China, France, Germany, Hong Kong, India, Ireland, Italy, Japan, Mexico, the Netherlands, Poland, South Africa, South Korea, Spain, Taiwan and the United Kingdom. The Company generally starts new operations from the ground up in these markets as opposed to acquiring existing operations, and it often enters these markets to support its North American clients as they expand internationally. Based on information from competitors’ annual reports, the Company believes it is the third largest life reinsurer in the world based on 2009 life reinsurance premiums. The Company conducts business with the majority of the largest U.S. and international life insurance companies. The Company has also developed its capacity and expertise in the reinsurance of asset-intensive products (primarily annuities and corporate-owned life insurance) and financial reinsurance.
Facultative Reinsurance. Based on discussions with the Company’s clients, an industry survey and informal knowledge about the industry, the Company believes it is a leader in facultative underwriting in North America. The Company intends to maintain that status by emphasizing its underwriting standards, prompt response on quotes, competitive pricing, capacity and flexibility in meeting customer needs. The Company believes its facultative business has allowed it to develop close, long-standing client relationships and generate additional business opportunities with its facultative clients. Since 2007, the Company’s U.S. facultative operation has processed over 100,000 facultative submissions annually.
Income before income taxes for the U.S. Traditional sub-segment increased by $134.3 million, or 52.5%, and $24.7 million, or 10.7% in 2010 and 2009, respectively. The increase in income before income taxes in 2010 was primarily due to an increase in net investment related gains of $108.7 million and income generated from the newly acquired group life and health business as compared to 2009. The increase in 2009 was primarily driven by an increase in business and slightly better mortality experience as compared to 2008, partially offset by increased investment related losses in 2009.
The average invested asset base supporting this sub-segment was $5.6 billion, $5.1 billion and $5.1 billion for 2010, 2009 and 2008, respectively. The growth in the asset base in 2010 was driven primarily by new business written on existing equity-indexed treaties. The asset base in 2009 was relatively flat compared to 2008 due to annuity contract surrenders which led to a decline in the account value and related invested asset base, offset by new business written on an existing equity-indexed treaty. Invested assets outstanding were $5.6 billion as of December 31, 2010 compared to $5.2 billion in 2009. As of December 31, 2010, $3.9 billion of the invested assets were funds withheld at interest, of which 95.2% of the balance was associated with equity-indexed annuity treaties with one client. As of December 31, 2009, $3.6 billion of the invested assets were funds withheld at interest, of which 94.9% of the balance was associated with equity-indexed annuity treaties with one client.
Other operating expenses increased $7.1 million, or 31.1%, and decreased $0.3 million, or 1.3%, in 2010 and 2009, respectively. The effect of changes in the Canadian dollar exchange rates resulted in an increase in operating expenses of approximately $2.2 million and a decrease of approximately $1.2 million in 2010 and 2009, respectively. Other operating expenses as a percentage of net premiums were 3.7%, 3.7% and 4.3% in 2010, 2009 and 2008, respectively.
At December 31, 2010 and 2009, the Company’s fixed maturity and funds withheld portfolios included approximately $640.7 million and $601.8 million, respectively, in estimated fair value, of securities that are insured by various financial guarantors, or less than five percent of consolidated investments. The securities are diversified between municipal bonds and asset-backed securities with well diversified collateral pools. The Company held investment-grade securities issued by financial guarantors totaling $8.3 million in amortized cost at December 31, 2010 and 2009.
The Company’s average investment in impaired loans was $3.6 million and $3.3 million as of December 31, 2010 and 2009 respectively. Interest income on impaired loans was $0.8 million for the years ended December 31, 2010 and 2009, respectively. The Company has an unpaid principal balance on impaired mortgage loans of $35.6 million at December 31, 2010. The Company did not acquire any impaired mortgage loans during the year ended December 31, 2010. The Company has $10.4 million of mortgage loans that are on a nonaccrual status at December 31, 2010.
The Chief Risk Officer (“CRO”), aided by Business Unit Chief Risk Officers and Risk Management Officers, is responsible for ensuring, on an ongoing basis, that objectives of the ERM framework are met; this includes ensuring proper risk controls are in place, that risks are effectively identified and managed, and that key risks to which the firm is exposed are disclosed to appropriate stakeholders. For each Business Unit and key risk, a Risk Management Officer is assigned. In addition to this network of Risk Management Officers, the Company also has risk focused committees such as the Business Continuity Management Steering Committee, Consolidated Investment Committee, Asset and Liability Management Committee and the Regulatory Change Steering Committee. These committees are comprised of various risk experts and have overlapping membership, enabling consistent and holistic management of risks. These committees report directly or indirectly to the Risk Management Steering Committee. The Risk Management Steering Committee, which includes senior management executives, including the Chief Executive Officer, the Chief Financial Officer and the CRO, is the primary source of risk management of the Company.
Generally, RGA’s insurance subsidiaries retrocede amounts in excess of their retention to RGA Reinsurance, Parkway Re, RGA Barbados, RGA Americas, Manor Re, RGA Worldwide or RGA Atlantic. External retrocessions are arranged through the Company’s retrocession pools for amounts in excess of its retention. As of December 31, 2010, all retrocession pool members in this excess retention pool reviewed by the A.M. Best Company were rated “A-”, the fourth highest rating out of fifteen possible ratings, or better. For a majority of the retrocessionaires that were not rated, letters of credit or trust assets have been given as additional security in favor of RGA Reinsurance. In addition, the Company performs annual financial and in force reviews of its retrocessionaires to evaluate financial stability and performance.
Goodwill and certain intangibles, reported in other assets, are not amortized into results of operations, but instead are reviewed at least annually for impairment and written down and charged to results of operations only in the periods in which the recorded value of goodwill and certain intangibles is more than its fair value. From 2008 through 2010, there were no changes to goodwill as a result of acquisitions or disposals. Goodwill as of December 31, 2010 and 2009 totaled $7.0 million including accumulated amortization of $1.0 million, and was related to the purchase by the Company’s U.S. operations of RGA Financial Group L.L.C. in 2000. The value of business acquired (“VOBA”) is amortized in proportion to the ratio of annual premium revenues to total anticipated premium revenues or in relation to the present value of estimated profits. Anticipated premium revenues have been estimated using assumptions consistent with those used in estimating reserves for future policy benefits. The carrying value is reviewed at least annually for indicators of impairment in value. The VOBA was approximately $1.0 million and $1.3 million, including accumulated amortization of $24.4 million and $12.1 million, as of December 31, 2010 and 2009, respectively. The VOBA amortization expense for the years ended December 31, 2010, 2009 and 2008 was $12.3 million, $0.4 million, and $0.4 million, respectively. The increase in the VOBA amortization in 2010 is related to acquisition of Reliastar Life Insurance Company’s U.S. and Canadian group life, accident and health reinsurance business, which was entirely amortized in 2010. These amortized balances are included in other assets on the consolidated balance sheets. Amortization of the VOBA is estimated to be $0.2 million, $0.2 million, $0.1 million, $0.1 million and $0.1 million during 2011, 2012, 2013, 2014 and 2015, respectively.
and the amount relating to other factors, if the Company does not have the intent to sell or it more likely than not will not be required to sell prior to recovery of the amortized cost less any current period credit loss. Credit losses will be recognized in net income and losses relating to other factors will be recognized in accumulated other comprehensive income (“AOCI”). If the Company has the intent to sell or it more likely than not will be required to sell before its recovery of amortized cost less any current period credit loss, the entire OTTI will be recognized in net income. This amendment is effective for interim and annual reporting periods ending after June 15, 2009. The adoption of this amendment resulted in a net after-tax increase to retained earnings and a decrease to accumulated other comprehensive income of $4.4 million, as of April 1, 2009. The required disclosures are provided in Note 4 - “Investments”.
In January 2010, the FASB amended the general accounting principles for Fair Value Measurements and Disclosures as it relates to the disclosures about fair value measurements. This amendment requires new disclosures about the transfers in and out of Level 1 and 2 measurements and also enhances disclosures about the activity within the Level 3 measurements. It also clarifies the required level of disaggregation and the disclosures regarding valuation techniques and inputs to fair value measurements. The amendment is effective for interim and annual reporting periods beginning after December 15, 2009, except for the enhanced Level 3 disclosures. Those disclosures are effective for interim and annual reporting periods beginning after December 15, 2010. The Company adopted the effective portions of this amendment in the first quarter of 2010 and is evaluating the impact of the enhanced Level 3 disclosures. The required disclosures are provided in Note 6 - “Fair Value of Financial Instruments”.
In periods after an other-than-temporary impairment loss is recognized on a debt security, the Company will report the impaired security as if it had been purchased on the date it was impaired and will continue to estimate the present value of the estimated cash flows of the security. Estimated cash flows exceeding the new amortized cost basis will be accreted as interest income.
The following table presents the notional amounts and fair value of derivative instruments as of December 31, 2010 and 2009 (dollars in thousands):
The Company does not enter into derivative instruments for speculative purposes. As of December 31, 2010 and 2009, the Company held interest rate swaps that were designated and qualified as fair value hedges of interest rate risk. As of December 31, 2010 and 2009, the Company held foreign currency swaps that were designated and qualified as fair value hedges of a portion of its net investment in its foreign operations. Gains of $50.0 million related to foreign currency swaps terminated in 2009 continue to be reflected in AOCI. As of December 31, 2010 and 2009, the Company also had derivative instruments that were not designated as hedging instruments. See Note 2 - “Summary of Significant Accounting Policies” for a detailed discussion of the accounting treatment for derivative instruments, including embedded derivatives. Derivative instruments are carried at fair value and generally require an insignificant amount of cash at inception of the contracts.
During 2010, 2009, and 2008, the Company received federal and foreign income tax refunds of approximately $37.5 million, $0.3 million and $31.0 million, respectively. The Company made cash income tax payments of approximately $48.0 million, $25.9 million and $54.2 million in 2010, 2009 and 2008, respectively. At December 31, 2010 and 2009, the Company had recognized gross deferred tax assets associated with net operating losses of approximately $1,075.5 million and $957.0 million, respectively, $904.3 million of which will begin to expire in 2021. The remaining net operating losses have indefinite carryforward periods. However, these net operating losses, other than the net operating losses for which there is a valuation allowance, are expected to be utilized in the normal course of business during the period allowed for carryforwards and in any event, will not be lost, due to the application of tax planning strategies that management would utilize.
Mutual funds were invested 38% in bond index funds, 26% in S&P 500 index funds, 13% in mid-cap stock funds, 15% in foreign large blend funds and 8% in small-cap funds.
The amounts above are net of expected sublease income of approximately $0.4 million annually through 2010. Rent expenses amounted to approximately $17.1 million, $13.9 million and $12.5 million for the years ended December 31, 2010, 2009 and 2008, respectively.
The domestic and foreign insurance subsidiaries of the Company prepare their statutory financial statements in conformity with statutory accounting practices prescribed or permitted by the applicable state insurance department or local regulatory authority, which vary materially from under U.S. generally accepted accounting principles (“GAAP”). Prescribed statutory accounting practices include publications of the NAIC, as well as state laws, local regulations and general administrative rules. The differences between statutory financial statements and financial statements prepared in accordance with GAAP vary between domestic and foreign jurisdictions. The principal differences are that statutory financial statements do not reflect deferred policy acquisition costs and limit deferred income taxes, life benefit reserves predominately use interest rate and mortality assumptions prescribed by the NAIC and local regulatory agencies, bonds are generally carried at amortized cost and reinsurance assets and liabilities are presented net of reinsurance.
facility which is scheduled to mature in September 2019. This letter of credit is expected to be fully utilized though 2016 and then amortize to zero by 2019. As of December 31, 2010, the Company had $200.0 million in issued, but undrawn, letters of credit under this facility, which is included in the total above. Letter of credit fees for this facility are fixed for the term of the facility. Fees associated with the Company’s other letters of credit are not fixed for periods in excess of one year and are based on the Company’s ratings and the general availability of these instruments in the marketplace.
The Company has five geographic-based operational segments, each of which is a distinct reportable segment: U.S., Canada, Europe & South Africa, Asia Pacific and Corporate and Other. The U.S. operations provide traditional life, long-term care, group life and health reinsurance, annuity and financial reinsurance products. The Canada operations provide insurers with reinsurance of traditional life products as well as creditor reinsurance, group life and health reinsurance, non-guaranteed critical illness products and longevity reinsurance. Europe & South Africa operations include traditional life reinsurance and critical illness business from Europe & South Africa, in addition to other markets the Company is developing. Asia Pacific