statutory policy reserves are based upon the Commissioners’ Reserve Valuation Methods and statutory mortality, morbidity and interest assumptions, whereas United States GAAP reserves would generally be based upon net level premium, estimated gross margin method, and appropriate estimates of future mortality, morbidity and interest assumptions;
deferred income taxes, which provide for book/tax temporary differences, are subject to limitation and are charged directly to shareholder’s equity whereas, United States GAAP would include deferred taxes as a component of net income;
payments received for universal and variable life products and variable annuities are reported as premium income and changes in reserves, whereas, under United States GAAP, these payments would be recorded as deposits to policyholders’ account balances;
The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as well as disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during reporting periods. The most significant estimates include those used in determining investment valuation reserves, impairments and the liability for future policyholders’ reserves and funds. Future events, including changes in the levels of mortality, morbidity, interest rates, persistency and asset valuations, could cause actual results to differ from the estimates used in the financial statements. Although some variability is inherent in these estimates, management believes the amounts presented are appropriate.
This information 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 filing. The results for past accounting periods are not necessarily indicative of the results to be expected for any future accounting period.
Net income (loss) $ (29.6 ) $ (13.9 ) $ (44.0 ) $ 2.6
In 2001, 2000 and 1998, we received surplus contributions of $45.0 million, $85.0 million and $25.0 million, respectively, from MassMutual.
Defined by the National Association of Insurance Commissioners as surplus plus asset valuation reserves.
Together with our parent, MassMutual and its subsidiaries, we comprise a growth-oriented, diversified financial services company that seeks to provide superior value for policyholders and other customers by achieving exceptional results. We are in the business of helping our customers achieve financial success while protecting their families and businesses. We are committed to maintaining a position of preeminent financial strength by achieving consistent and long-term profitable growth. This will be done by:
developing and distributing a broad and superior portfolio of innovative financial products and services,
Certain information contained in this discussion is or may be considered forward-looking. Forward-looking statements are those not based on historical information, but rather, related to future operations, strategies, financial results, or other developments, and contain terms such as “may,” “expects,” “should,” “believes,” “anticipates,” “intends,” “estimates,” “projects,” “goals,” “objectives,” or similar expressions.
Costs related to the production of new business include commissions and other variable producer compensation, management fees assessed by 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 2001, costs related to the production of new business as a percentage of premiums were higher, primarily because a lower portion of new business was generated through variable annuity exchange programs with MassMutual contract owners. 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 9, Notes to Statutory Financial Statements, for further information on the annuity exchange programs with MassMutual.
Net losses decreased in 2000 primarily due to a new universal life coinsurance treaty, effective January 1, 2000, resulting in increased commission and expense allowance benefits from MassMutual. Excluding this coinsurance treaty, our net loss was approximately the same as the prior year due to continued growth in our
Net investment income increased in 2001 primarily due to a 21% increase in average invested assets, partially offset by a decrease in the gross yield for the investment portfolio to 7.5% in 2001 from 7.8% in 2000. 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.
The increase in 2001 gross investment income from bonds is due to increased investment levels, partially offset by lower yields. The increase in 2000 in gross investment income from bonds is due to increased investment levels coupled with a 50 basis point increase in the gross yield from 1999.
The increase in mortgage loans’ investment income in 2001 is primarily due to an increase in commercial mortgages, partially offset by a decrease in mortgage yields. The 2000 increase is primarily due to increases in commercial mortgages, coupled with an increase in mortgage yields.
The increase in other investments' gross investment income in 2001 is primarily due to an increase in income from interest rate swaps. The decrease in other investments gross investment income in 2000 is primarily due to a reduction in dividends received from affiliated mutual funds.
The decrease in gross investment income from cash and short-term investments in 2001 is primarily due to the declining interest rate environment, partially offset by an increase in average invested cash and short-term investments balances over the prior year. The increase in gross investment income from cash and short-term investments in 2000 is primarily due to an increase in average invested cash and short-term investments balances over the prior year.
Fees increased in 2001 and 2000 due to increases in fees collected from the administration of separate accounts as a result of variable life and variable annuity sales. Commissions and expense allowances on reinsurance ceded decreased in 2001 primarily due to lower first year commission allowance on annuity products. In 2000 commissions and expense allowances on reinsurance ceded increased primarily due to a new coinsurance agreement with MassMutual resulting in a $45.0 million increase in commission and expense allowance benefits.
Life insurance surrenders decreased $7.6 million in 2001 after an increase of $7.1 million in 2000. This decrease is due to improved customer service efforts and asset retention rates over the last twelve months. The life insurance lapse rate, which is based on the amount of life insurance in force, improved to 6.0% for 2001 from 7.4% in 2000 and 7.9% in 1999. Death claims, net of reinsurance, increased $24.3 million in 2001, primarily due to less favorable direct mortality. Death claims, net of reinsurance, decreased by $11.2 million in 2000 primarily due to favorable direct mortality experienced in the life and corporate owned life products.
decrease in separate account withdrawals and other transfers and a $209.9 million increase in general account reserves. The increase during 2000 was primarily attributable 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 $209.9 million increase in 2001 in the general account reserves is primarily attributable to a $193.9 million increase in annuity reserves and an $16.0 million increase in life reserves, whereas in 2000 the general account reserve increases remained relatively level. The 2001 increase in annuity reserves is primarily due to increases in the reserves of our fixed annuity products. The 2001 increase in life reserves is primarily due to new universal life products.
The decrease in federal income taxes during 2001 is primarily attributable to the higher net loss from operations before federal income taxes plus the timing of the tax deductibility of policyholder acquisition costs and the difference between statutory insurance reserves and tax reserves. The increase in federal income taxes during 2000 is primarily attributable to the declining net loss from operations before federal income taxes plus the timing of the tax deductibility of policyholder acquisition costs.
Total assets at December 31, 2001, increased by $641.4 million, from December 31, 2000. We attribute this increase primarily to growth in our general investment account as a result of investors electing the fixed rate investment option for annuity contracts in the general account, as well as continued growth in our separate accounts.
General account assets increased $398.1 million, or 24%, to $2,064.3 million as of December 31, 2001, from $1,666.2 million as of December 31, 2000. We attribute this increase primarily to increases in bonds, mortgage loans and cash and short-term investments, partially offset by a reduction in other assets. 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, in both 2001 and 2000.
Bonds and short-term securities in NAIC classes 1 and 2 increased to 67% at December 31, 2001 from 64% of general account invested assets at December 31, 2000. The percentage of our general account invested assets representing bonds and short-term investments in NAIC classes 3 through 6 remained the same at 7% at December 31, 2001 and December 31, 2000, respectively. See “Investments” section for a related discussion of NAIC investment classes.
The increase in mortgage loans is primarily attributed to a continuation of our strategy of increasing our investment in mortgage loans due to favorable market conditions. For the year ended December 31, 2001, $119.4 million of new loans were issued and $61.0 million was received on outstanding accounts.
Policy loans increased by 7% in 2001, primarily due to increased loan activity by variable life policyholders.
Other investments consisting of financial options, interest rate swaps, currency swaps, common stocks and preferred stocks decreased in 2001. This decrease is primarily due to the sale of all our investments in affiliated common stock, partially offset by an increase in interest rate swaps.
As with assets, most of the 2001 growth in liabilities occurred in general investment account liabilities, coupled with continued growth in our separate account liabilities. The growth in the general investments accounts is primarily attributable to growth in reserves for our life insurance business and the fixed account option in our annuity contracts.
The increase in policyholders’ reserves and funds was primarily attributable to growth from new sales in annuity products, interest credited and transfers from separate accounts.
The increase in shareholder’s equity at December 31, 2001 was due to:
additional paid in capital of $45.0 million contributed by MassMutual for general corporate purposes,
an increase of $6.7 million due to a change in asset valuation and other investment reserves, and other items,
a decrease of $4.9 million due to a change in unrealized capital losses on general invested assets.
Cash and short-term investments increased $94.2 million, or 82%, during 2001 as a result of cash provided by operating and financing activities partially offset by cash used in investing activities.
Loans and purchases of investments increased $139.3 million, or 24%, primarily due to a higher level of bond and mortgage purchase activity during 2001 driven by capital contributions received in 2001. Sales and maturities of investments and receipts from repayments of loans increased $5.7 million, or 2%, in 2001. We attribute this increase primarily to higher mortgage loan repayments, partially offset by lower bond sales proceeds.
MassMutual made capital contributions of $45.0 million in 2001 and $85.0 million in 2000. 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 utilize sophisticated asset/liability analysis techniques in order to set the investment policy for each liability class. Additionally, we test the adequacy of the projected cash flow provided by assets to meet all of our future policyholder and other obligations. We perform these studies 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 our underlying assets, reserves, and capital.
Our principal sources of liquidity are operating cash flow and holdings of cash, cash equivalents, and other readily marketable assets. Our primary cash flow sources are investment income, principal repayments on invested assets, and life insurance premiums.
Our liquid assets include U.S. Treasury bond holdings, short-term money market investments, stocks, and marketable long-term fixed income securities. Cash and short-term investments totaled $209.6 million at December 31, 2001. The carrying value of highly liquid securities, comprised of NAIC Class 1 and 2 publicly traded bonds, was approximately $901.2 million at December 31, 2001.
As of December 31, 2001, our total adjusted capital as defined by the NAIC was $203.5 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 in excess of all RBC standards at December 31, 2001 and 2000. We believe that we are well positioned to meet policyholder and other obligations.
A large portion of our operating expenses consists of administrative fees charged by MassMutual. The largest component of these fees is salaries, which are subject to wage increases that are at least partially affected by the rate of inflation. Our continuing efforts to control expenses may reduce the impact of inflation on operating expenses.
Inflation also indirectly affects us. New sales and surrenders of our insurance products, as well as investment income are influenced by inflation to the extent that the government’s economic policy to control the level of inflation results in changes in interest rates.
The following table sets forth our invested assets in the general investment account and the related gross investment yield:
Bonds consist primarily of government securities and high quality marketable corporate securities. We invest a significant portion of our investments in high quality publicly traded bonds in order to maintain and manage liquidity and reduce the risk of default in the portfolio.
As of December 31, 2001, mortgage-backed securities consisted of $51.4 million of Government National Mortgage Association (“GNMA”), Federal National Mortgage Association (“FNMA”), Federal Home Loan Mortgage Corporation (“FHLMC”) and Federal Housing Administration (“FHA”) issues and $90.1 million of government agency-backed collateralized mortgage obligations.
interest rate spreads based on quality and asset type to the appropriate duration on the U.S. Treasury yield curve.
The table below sets forth the NAIC SVO ratings for our bond portfolio (including short-term securities) and, what we believe are the equivalent rating agency designations. At December 31, 2001 and 2000, 91% and 90%, respectively, of the portfolio was invested in NAIC Classes 1 and 2 securities.
a higher level of collateralization than can customarily be achieved in the public market.
trading of public securities at a substantial discount due to specific credit concerns, and
The NAIC defines under-performing bonds as 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. At December 31, 2001, we had $5.1 million of under-performing bonds. At December 31, 2000, we had $3.3 million of under-performing bonds.
At December 31, 2001, mortgage loans represented 18% of the total investments in the general account compared to 19% at December 31, 2000. Mortgage loans consist of commercial mortgage loans and residential mortgage loan pools. At December 31, 2001, commercial mortgage loans comprised 68% of the mortgage loan portfolio compared to 80% at December 31, 2000.
The following tables set forth, by property type and geographic distribution, the carrying value of commercial mortgage loan balances:
Our residential mortgage loan portfolio consists of conventional and FHA/VA mortgage pools. We impose rigorous investment standards, including governmental agency guarantees, seasoned pools, and discount pricing as protection against prepayment risk.
We revalue all properties each year and re-inspect all properties either annually or every other year based on internal quality ratings.
We use the following criteria to determine whether a current or potential problem exists:
The carrying value of current and potential problem mortgage loans, consisting of restructured mortgage loans, was $2.8 million at December 31, 2001 and $2.9 million at December 31, 2000. There were no problem commercial mortgage loans in process of foreclosure, in default, or in actively managed properties.
The following tables set forth current and potential problem mortgage loans by property type and geographic region as of December 31, 2001:
When we determine that it is probable that the estimated fair value of an invested asset is less than our carrying value, we establish and record appropriate write-downs or investment reserves in accordance with statutory practice.
In the case of commercial mortgage loans, we make borrower and property-specific assessments as well.
Our total investment reserves at December 31, 2001, are $16.1 million a decrease of $4.7 million, or 23%, from $20.8 million at December 31, 2000.
(3) 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.
(4) These amounts offset unrealized capital gains (losses), recorded as a change in shareholder’s equity. Amounts include unrealized losses due to market value reductions of securities with a NAIC quality rating of 6 and net changes in the unrealized capital gains and losses from affiliated mutual funds.
(5) Amounts represent the reserve contribution (note 2) less amounts already recorded (notes 3 and 4). This net change in reserves is recorded as a change in shareholder’s equity.
Financial statements, in the form required by Regulation S-X, are set forth below. We are not required to file supplementary financial data specified by Item 302 of Regulation S-K.
As described more fully in Note 1 to the financial statements, the Company has prepared these financial statements using statutory accounting practices prescribed or permitted by the State of Connecticut Insurance Department, 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 accounting principles generally accepted in the United States of America, although not reasonably determinable, are presumed to be material.
In our opinion, because of the effects of the matters discussed in the preceding paragraph, the 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, 2001 and 2000, or the results of its operations or its cash flows for the years ended December 31, 2001, 2000 and 1999.
As discussed in Note 2 to the statutory financial statements, the Company has changed certain statutory accounting practices. These practices changed as a result of the State of Connecticut Insurance Department’s adoption of the National Association of Insurance Commissioners’ Accounting Practices and Procedures Manual effective January 1, 2001.
The accompanying statutory financial statements have been prepared in conformity with the statutory accounting practices, except as to form, of the National Association of Insurance Commissioners (“NAIC”) and the accounting practices prescribed or permitted by the State of Connecticut Insurance Department (the “Department”).
The Company operates in a business environment subject to various risks and uncertainties. Such risks and uncertainties include, but are not limited to, interest rate risk and credit risk. Interest rate risk is the potential for interest rates to change, which can cause fluctuations in the value of investments. To the extent that fluctuations in interest rates cause the duration of assets and liabilities to differ, the Company controls its exposure to this risk by, among other things, asset/liability matching techniques. Credit risk is the risk that issuers of investments owned by the Company may default or that other parties may not be able to pay amounts due to the Company. The Company manages its investments to limit credit risk by diversifying its portfolio among various security types and industry sectors. Management does not believe that significant concentrations of credit risk exist.
The following is a description of the Company’s principal accounting policies and practices.
Assets designated as “non-admitted” by the NAIC 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 by an adjustment to shareholder’s equity.
Policyholders’ reserves provide amounts adequate to discharge estimated future obligations in excess of estimated future premiums on policies in force. Reserves for life insurance contracts are developed using accepted actuarial methods computed principally on the net level premium, the Commissioners’ Reserve Valuation Method and the California Method bases using the 1980 Commissioners’ Standard Ordinary mortality tables with assumed interest rates ranging from 2.50 to 4.50 percent.
Reserves for individual annuities are based on accepted actuarial methods, principally at interest rates ranging from 5.25 to 9.00 percent.
During 2000, the Company adopted the continuous application of the Commissioners’ Reserve Valuation Method of calculating individual annuity reserves resulting in a $9.0 million decrease to shareholder’s equity. Previously, the Company used a curtate application of the Commissioners’ Reserve Valuation Method.
Life insurance premium revenue is recognized annually on the anniversary date of the policy. Annuity premium is recognized when received. Commissions and other costs related to issuance of new policies, and policy maintenance and settlement costs are charged to current operations when incurred.
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, 2001, the Company has outstanding commitments to purchase privately placed securities and mortgage loans, which totaled $2.9 million and $203.6 million, respectively.
The carrying value and estimated fair value of bonds are as follows:
Proceeds from sales of investments in bonds were $275.0 million during 2001, $316.8 million during 2000 and $325.8 million during 1999. Gross capital gains of $1.6 million in 2001, $2.2 million in 2000 and $2.1 million in 1999 and gross capital losses of $9.3 million in 2001, $2.6 million in 2000 and $4.9 million in 1999 were realized, portions of which were deferred into the IMR. Impairment on bonds during the year ended December 31, 2001 was $4.7 million and was included in the gross capital losses noted above.
At December 31, 2001, scheduled mortgage loan maturities were as follows (in millions):
The Company invests in mortgage loans collateralized principally by commercial real estate. During 2001, commercial mortgage loan lending rates ranged from 6.3% to 15.0%.
The maximum percentage of any one loan to the value of security at the time the loan was originated, exclusive of insured, guaranteed or purchase money mortgages, was 78.0% and 75.0% at December 31, 2001 and 2000, respectively. Taxes, assessments and other amounts advanced and not included in the mortgage loan total were immaterial at December 31, 2001 and 2000.
The Company uses derivative financial instruments in the normal course of business to manage its investment risks, primarily to reduce interest rate and duration imbalances determined in asset/liability analyses. The investment risk is assessed on a portfolio basis and derivative financial instruments are not designated as a hedge with respect to a specific risk; therefore, the criteria for deferral accounting is not met. The Company does not hold or issue these financial instruments for trading purposes.
The Company utilizes interest rate swap agreements and options to reduce interest rate exposures arising from mismatches between assets and liabilities and to modify portfolio profiles to manage other risks identified. Under interest rate swaps, the Company agrees to 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. The fair value of these contracts is included in other investments on the Statutory Statements of Financial Position. Changes in the fair value of these contracts are recorded as realized gains and losses when contracts are closed and at each reporting date. Net amounts receivable and payable are accrued as adjustments to net investment income and included in other investments on the Statutory Statements of Financial Position. At December 31, 2001 and 2000, the Company had interest rate swaps with notional amounts of $594.9 million and $315.0 million, respectively. The Company’s credit risk exposure was limited to the fair values of $6.7 million and $7.2 million at December 31, 2001 and 2000, 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 fifteen years. The fair value of these contracts is included in other investments on the Statutory Statements of Financial Position. Changes in the fair value of these contracts are recorded as realized gains and losses when contracts are closed and at each reporting date. At December 31, 2001 and 2000, the Company had option contracts with notional amounts of $669.5 million and $809.5 million, respectively. The Company’s credit risk exposure was limited to the fair values of $3.8 million and $3.6 million at December 31, 2001 and 2000, respectively.
The Company utilizes currency swaps for the purpose of managing currency exchange risks that are mainly related to funding agreements. Changes in the value of these contracts are recorded as realized capital gains and losses when contracts are closed and at each reporting date. Notional amounts related to these agreements totaled $11.9 million and $6.6 million at December 31, 2001 and 2000, respectively. The Company’s credit risk exposure on these agreements is limited to the fair values of $0.8 million and $0.5 million at December 31, 2001 and 2000, respectively.
The notional amounts described do not represent amounts exchanged by the parties and, thus, are not a measure of the exposure of the Company. The amounts exchanged are calculated on the basis of the notional amounts and the other terms of the instruments, which relate to interest rates, exchange rates, security prices or financial or other indices.
Fair values are based on quoted market prices, when available. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. These valuation techniques require management to develop a significant number of assumptions, including discount rates and estimates of future cash flow. Derived fair value estimates cannot be substantiated by comparison to independent markets or to disclosures by other companies with similar financial instruments. These fair value disclosures may not represent the amount that could be realized in immediate settlement of the financial instrument. The use of different assumptions or valuation methodologies may have a material affect on the estimated fair value amounts.
The following table summarizes the carrying value and fair value of the Company’s financial instruments at December 31, 2001 and 2000:
The Company records a receivable for reinsured benefits paid and the portion of insurance liabilities that are reinsured. The cost of reinsurance is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies.
Premiums ceded were $48.4 million, $46.2 million and $34.3 million and reinsurance recoveries were $71.6 million, $40.8 million and $43.7 million for the periods ended December 31, 2001, 2000 and 1999, respectively. Amounts recoverable from reinsurers were $22.1 million and $6.9 million as of December 31, 2001 and 2000, respectively.
At December 31, 2001, four reinsurers accounted for 86% of the outstanding reinsurance recoverable from reinsurers.
Federal income tax refunds were $12.8 million and $14.6 million in 2001 and 2000, respectively. The Company paid federal income taxes in the amount of $6.8 million in 1999.
Through December 31, 2001, the Company incurred gross claims in the amount of $5.3 million related to the events of September 11, 2001, of which $4.5 million are reinsured, resulting in a net exposure of $0.8 million. In addition to insurance risk, the Company does have investments in certain sectors of the economy, which are directly impacted by these events, such as the airline or travel and leisure industries. These investments are not material with respect to the total investment portfolio. The Company believes that its investment portfolio is of sufficient quality and diversity as to not be materially impacted by the events of September 11, 2001.
The withdrawal characteristics of the policyholders’ reserves and funds, including separate accounts, and the invested assets which support them at December 31, 2001 are illustrated below (in millions):
The relationship of the Company, MassMutual and affiliated companies as of December 31, 2001, is illustrated below. Subsidiaries are wholly owned by MassMutual, except as noted.