Policy acquisition costs and other insurance expenses as a percentage of net premiums were 13.6%, 13.4% and 14.6% in 2009, 2008 and 2007, respectively. Overall, while these ratios are expected to remain in a predictable range, they may fluctuate from period to period due to varying allowance levels within coinsurance-type arrangements. In addition, the amortization pattern of previously capitalized amounts, which are subject to the form of the reinsurance agreement and the underlying insurance policies, may vary. Also, the mix of first year coinsurance business versus yearly renewable term business can cause the percentage to fluctuate from period to period.
and variable annuities with guaranteed minimum benefit riders. The following table summarizes the asset-intensive results and quantifies the impact of these embedded derivatives for the periods presented.
The changes in derivatives discussed above are considered unrealized by management and do not affect current cash flows, crediting rates or spread performance on the underlying treaties. Fluctuations occur period to period primarily due to changing investment conditions including, but not limited to, interest rate movements (including risk-free rates and credit
Income before income taxes decreased by $13.3 million, or 20.3%, and increased by $18.2 million or 38.4%, in 2009 and 2008, respectively. The decrease in income before income taxes in 2009 was primarily due to an increase in claims and other policy benefits and an unfavorable foreign currency exchange fluctuation partially offset by a decrease in policy acquisition costs and other insurance expenses. In addition, a retrocession block of business was recaptured in 2009 that increased income before income taxes by $6.0 million. The increase in income before income taxes for 2008 was primarily due to increased net premiums and decreased policy acquisition costs and other insurance expenses partially offset by adverse claims experience and an unfavorable foreign currency exchange fluctuation. In addition, a block of business was recaptured in 2008 that increased income before income taxes by $6.1 million. Unfavorable foreign currency exchange fluctuations contributed to a decrease in income before income taxes totaling approximately $2.1 million and $8.6 million in 2009 and 2008, respectively.
Other operating expenses increased $15.2 million, or 23.4%, and $11.6 million, or 21.6%, in 2009 and 2008, respectively. Other operating expenses as a percentage of net premiums totaled 10.3%, 9.2% and 7.9% in 2009, 2008 and 2007, respectively. These increases were due to higher costs associated with maintaining and supporting the segment’s increase in business over the past several years and the Company’s recent expansion into Central Europe. The Company believes that sustained growth in net premiums should lessen the burden of start-up expenses and expansion costs over time.
During 2008, the capital and credit markets experienced extreme volatility and disruption. Between September 2008 and the first quarter of 2009, the volatility and disruptions intensified significantly. This environment was driven by, among other things, heightened concerns over conditions in the U.S. housing and mortgage markets, the availability and cost of credit, the health of U.S. and global financial institutions, a decline in business and consumer confidence and increased unemployment. Turmoil in the U.S. and global financial markets resulted in bankruptcies, credit defaults, consolidations and government interventions. The U.S. and global financial markets have improved significantly since the first quarter of 2009.
As witnessed during parts of 2008 and 2009, a general economic downturn or a downturn in the equity and other capital markets can adversely affect the market for many annuity and life insurance products. Because the Company obtains substantially all of its revenues through life and annuity reinsurance, its business would be adversely affected if the market for annuities or life insurance was adversely affected.
The Company had commitments to fund investments in limited partnerships, commercial mortgage loans and private placement investments in the amount of $86.6 million, $12.6 million and $7.0 million, respectively, at December 31, 2009. The Company anticipates that the majority of its current commitments will be invested over the next five years, however, contractually, these commitments could become due at the request of the counterparties. Investments in limited partnerships are carried at cost after consideration of any other-than-temporary impairments and included in other invested assets in the consolidated balance sheets.
The Company’s fixed maturity portfolio includes structured securities. The following table shows the types of structured securities the Company held at December 31, 2009 and 2008 (dollars in thousands):
As of December 31, 2009 and 2008, the Company held investments in securities with sub-prime mortgage exposure with amortized costs totaling $164.6 million and $230.1 million, and estimated fair values of $104.3 million and $147.8 million, respectively. Those amounts include exposure to sub-prime mortgages through securities held directly in the Company’s investment portfolios within asset-backed securities, as well as securities backing the Company’s funds withheld at interest investment. The weighted average S&P credit ratings on these securities was approximately “BBB+” and “AA-” at December 31, 2009 and 2008, respectively. Additionally, the Company has largely avoided investing in securities originated since the second half of 2005, which management believes was a period of lessened underwriting quality. The Company recorded other-than-temporary impairments of $40.6 million, net of non-credit adjustments, and $11.6 million, in its subprime portfolio for the years ended December 31, 2009 and 2008, respectively, due primarily to the increased likelihood that some or all of the remaining scheduled principal and interest payments on select securities will not be received. The following tables summarize the securities by rating and underwriting year at December 31, 2009 and 2008 (dollars in thousands):
Based on data provided by the ceding companies at December 31, 2009, the maturity distribution of the segregated portfolio portion of funds withheld at interest was approximately (dollars in thousands):
Impairment losses on equity securities are recognized in net income. The way in which impairment losses on fixed maturity securities are recognized in the financial statements is dependent on the facts and circumstances related to the specific security. If the Company intends to sell a security or it is more likely than not that it would be required to sell a security before the recovery of its amortized cost, less any recorded credit loss, it recognizes an other-than-temporary impairment in net income for the difference between amortized cost and fair value. If the Company does not expect to recover the amortized cost basis, it does not plan to sell the security and if it is not more likely than not that it would be required to sell a security before the recovery of its amortized cost,
The Company reinsures certain annuity products that contain terms that are deemed to be embedded derivatives, primarily equity-indexed annuities and variable annuities with guaranteed minimum benefits. The Company assesses each identified embedded derivative to determine whether it is required to be bifurcated under the general accounting principles for Derivatives and Hedging. If the instrument would not be reported for in its entirety at fair value and it is determined that the terms of the embedded derivative are not clearly and closely related to the economic characteristics of the host contract, and that a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative is bifurcated from the host contract and accounted for separately. Such embedded derivatives are carried on the consolidated balance sheets at fair value with the host contract. Changes in the fair value of embedded derivatives associated with equity-indexed annuities are reflected in interest credited on the consolidated statements of income and changes in the fair value of embedded derivatives associated with variable annuity guaranteed minimum benefits are reflected in investment related gains (losses), net on the consolidated statements of income. The Company has implemented a hedging strategy to mitigate the volatility associated with its reinsurance of variable annuity guaranteed minimum benefits. The hedging strategy is designed such that changes in the fair value of the hedge contracts, primarily future and swap contracts, move in the opposite direction of changes in the fair value of the embedded derivatives, except for those changes associated with market implied volatility. While the Company actively manages its hedging program, it does not hedge market implied volatility, and the hedges that are in place may not be totally effective in offsetting the embedded derivative changes due to the many variables that must be managed.
In March 2008, the FASB amended the general accounting principles for Derivatives and Hedging as it relates to the disclosures about derivative instruments and hedging activities. This amendment requires enhanced qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. The
The Company’s average investment in impaired loans was $3.3 million and $3.7 million as of December 31, 2009 and 2008, respectively. Interest income on impaired loans was $0.8 million and $1.3 million for the years ended December 31, 2009 and 2008, respectively.
The Company measures ineffectiveness on the foreign currency swaps based upon the change in forward rates. There was no ineffectiveness recorded in the periods presented herein.
The Company invests in credit default swaps to diversify its credit risk exposure in certain portfolios. These credit default swaps are over-the-counter instruments in which the Company receives payments at specified intervals to insure credit risk on a portfolio of 125 U.S. investment-grade securities. Generally, if a credit event, as defined by the contract, occurs, the contract will require the swap to be settled gross by the delivery of par quantities or value of the referenced investment
future policy benefits. Potential guaranteed amounts of future payments will vary depending on production levels and underwriting results. Guarantees related to trust preferred securities and credit facilities provide additional security to third parties should a subsidiary fail to make principal and/or interest payments when due. As of December 31, 2009, RGA’s exposure related to these guarantees was $159.2 million. RGA has issued payment guarantees on behalf of two of its subsidiaries in the event the subsidiaries fail to make payment under their office lease obligations, the exposure of which was $4.3 million as of December 31, 2009.
The Company has three revolving credit facilities under which it may borrow up to approximately $819.2 million in cash. As of December 31, 2009, the Company had no cash borrowings under these facilities and as of December 31, 2008, the Company had drawn approximately $21.9 million in cash under these facilities. The interest rates on borrowings from the Company’s revolving credit facilities ranged from 1.52% to 3.11% during 2009 and 3.11% to 6.13% during 2008. The Company may borrow up to $750.0 million in cash and obtain letters of credit in multiple currencies on its revolving credit facility that expires in September 2012. As of December 31, 2009 and 2008, respectively, the Company had no cash borrowings outstanding and $373.9 million and $389.7 million in issued, but undrawn, letters of credit under this facility. The Company’s other credit facilities consist of a £15.0 million credit facility that expires in May 2010 and an A$50.0 million Australian credit facility that expires in March 2011, both with no outstanding balances as of December 31, 2009 and a combined outstanding balance of $21.9 million at December 31, 2008. Repayments of debt over the next five years total $200.0 million, due in 2011.
The Company allocates capital to its segments based on an internally developed economic capital model, the purpose of which is to measure the risk in the business and to provide a basis upon which capital is deployed. The economic capital model considers the unique and specific nature of the risks inherent in RGA’s businesses. As a result of the economic capital allocation process, a portion of investment income and investment related gains and losses are credited to the segments based on the level of allocated equity. In addition, the segments are charged for excess capital utilized above the allocated economic capital basis. This charge is included in policy acquisition costs and other insurance expenses.
A summary of the components of net unrealized appreciation (depreciation) of balances carried at fair value is as follows (dollars in thousands):