The financial information of C.M. Life has been prepared on the basis of Statutory Accounting Practices prescribed or permitted by the Department of Insurance of the State of Connecticut. The following statutory information for the years ended and at December 31, 1997, 1996, 1995, 1994 and 1993 has been derived from C.M. Life's statutory financial statements and have been audited by Coopers & Lybrand L.L.P., independent accountants for the years 1997 and 1996. Coopers & Lybrand L.L.P. did not audit the statutory financial statements of C.M. Life for the years 1995, 1994 and 1993. Those statements were audited by other auditors. For a description of the accounting principles applicable to this financial information and certain differences between statutory accounting practices and GAAP, see below. The information presented below should be read in conjunction with, and is qualified in its entirety by, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the financial statements and other information included elsewhere in this Prospectus. The results for past accounting periods are not necessarily indicative of the results to be expected for any future accounting period.
The accompanying statutory financial statements are different in some respects from GAAP financial statements. The more significant differences are as follows: (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 require these expenses to be capitalized and recognized over the life of the policies; (b) policy reserves are based upon statutory mortality and interest requirements without consideration of withdrawals, whereas GAAP reserves would be based upon reasonably conservative estimates of mortality, morbidity, interest and withdrawals; (c) bonds are generally carried at amortized cost whereas GAAP generally requires they be valued at fair value; (d) deferred income taxes are not provided for book-tax timing differences as would be required by GAAP; and (e) payments received for universal life products and variable annuities are reported as premium revenue, whereas under GAAP, these payments would be recorded as deposits to policyholders' account balances.
ITEM 6. SELECTED FINANCIAL DATA C.M. LIFE INSURANCE COMPANY SELECTED STATUTORY FINANCIAL DATA FOR THE YEARS ENDED DECEMBER 31, ($ IN MILLIONS)
Results of Operations --------------------- For the Year Ended December 31, 1997 ------------------------------------ Compared to the Year Ended December 31, 1996 --------------------------------------------
For the year ended December 31, 1997, C.M. Life had a net gain from operations of $7.5 million, as compared with a net gain of $1.6 million in 1996. The increase of $5.9 million was primarily attributable to increased sales of Universal and other life products and increased fees received from the separate accounts partially offset by increased commissions, increased expenses associated with management services charged by MassMutual and increased federal income taxes attributable to taxable income in excess of book income. The increase in fees from separate accounts and the increase in commissions are primarily attributable to the modification of the underwriting agreement, discussed below.
Effective March 1, 1996, C.M. Life modified its underwriting agreements such that it would pay all future commissions relating to variable annuity contracts and in return, would retain rights to all future contract fees and charges related to these contracts. Prior to the contract modification, G.R. Phelps and MML Distributors paid variable annuity commissions in exchange for the rights to future contract fees and charges related to these contracts. C.M. Life expects the future revenue on these contracts to exceed acquisition costs.
Net investment and other income decreased $4.3 million to $72.1 million in 1997 from $76.4 million in 1996. Net investment income was level at $75.3 million in 1997 compared to $75.2 million in 1996 as result of a 3.7% increase in invested assets offset by a decrease in the average gross yield for the portfolio which was 7.6% in 1997 compared to 7.9% in 1996.
Addition to policyholder reserves, funds and separate accounts decreased $20.3 million to $190.0 million in 1997 from $210.3 million in 1996. Additions to policyholder reserves, funds and separate accounts includes transfers (to) from the separate account based upon policyholder elections. The decrease is primarily attributable to a reduction in separate account deposits and an increase in separate account withdrawals, partially offset by an increase in fees charged by the general account for assets under management, which increased due to deposits and market appreciation.
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, decreased $0.5 million to $0.1 million in 1997 from $0.6 million in 1996. The decrease in 1997 from 1996 is primarily attributable to gains generated during the first quarter of 1996 on the sale of common stock
For the year ended December 31, 1996, C.M. Life had a net gain from operations of $1.6 million, as compared with a net gain of $14.3 million in 1995. The decrease of $12.7 million is primarily attributable to increased sales of Universal Life Enterprise Plus and variable annuity products, which in the year of issuance, generate commissions and other acquisition costs which exceed the revenues received. These products are priced to be profitable over the life of the contract.
Premium income, net of reinsurance ceded, increased $53.6 million to $314.4 million in 1996 from $260.8 million in 1995. The 20.6% growth in premiums is attributable to increased sales of the Universal Life Enterprise Plus product, which increased by 41.0%, and variable annuity products which increased by 26.9%. Sales of single premium deferred annuity products decreased 90.5%, due to less demand in the market place for fixed rate annuity products.
Net investment and other income decreased $7.9 million to $76.5 million in 1996 from $84.4 million in 1995. Other income, which is primarily comprised of reserve adjustment and commission and expense allowances on reinsurance ceded, decreased by $14.3 million, due to little growth in the reinsured block of business. Net investment income increased by $6.3 million primarily attributable to the 4.3% growth in the general investment account assets. The gross yield for the portfolio was 7.9% for 1996 compared to 7.8% for 1995.
Operating expenses, commissions and state taxes, licenses and fees increased $22.4 million to $73.6 million in 1996 from $51.2 million in 1995. The increase is attributable to increased expenses 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, as discussed in the preceding section.
As a result of the foregoing factors, net income for 1996 was $2.2 million compared to $13.8 million in 1995, representing a decrease of $11.6 million or 84% decrease over prior year.
Bonds at December 31, 1997 were $664.5 million, representing a decrease of $72.0 million, or 9.8% from $736.5 million at December 31, 1996. This reflects a shift to investing additional funds in commercial mortgages to enhance yields. Bonds and short-term securities in NAIC categories 1 and 2 were 65.0% of general investment account assets at December 31, 1997, as compared to 73.1% at December 31, 1996. The percentage of general investment account assets representing bonds and short-term investments in NAIC categories 3 through 6 was 5.9% at December 31, 1997 and 4.9% at December 31, 1996.
Common stocks at December 31, 1997 were $61.4 million, representing an increase of $5.8 million, or 10.4% from $55.6 million at December 31, 1996. This increase is a result of dividend reinvestment. Cash and short-term investments at December 31, 1997 were $88.4 million, representing an increase of $24.7 million, or 38.8% from $63.7 million at December 31, 1996.
Separate account assets at December 31, 1997 were $1,096.5 million, representing an increase of $316.7 million, or 40.6%, from $779.8 million at December 31, 1996. This increase is due to significant market appreciation and continued deposits of variable products partially offset by withdrawals.
C.M. Life utilizes sophisticated asset/liability analysis techniques in order to set the investment policy for each liability class and test the adequacy of the projected cash flow provided by assets to meet all of its future policyholder and other obligations. These studies are performed using stress tests regarding future credit and other asset losses, market interest rate fluctuations, claim losses and other considerations. The result is a complete picture of the adequacy of the underlying assets, reserves and capital. See Liquidity and Capital Resources below for further discussions on this issue.
Net cash provided by operating activities was $52.2 million, $42.4 million, and $97.9 million for the years ended 1997, 1996 and 1995, respectively. In 1997, net cash provided by operating activities increased by $9.8 million as compared to 1996, primarily due to increased sale of Universal and other life products and reductions of policyholder reserves attributable to reinsurance. The Board of Directors of MassMutual has authorized the contribution of funds to C.M. Life sufficient to meet the capital requirements of all states in which C.M. Life is licensed to do business.
C.M. Life also employs sophisticated quantitative asset/liability cash flow management techniques to optimize and control the investment return and liquidity for its portfolio, taking into account the liability characteristics of its portfolio.
As of December 31, 1997, C.M. Life's total adjusted capital as defined by the NAIC was $135.9 million in 1997. The NAIC developed the Risk Based Capital ("RBC") model to compare the total adjusted capital with a standard design in order to reflect C.M. Life's risk profile. Although C.M. Life believes that there is no single appropriate means of measuring risk-based capital needs, it feels that the NAIC approach to RBC measurement is reasonable, and will manage its capital position with significant attention to maintaining adequate total adjusted capital relative to RBC. C.M. Life's total adjusted capital was well in excess of all RBC standards at December 31, 1997 and 1996. Management believes that C.M. Life enjoys a strong capital position in light of the risks to which it is subject and that it is well positioned to meet policyholder and other obligations.
C.M. Life's operations consisted of one business segment, which was principally the sale of universal life insurance and annuity products. C.M. Life is not dependent upon any single customer and no single customer accounted for more than 10% of revenues in 1997, 1996 and 1995.
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. Reserves for individual annuities are based on accepted actuarial methods, principally the Commissioners Annuity Reserve Valuation Method at interest rates ranging from 5.5 to 9.0 percent.
Capital stock and surplus equity was $113.2 million at December 31, 1997, an increase of $3.4 million, or 3.1%, from December 31, 1996. This increase was composed of (i) 1997 net income of $7.6 million, (ii) an increase of $0.8 million from unrealized capital gains, (iii) a decrease of $76 million due to the change in Asset Valuation Reserve ("AVR") and General Investment Reserve ("GIR"), and (iv) a decrease of $0.2 million due to other changes.
The maturities of portfolio bonds are considered to be sufficiently diversified and are carefully monitored and managed in light of C.M. Life's liquidity needs.
Bonds consist primarily of government securities and high-quality marketable corporate securities. At December 31, 1997 and 1996, publicly traded bonds comprised 64.1% and 66.0% of the bond portfolio, respectively, and privately placed bonds comprised the remainder. Substantially all of the publicly traded and privately placed bonds held by C.M. Life are evaluated by the NAIC's Securities Valuation Office ("SVO") which assigns securities to one of six NAIC investment categories with Category 1 securities being the highest quality and Category 6 securities being the lowest quality. Categories 1 and 2 are investment grade, Category 3 is medium quality and Categories 4, 5 and 6 are non-investment grade. The remainder of the securities which have not as yet received NAIC ratings are rated under an internal system which C.M. Life believes to be equivalent to that used by the SVO.
The table below sets forth, as of the dates indicated, the NAIC SVO ratings for C.M. Life's bond portfolio (including short-term securities) and the equivalent public rating agency designations. The bond portfolio consists primarily of high grade securities. At December 31, 1997 and 1996, 91.7% and 93.7%, respectively, of the portfolio was invested in NAIC Categories 1 and 2 securities.
The estimated fair value of bonds is based upon quoted market prices for actively traded securities. C.M. Life subscribes to commercial pricing services providing estimated fair values of fixed income securities that are not actively traded. Estimated fair values for privately placed bonds are generally determined by applying interest rate spreads based on quality and asset type to the appropriate duration on the Treasury yield curve.
The residential mortgage loan portfolio consists of conventional and FHA/VA mortgage pools. The Company imposes rigorous investment standards, including governmental agency guarantees, seasoned pools and discount pricing as protection against prepayment risk.
The commercial mortgage loan portfolio consists of fixed rate loans on completed, income producing properties.
C.M. Life had one of bullet loan of $4.4 million scheduled to mature during 1997 which was paid off at discount in 1997.
During 1997 and 1996, all renewed bullet loans were performing assets prior to renewal and all loan renewals reflected market conditions. Past experience with regard to bullet maturities, however, is not necessarily indicative of future results.
As defined by the NAIC, under performing bonds are those whose deferral of interest and/or principal payments are deemed to be caused by the inability of the obligor to make such payments as called for in the bond contract.
As a result of C.M. Life's conservative monitoring process, an internal watch list is generated which includes certain securities that would not be classified as under-performing under the SVO credit rating system. At December 31, 1997, bonds having a carrying value of $22.6 million (34.0% of the total bond portfolio) had been placed on the internal watch list, which is comprised of bonds that have the following NAIC ratings: $6.8 million NAIC Category 2, $4.7 million NAIC Category 3, $4.1 million NAIC Category 4 and $7.0 million NAIC Category 5.
Restructured mortgage loans are loans for which current payment terms have been modified to less than current market rates, at the time of modification and are currently performing in accordance with such modified terms. Loans on which maturities have been extended but on which current payments are being made at or above market interest rates are not classified as restructured loans.
C.M. Life does not accrue interest income on mortgage loans which are delinquent more than 90 days or when management believes the collection of interest is uncertain. Interest not accrued on mortgage loans was zero million for both the years ended December 31, 1997 and 1996.
In the case of real estate and commercial mortgage loans, borrower and property- specific assessments are also made.
In compliance with regulatory requirements, C.M. Life maintains the AVR. The AVR stabilizes policyholders' contingency reserves against non-interest rate related fluctuations in the value of stocks, bonds, mortgage loans and real estate investments. GIR, which are not mandated by regulation, are maintained by C.M. Life in anticipation of future losses on specific mortgage loans and real estate holdings, particularly mortgage loans in the process of foreclosure.
C.M. Life's total investment reserves at December 31, 1997 were $26.6 million, an 18.0% increase from December 31, 1996, consisting of AVR of $22.7 million and mortgage loan GIR of $3.9 million.
The following table presents the change in total investment reserves for the years 1997 and 1996:
(1) The balance is comprised of the AVR and GIR, which are recorded separately as liabilities on the statutory statement of financial position as follows:
We have audited the accompanying statutory statements of financial position of C.M. Life Insurance Company as of December 31, 1997 and 1996, and the related statutory statements of income, changes in capital stock and surplus, 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. The statutory financial statements of C.M. Life Insurance Company for the year ended December 31, 1995 were audited by other auditors whose report, dated February 15, 1996, expressed an adverse opinion on those statements as to fair presentation in conformity with generally accepted accounting principles and expressed an unqualified opinion in conformity with accounting practices prescribed or permitted by the Insurance Department of the State of Connecticut.
As described more fully in Note 1, these financial statements were prepared in conformity with statutory accounting practices of the National Association of Insurance Commissioners and the accounting practices prescribed or permitted by the Department of Insurance of the State of Connecticut ("statutory accounting principles"), which practices differ from generally accepted accounting principles. The effects on the financial statements of the variances between the statutory basis of accounting and generally accepted accounting principles, although not reasonably determinable at this time, are presumed to be material.
In our opinion, because of the effects of the matter discussed in the preceding paragraph, the financial statements referred to above do not present fairly, in conformity with generally accepted accounting principles, the financial position of C.M. Life Insurance Company at December 31, 1997 and 1996, or the results of its operations or its cash flows for the years then ended.
1. Nature of Operations and Basis of Presentation C.M. Life Insurance Company (the Company) is a wholly owned stock life insurance subsidiary of Massachusetts Mutual Life Insurance Company ("MassMutual"). On March 1, 1996, the operations of the Company's former parent, Connecticut Mutual Life Insurance Company, were merged into MassMutual. The Company is primarily engaged in the sale of flexible premium universal 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 all 50 states except New York.
In compliance with regulatory requirements, the Company maintains an Asset Valuation Reserve and an Interest Maintenance Reserve. The Asset Valuation Reserve and other investment reserves stabilize surplus against fluctuations in the value of stocks, as well as declines in the value of bonds and mortgage loans.
Realized capital gains and losses, less taxes, not includable in the Interest Maintenance Reserve, 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 surplus.
Assets designated as "non-admitted" (principally prepaid agent commissions, other prepaid expenses and the Interest Maintenance Reserve, when in a net loss deferral position) are excluded from the statutory statement of financial position. These amounted to $5.7 million and $6.6 million as of December 31, 1997 and 1996, respectively and changes therein are charged directly to surplus.
The Internal Revenue Service has completed its examination of the Company's income tax returns through the year 1991 and is currently examining the Company for the years 1992 through 1995. The Company believes any adjustments resulting from such examinations will not materially affect its financial statements.
The Company plans to file a separate company 1997 federal income tax return.
MassMutual and the Company have an agreement whereby MassMutual, for a fee, will furnish the Company, as required, operating facilities, human resources, computer software development and managerial services. Investment and administrative services are provided to the Company pursuant to a management services agreement with MassMutual. Similar arrangements were in place with Connecticut Mutual Life Insurance Company, the Company's former parent, prior to its merger with MassMutual. Fees incurred under the terms of these agreements were $39.7 million, $45.9 million and $34.0 million in 1997, 1996 and 1995, respectively.
The Company also has a stop-loss agreement with MassMutual, with maximum coverage at $25.0 million, under which the Company cedes claims which, in aggregate, exceed $35.6 million in 1997, $28.1 million in 1996, and $24.2 million in 1995. For each of the years, the limit was not exceeded. The Company paid approximately $1.0 million, $0.4 million, and $0.6 million in premiums under the agreement in 1997, 1996 and 1995, respectively.
The carrying value and estimated fair value of investments in bonds as of December 31, 1997 and 1996 are as follows:
Common stocks had a cost of $50.2 million in 1997 and $47.2 million in 1996.
The Company had restructured loans with book values of $17.3 million and $21.9 million at December 31, 1997 and 1996, respectively. The loans typically have been modified to defer a portion of the contracted interest payments to future periods. Interest deferred to future periods totaled $0.2 million in 1997, 1996 and 1995.
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 five years. The amounts paid for options purchased are included in other investments on the Statutory Statement of Financial Position. Gains and losses on these contracts are recorded at the expiration or termination date and are amortized through the Interest Maintenance Reserve over the remaining life of the option contract. At December 31, 1997 and 1996, the Company had option contracts with notional amounts of $111.3 million and $34.7 million, respectively. The Company's credit risk exposure was limited to the unamortized costs of $2.2 million and $0.1 million which had fair values of $2.3 million and $0.1 million at December 31, 1997 and 1996, 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' interest income. Gains and losses realized on the termination of these contracts adjusts the bases of the underlying asset. Notional amounts relating to asset and currency swaps totaled $1.0 million at December 31, 1997 and 1996. The fair values of these instruments were an unrealized gain of $0.1 million and an unrealized loss of $0.1 million at December 31, 1997 and 1996, respectively.
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 $2.6 million and $0.1 million at December 31, 1997 and 1996, respectively. The Company monitors exposure to ensure counterparties are credit worthy and concentration of exposure is minimized. Additionally, contingent collateral positions have been obtained with counterparties when considered prudent.
10. Reclassifications Certain 1996 and 1995 amounts have been reclassified to conform with the current year presentation.
Subsidiaries of MassMutual Holding Company ------------------------------------------ GR Phelps, Inc. MassMutual Holding Trust I MassMutual Holding Trust II MassMutual Holding MSC, Inc. MassMutual International, Inc. MassMutual Reinsurance Bermuda (Sold in December 1996) MML Investor Services, Inc. State House One (Liquidated in December 1996)
Subsidiaries of MassMutual Holding Trust II ------------------------------------------- CM Advantage, Inc. - (Liquidated in December 1997) CM International, Inc. CM Property Management, Inc. - (Liquidated in December 1997) High Yield Management, Inc. MMHC Investments, Inc. MML Realty Management Urban Properties, Inc. Westheimer 335 Suites, Inc.
We have audited the 1997 and 1996 statutory financial statements and the related financial statement schedules of C.M. Life Insurance Company listed in Item 14(a) 1 and 2 of this Form 10-K. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the financial statement schedules based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles, used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, because of the effects of the matter discussed in the preceding paragraph, the financial statements referred to above do not present fairly, in conformity with generally accepted accounting principles, the financial position of C.M. Life Insurance Company at December 31, 1997, or the results of its operations or its cash flows for the year then ended.
In our opinion, the 1997 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 the results of its operations and its cash flows for the year then ended, on the statutory basis of accounting described in Note 1. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe our audit provides a reasonable basis for our opinion.
In our opinion, because of the effects of the matter discussed in the preceding paragraph, the financial statements referred to above do not present fairly, in conformity with generally accepted accounting principles, the results of operations and cash flows of C.M. Life Insurance Company for the year ended December 31, 1995.
In our opinion, the financial statements referred to above do present fairly, in all material respects, the results of operations and cash flows of C.M. Life Insurance Company for the year ended December 31, 1995 in conformity with accounting practices prescribed or permitted by the Insurance Department of the State of Connecticut.