in 1998 and 1997. The deposit growth for variable life is consistent with the Company's commitment to develop variable core "estate/business planning products". Sales of the COLI variable universal life product launched in 1997 continued to grow in 1998. With the merger of Manulife Financial and North American Life Assurance Company in 1996, the sale of variable annuities in the Company was de-emphasized in October 1997 and all variable annuity sales are made through an affiliated company, The Manufacturers Life Insurance Company of North America.
The Company had total consolidated assets of $1,364 million at December 31, 1998, an increase of $197 million or 16.9% from 1997. This change is principally a result of separate account asset growth of $178 million due to strong investment performance of the underlying investment funds, continued consumer preference for participation in the stock market through separate accounts, and the additional product offerings and investment options introduced in 1998.
As at December 31, 1998, 91% of the bond portfolio was rated "A" or higher, and 100% was rated investment grade, "BBB" or higher. The corresponding percentages at the end of 1997 were 97.5% and 100%.
The Company had no provisions for impairments as at December 31, 1998 and 1997.
Separate account liabilities are $1,075 million, an increase of 20% over 1997. This reflects the growing popularity of variable products in the marketplace and the increase in existing fund values due to the increase in the stock market in 1998 and sales of the COLI product.
The decrease in reinsurance reserves reflects the transfer of reserves to ManUSA resulting from the termination of the reinsurance agreement between the two companies discussed previously.
Risk management is a fundamental component in the Company's financial strength and stability, and is essential to its continuing success. The Company is committed to comprehensive risk management policies and procedures which measure and control risk in all of its business activities and allow for periodic reviews by internal and external auditors and regulators.
Based upon the Company's investment strategy and its asset-liability management process, management estimates that a 100 basis point immediate, parallel increase in interest rates for the entire year of 1999 would decrease the fair value of its fixed maturity securities by approximately $2.6 million. The Company's liabilities are comprised primarily of separate account liabilities for which contract holders bear the risk of fluctuations in interest rates.
The Company earns asset based fees based on the asset levels invested in the separate accounts. As a result, the Company is subject to equity risk and the effect changes in equity market levels will have on the amounts invested in the separate accounts. The Company estimates that the effect of a 10% decline in equity fair values in force at December 31, 1998 would adversely affect the Company's asset based fees by $2.0 million if applicable over the entire year of 1999.
The Company is always subject to the risk of change in the life expectancy of the population. Claims trends are therefore monitored on an ongoing basis. The Company uses both its own and industry experience to develop estimates of future claims.
The Company manages pricing risks by setting standards and guidelines for pricing. These standards and guidelines cover pricing methods and assumption setting, profit margin objectives, required scenario analysis, and documentation. They also address the areas of pricing software, approved pricing personnel, and pricing approvals. These standards and guidelines ensure that an appropriate level of risk is borne by the Company and that an appropriate return is provided to the policyholders.
The Year 2000 risk, as it is commonly known, is the result of computer programs being written using two digits, rather than four, to define the applicable year. Any of the Company's computer programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the Year 2000. This could result in systems failures or miscalculations causing disruptions of operations, including among other things, a temporary inability to process transactions, send premium billing notices, make claims payments or engage in other normal business activities.
In addition to efforts directed at Manufacturers Life's own systems, Manufacturers Life is presently consulting vendors, customers, and other third parties with which it deals in an effort to ensure that no material aspect of Manufacturers Life's operations will be hindered by Year 2000 problems of these third parties. This process includes providing third parties with questionnaires regarding the state of their Year 2000 readiness and, where possible or where appropriate, conducting further due diligence activities. Manufacturers Life recognizes the importance of preparing for the change to the Year 2000 and, in January 1999, commenced preparation of contingency plans, in the event that Manufacturers Life's Year 2000 program has not fully resolved its Year 2000 issues. The Year 2000 Project Management Office for Manufacturers Life's U.S. Division is coordinating the preparation of the Year 2000 contingency plan on behalf of U.S. Division affiliates and subsidiaries. Contingency planning is targeted for completion by mid-1999.
Management currently believes that, with modifications to existing software and conversions to new software, the Year 2000 risk will not pose significant operational problems for Manufacturers Life's computer systems. As part of the Year 2000 program, critical systems were "time-shift" tested in the Year 2000 and beyond to confirm that they will continue to function properly before, during and after the change to the Year 2000. However, there can be no assurance that Manufacturers Life's Year 2000 program, including consulting third parties and its contingency planning, will avoid any material adverse effect on Manufacturers Life's operations, customer relations or financial condition. Manufacturers Life estimates the total cost of its Year 2000 program will be approximately $59 million, of which $49.5 million has been incurred through December 31, 1998; however, there can be no assurance that the actual cost incurred will not be materially higher than such estimate. Most costs will be expensed as incurred; however, those costs attributed to the purchase of new software and hardware will generally be
capitalized. The total cost of the Year 2000 program is not expected to have a material effect on Manufacturers Life's net operating income.
Report of Independent Auditors............................................. 17 Audited Consolidated Financial Statements.................................. 18 Consolidated Balance Sheets........................................... 18 Consolidated Statements of Income..................................... 19 Consolidated Statements of Changes in Capital And Surplus............. 20 Consolidated Statements of Cash Flows................................. 21 Notes to Consolidated Financial Statements................................. 22
The Board of Directors The Manufacturers Life Insurance Company of America
We have audited the accompanying consolidated balance sheets of The Manufacturers Life Insurance Company of America as of December 31, 1998 and 1997, and the related consolidated statements of income, changes in capital and surplus and cash flows for each of the three years in the period ended December 31, 1998. 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.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 (IN THOUSANDS OF DOLLARS)
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from reported results using those estimates.
Certain reclassifications have been made to 1997 and 1996 financial information to conform to the 1998 presentation.
i) During 1998, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income". SFAS No. 130 establishes standards for reporting and displaying comprehensive income and its components in a full set of general-purpose annual financial statements. Comprehensive income includes all changes in shareholder's equity during a period except those resulting from investments by and distributions to shareholders. The adoption of SFAS No. 130 resulted in revised and additional disclosures but had no effect on the financial position, results of operations, or liquidity of the Company.
Other comprehensive income (loss) is reported net of tax expense (benefit) of $1,430, $(513), and $260 for 1998, 1997, and 1996, respectively.
ii) During 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". SFAS No. 131 establishes standards for the disclosure of information about the Company's operating segments, including disclosures about products and services, geographic areas, and major customers. The adoption of SFAS No. 131 did not affect results of operations or financial position, nor did it affect the manner in which the Company defines its operating segments. The Company reports two business segments: Traditional Life Insurance sold in Taiwan and Variable Life and Annuities sold in the U.S. Refer to Note 12 for additional segment information.
For variable annuity and variable life contracts, reserves equal the policyholder account value. Account values are increased for deposits received and interest credited and are reduced by withdrawals, mortality charges and administrative expenses charged to the policyholders. Policy charges which compensate the Company for future services are deferred and recognized in income over the period earned, using the same assumptions used to amortize DAC.
Policyholder liabilities for traditional life insurance policies sold in Taiwan are computed using the net level premium method and are based upon estimates as to future mortality, persistency, maintenance expense and interest rate yields that were established in the year of issue.
At December 31, 1998, all fixed maturity and equity securities have been classified as available-for-sale and reported at fair value. The amortized cost and fair value is summarized as follows:
Proceeds from sales of fixed maturity securities during 1998 were $27,852 (1997 $73,772; 1996 $120,234). Gross gains of $362 and gross losses of $107 were realized on those sales (1997 $955 and $837; 1996 $1,858 and $1,837 respectively).
Proceeds from sale of equity securities during 1998 were $8,555 (1997 $10,586; 1996 $25,505). Gross gains of $16 and gross losses of $477 were realized on those sales (1997 $NIL and $NIL; 1996 $NIL and $140 respectively).
The contractual maturities of fixed maturity securities at December 31, 1998 are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties. Corporate requirements and investment strategies may result in the sale of investments before maturity.
b) On December 31, 1998, the surplus debenture in the amount of $8,500 plus interest at 6.7% issued on December 31, 1995 to ManUSA was discharged and the amount due of $8,500 was recorded as a capital contribution.
In 1998, the outstanding promissory note payable referred to in note 7(a) above, totaling $34,318, was discharged and recorded as a capital contribution.
On December 31, 1998, the Company issued one common share to ManUSA in exchange for a capital contribution of $60,209. Included in this capital contribution was the discharge of the surplus debenture in the amount of $8,500 referred to in note 7(b) above.
FIXED MATURITY AND EQUITY SECURITIES: Fair values of fixed maturity and equity securities were based on quoted market prices, where available. Fair values were estimated using values obtained from independent pricing services.
SHORT-TERM INVESTMENTS AND CASH AND CASH EQUIVALENTS: Carrying values approximate fair values.
The Company has formal service agreements with Manulife Financial and ManUSA which can be terminated by any party upon two months' notice. Under the agreements, the Company will pay direct operating expenses incurred each year by Manulife Financial and ManUSA on its behalf. Services provided under the agreement include legal, actuarial, investment, data processing and certain other administrative services. Costs incurred under these agreements were $34,070, $32,733 and $29,384 in 1998, 1997 and 1996 respectively. In addition, there were $12,817, $11,249 and $6,934 of agents bonuses allocated to the Company during 1998, 1997 and 1996, respectively, which are included in deferred acquisition costs.
The Company has several reinsurance agreements with affiliated companies which may be terminated upon the specified notice by either party. These agreements are summarized as follows:
The Company and Manulife Financial have entered into an agreement whereby Manulife Financial provides a claims paying guarantee to the Company's U.S. policyholders. This claims paying guarantee does not apply to the Company's separate account contract holders.
The accounting policies for each segment above are the same as those described in the summary of significant accounting policies. The Company has no intersegment revenues and no significant major customers.
+THE MANUFACTURERS LIFE INSURANCE COMPANY OF AMERICA SCHEDULE III -- SUPPLEMENTARY INSURANCE INFORMATION ($ THOUSANDS)