The selected financial data presented for, and as of the end of, each of the years in the five-year period ended December 31, 2004, have been prepared in accordance with accounting principles generally accepted in the United States of America. All amounts shown are in millions, except per share and operating data. The following data should be read in conjunction with the Consolidated Financial Statements and the Notes to Consolidated Financial Statements appearing in Part II Item 8 and Management's Discussion and Analysis of Financial Condition and Results of Operations appearing in Part II
This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 including, among others, statements relating to projections of the strategies, earnings, revenues, income or loss, ratios, future financial performance, and growth potential of Reinsurance Group of America, Incorporated and its subsidiaries (referred to in the following paragraphs as "we," "us," or "our"). The words "intend," "expect," "project," "estimate," "predict," "anticipate," "should," "believe," and other similar expressions also are intended to identify forward-looking statements. Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. Future events and actual results, performance, and achievements could differ materially from those set forth in, contemplated by, or underlying the forward-looking statements.
The consolidated financial statements include the assets, liabilities, and results of operations of RGA, RGA Reinsurance, RGA Barbados, RGA Canada, RGA Americas, RGA Australia and RGA UK as well as several other subsidiaries subject to an ownership position of greater than fifty percent (collectively, the "Company").
We are primarily engaged in traditional individual life, asset-intensive, critical illness and financial reinsurance. RGA and its predecessor, the Reinsurance Division of General American, have been engaged in the business of life reinsurance since 1973. Approximately 73.7% of our 2004 net premiums were from our more established operations in North America, which include our U.S. and Canada segments.
In 1994, we began using our North American underwriting expertise and industry knowledge to expand into international markets and now have subsidiaries, branches or offices in Australia, Barbados, Hong Kong, India, Ireland, Japan, Mexico, South Africa, South Korea, Spain, Taiwan and the United Kingdom. These operations are included in either our Asia Pacific segment or our Europe & South Africa segment. We generally start new operations from the ground up in these markets as opposed to acquiring existing operations, and we often enter these markets to support our North American clients as they expand internationally. Based on Standard & Poor's Global Reinsurance Highlights, 2004 Edition, we believe we are the fourth largest life reinsurer in the world based on 2003 gross premiums. While RGA believes information published by Standard & Poor's is generally reliable, RGA has not independently verified the data. Standard & Poor's does not guarantee the accuracy and completeness of the information. We conduct business with the majority of the largest U.S. and international life insurance companies, with no single non-affiliated client representing more than 10% of 2004 consolidated gross premiums. We have also developed our capacity and expertise in the reinsurance of asset-intensive products (primarily annuities and corporate-owned life insurance) and financial reinsurance.
Outsourcing of Mortality. The SOA survey indicates that U.S. life reinsurance in force has grown from $2.6 trillion in 1998 to $5.8 trillion at year-end 2003. We believe this trend reflects increased utilization by life insurance companies of reinsurance to manage capital and mortality risk and to develop competitive products. Reinsurers are able to efficiently aggregate a significant volume of life insurance in force, creating economies of scale and greater diversification of risk. As a result of having larger amounts of data at their disposal compared to primary life insurance companies, reinsurers tend to have better insights into mortality trends, creating more efficient pricing for mortality risk.
The SOA surveys indicate that the authors obtained information from participating or responding companies and do not guarantee the accuracy and completeness of their information. Additionally, the surveys do not survey all
reinsurance companies, but RGA believes most of its principal competitors are included. While RGA believes these surveys to be generally reliable, RGA has not independently verified their data.
Additionally, the number of merger and acquisition transactions within the life insurance industry has increased in recent years. We believe that reorganizations and consolidations of life insurers will continue. As reinsurance products are increasingly used to facilitate these transactions and manage risk, we expect demand for our products to continue.
- Facultative Reinsurance. Based on discussions with our clients and informal knowledge about the industry, we believe we are a leader in facultative underwriting in North America. We intend to maintain that status by emphasizing our underwriting standards, prompt response on quotes, competitive pricing, capacity and flexibility in meeting customer needs. We believe our facultative business has allowed us to develop close, long-standing client relationships and generate additional business opportunities with our facultative clients.
We generally start new operations in these markets from the ground up as opposed to acquiring existing operations, and we often enter these markets to support our North American clients as they expand internationally. Many of the markets that we have entered since 1994, or may enter in the future, are not utilizing life reinsurance, including facultative life reinsurance, at the same levels as the North American market, and therefore, we believe represent opportunities for increasing reinsurance penetration.
- Asset-intensive and Other Products. We intend to continue leveraging our existing client relationships and reinsurance expertise to create customized reinsurance products and solutions. Industry trends, particularly the increased pace of consolidation and reorganization among life insurance companies and changes in products and product distribution, are expected to enhance existing opportunities for asset-intensive and other products.
- Achieving annual earnings per share growth of 12% to 13%; and
- Maintaining a debt to capital ratio of 20% to 25%.
Additionally, we establish various financial growth objectives for our operational segments for the intermediate period (next three to five years). For our U.S. and Canada operations, we are targeting premium and income before income taxes growth of 10% to 12%. Our newer international operations, which include Europe & South Africa, and Asia Pacific, are smaller and their annual financial results are subject to more volatility. However, over the intermediate term (next three to five years), we are targeting premium and income before income taxes growth of 20% to 25%.
These targets are aspirational and you should not rely on them. We can give no assurance that we will be able to approach or meet any of these objectives, and we may fall short of any or all of them. See "Forward-Looking and Cautionary Statements."
During December 2003, we completed a large coinsurance agreement with Allianz Life. Under this agreement, RGA Reinsurance assumed the traditional life reinsurance business of Allianz Life, including yearly renewable term reinsurance and coinsurance of term policies. The business did not include any accident and health risk, annuities or related guaranteed minimum death benefits or guaranteed minimum income benefits. This transaction added additional scale to our U.S. traditional business, but did not significantly add to our client base because most of the underlying ceding companies were already our clients. As of December 31, 2004, approximately 96.2% of the underlying ceding companies, representing approximately 95.7% of the business in force, had novated their treaties from Allianz Life to RGA Reinsurance during 2004. Novation results in the underlying client companies reinsuring the business directly to RGA Reinsurance versus passing through Allianz Life. The profitability of the business is not dependent on novation.
Consolidated assumed insurance in force increased from $1.3 trillion to $1.5 trillion for the year ended December 31, 2004. Assumed new business production for 2004 totaled $279.1 billion compared to $544.4 billion in 2003 and $230.0 billion in 2002. The transaction with Allianz Life contributed $287.2 billion of the 2003 increase in new business production.
common equity offering in which 12,075,000 new shares were issued. The average yield earned on investments, excluding funds withheld, was 5.91% in 2004, compared with 6.39% in 2003 and 6.51% in 2002. We expect the average yield to vary from year to year depending on a number of variables, including the prevailing interest rate environment, and changes in the mix of our underlying investments. Funds withheld assets are associated with annuity contracts on which we earn a spread. Fluctuations in the yield on funds withheld assets are generally offset by a corresponding adjustment to the interest credited on the liabilities. Investment income and realized investment gains and losses are allocated to the operating segments based upon average assets and related capital levels deemed appropriate to support the segment business volumes.
Costs of acquiring new business, which vary with and are primarily related to the production of new business, have been deferred to the extent that such costs are deemed recoverable from future premiums or gross profits. DAC amounts reflect our expectations about the future experience of the business in force and include commissions and allowances as well as certain costs of policy issuance and underwriting. Some of the factors that can affect the carrying value of DAC include mortality assumptions, interest spreads and policy lapse rates. The Company performs periodic tests to establish that DAC remains recoverable, and if experience significantly deteriorates to the point where a premium deficiency exists, a cumulative charge to current operations will be recorded. No such adjustments were made during 2004, 2003 or 2002. As of December 31, 2004, the Company estimates that approximately 52% of its DAC balance is collateralized by surrender fees due to the Company and the reduction of policy liabilities, in excess of termination values, upon surrender or lapse of a policy.
Claims payable for incurred but not reported claims are determined using case basis estimates and lag studies of past experience. These estimates are periodically reviewed, and any adjustments to such estimates, if necessary, are reflected in current operations.
Income before income taxes for the U.S. operations totaled $289.9 million in 2004, compared to $216.1 million for 2003 and $175.8 million in 2002. The increase in revenue from a larger portfolio of mortality risk in the Traditional sub-segment is the primary reason for the growth in earnings for the current year. The Allianz Life acquisition is the major factor for the growth in revenue in 2004 compared to the prior periods. Revenue growth in the traditional sub-segment, including the Allianz Life business, and the change in fair value of embedded derivatives in the Asset Intensive sub-segment contributed to the increase in income before income taxes in 2003 compared to 2002.
The U.S. traditional sub-segment provides life reinsurance to domestic clients for a variety of life products through yearly renewable term agreements, coinsurance and modified coinsurance agreements. These reinsurance arrangements may be either facultative or automatic agreements. During 2004, production totaled $168.8 billion of face amount of new business, compared to $423.4 billion in 2003 and $150.3 billion in 2002. Production for 2003 includes $287.2 billion related to the Allianz Life transaction. Management believes industry consolidation and the trend toward reinsuring mortality risks should continue to provide opportunities for growth.
Income before income taxes for U.S. traditional reinsurance increased 45.8% in 2004 and 17.1% in 2003. Contributing to the increase for 2004 and 2003 is the Allianz Life business, which generated a full year of premium and income in 2004 and 6 months of premium and income in 2003.
Net investment income increased $38.2 million, or 21.0%, and $20.0 million, or 12.4%, in 2004 and 2003, respectively. The increase in both years is due to growth in the invested asset base, primarily due to the Allianz Life transaction as well as increased operating cash flows on traditional reinsurance. Investment income and realized investment gains and losses are allocated to the various operating segments based on average assets and related capital levels deemed appropriate to support the segment business volumes. Investment performance varies with the composition of investments and the relative allocation of capital to the operating segments.
Claims and other policy benefits, as a percentage of net premiums (loss ratios), were 79.6%, 81.1%, and 78.0% in 2004, 2003, and 2002, respectively. Over the past 3 years, the mortality experience in this sub-segment has fluctuated. This is somewhat expected as death claims are reasonably predictable over a period of many years, but are less predictable over shorter periods and are subject to significant fluctuation. In 2004, overall mortality experience was slightly favorable. Conversely, in 2003, mortality experience in this business was slightly higher than anticipated, while the 2002 ratio reflects favorable mortality experience.
Income before income taxes decreased in 2004 to $17.3 million compared to $25.4 million and $14.3 million in 2003 and 2002, respectively. This decrease is primarily due to the change in the fair value of embedded derivatives, which resulted in a $3.2 million net gain for 2004 compared to a net gain of $12.9 million in 2003. The fair value of the derivatives is tied primarily to movements in credit spreads; therefore, the value is expected to fluctuate significantly over time. In addition, a $2.0 million loss on the conversion of a coinsurance-funds withheld annuity treaty to a coinsurance treaty in the third quarter of 2004 contributed to the decrease in income before income taxes. The conversion resulted in $11.7 million of additional investment income offset by $13.7 million in amortization of policy acquisition costs. Higher realized investment losses also contributed to the decrease in income for 2004. Somewhat offsetting the losses was increased investment income due to the higher invested asset base. Results for 2003 were also affected by higher than expected credit losses within the funds withheld portfolios.
Total revenues, which are comprised primarily of investment income, increased 15.0% and 85.5% in 2004 and 2003, respectively. The increase in 2004 is primarily attributed to continued growth in the asset base for this segment coupled with the $11.7 million increase in investment income due to the aforementioned converted annuity treaty. Contributing to the increase in 2003 was the implementation of Issue B36, which resulted in additional revenue of $43.6 million. This, along with the continued growth in the asset base, is the primary reason for the significant growth in 2003. The average invested asset balance was $3.3 billion, $2.7 billion and $1.9 billion for 2004, 2003 and 2002, respectively. Invested assets outstanding as of December 31, 2004 and 2003 were $3.7 billion and $3.1 billion, of which $1.9 billion and $2.0 billion were funds withheld at interest, respectively.
Income before income taxes increased 1.8% and 33.3% in 2004 and 2003, respectively. Income in 2004 remained somewhat flat as the growth in capital provided was mostly offset by reduced spreads earned on the business. The increase for 2003 can be attributed to lower operating expenses allocated to this sub-segment in 2003 compared to 2002. Prior to 2003, all expenses associated with Non-Traditional Reinsurance business were allocated to Financial Reinsurance. In 2003, these expenses were divided proportionately between Asset-Intensive and Financial Reinsurance business.
At December 31, 2004, 2003 and 2002, the amount of reinsurance assumed from client companies, as measured by pre-tax statutory surplus, was $1.5 billion, $1.1 billion and $1.2 billion, respectively. The pre-tax statutory surplus includes all business assumed by the Company. Fees resulting from this business can be affected by large transactions and the timing of completion of new deals and therefore can fluctuate from period to period.
Net premiums increased by 18.2%, to $253.9 million in 2004, and increased by 18.5%, to $214.7 million in 2003, primarily due to new business from new and existing treaties. Additionally, a stronger Canadian dollar contributed $17.6 million, or 8.2%, and $24.1 million, or 13.3%, to net premiums reported in 2004 and in 2003, respectively. Premium levels are significantly influenced by large transactions, mix of business and reporting practices of ceding companies and therefore can fluctuate from period to period.
The segment provides life reinsurance for a variety of products through yearly renewable term and coinsurance agreements, and reinsurance of accelerated critical illness coverage (pays on the earlier of death or diagnosis of a pre-defined critical illness). Reinsurance agreements may be either facultative or automatic agreements covering primarily individual risks and in some markets, group risks.
Europe & South Africa net premiums grew 31.4% during 2004 and 60.6% in 2003. Future net premium growth is not expected to continue at these levels. The growth was primarily the result of new business from both existing treaties and new treaties, combined with favorable currency exchange rates. Several foreign currencies, particularly the British pound, the euro, and the South African rand strengthened against the U.S. dollar in 2004 and 2003. The effect of the strengthening of the local currencies was an increase in 2004 and 2003 premiums of $49.1 million and $41.7 million, respectively. Also, a significant portion of the growth of premiums was due to reinsurance of accelerated critical illness, primarily in the U.K. This coverage provides a benefit in the event of a death from or the diagnosis of a defined critical illness. Premiums earned from this coverage totaled $177.4 million, $145.7 million and $103.5 million in 2004, 2003 and 2002, respectively. Premium levels are significantly influenced by large transactions and reporting practices of ceding companies and therefore can fluctuate from period to period.
Other operating expenses increased 35.3% during 2004 and 21.6% for 2003. Increases in other operating expenses were due to higher costs associated with maintaining and supporting the significant increase in business over the past two years. As a percentage of premiums, other operating expenses were 4.5%, 4.4% and 5.8% in 2004, 2003 and 2002, respectively. The Company believes that sustained growth in premiums should lessen the burden of start-up expenses and expansion costs over time.
A portion of the growth of premiums for the segment in each year presented is due to reinsurance of accelerated critical illness, primarily in Australia. This coverage provides a benefit in the event of a death from or the diagnosis of a defined critical illness. Premiums earned from this coverage totaled $39.1, $31.2 million and $15.0 million in 2004, 2003 and 2002, respectively.
Loss ratios as a percentage of net premiums were 82.7%, 71.6% and 69.2% for 2004, 2003 and 2002, respectively. This percentage will fluctuate due to timing of client company reporting, variations in the mixture of business being reinsured and the relative maturity of the business. Death claims are reasonably predictable over a period of many years, but are less predictable over shorter periods and are subject to significant fluctuation. While loss ratios were relatively stable between 2002 and 2003, the overall segment loss ratio increased 11.1% from 2003 to 2004. The increase in this percentage was
attributable primarily to loss experience in Australia and New Zealand. Australia's loss ratio increased from 65.8% in 2003 to 87.7% in 2004, primarily due to additional reserves on disability income business of approximately $22.8 million and a reserve of approximately $3.4 million related to the Indian Ocean tsunami in December 2004. New Zealand's loss experience is primarily due to the unfavorable performance of five significant treaties. These five treaties combined reflect an increase of approximately $17.7 million in claims and other policy benefits over 2003.
Policy acquisition costs and other insurance expenses as a percentage of net premiums decreased by 5.2% to 13.1% during 2004 and by 4.6% to 18.3% during 2003. The ratio of policy acquisition costs and other insurance expenses as a percentage of net premiums will generally decline as the business matures. The percentages also fluctuate periodically due to timing of client company reporting and variations in the mixture of business being reinsured. During 2004, the percentage declined, in part, due to the addition of a significant block of yearly renewable term business with no allowance included within the treaty terms. Policy acquisition costs are capitalized and charged to expense in proportion to premium revenue recognized.
Corporate and Other revenues include investment income from invested assets not allocated to support segment operations and undeployed proceeds from the Company's capital raising efforts, in addition to unallocated realized capital gains or losses. General corporate expenses consist of unallocated overhead and executive costs and interest expense related to debt and the $225.0 million of 5.75% mandatorily redeemable trust preferred securities. Additionally, the Corporate and Other operations segment includes results from RGA Technology Partners, Inc., a wholly-owned subsidiary that develops and markets technology solutions for the insurance industry, the Company's Argentine privatized pension business, which is currently in run-off, and an insignificant amount of direct insurance operations in Argentina.
Loss before income taxes decreased $5.1 million, or 11.6%, during 2004 compared to 2003, primarily due to an increase in unallocated realized investment gains and investment income of $13.6 million and $5.4 million, respectively. These increases in revenue were partially offset by an increase in AFJP reserves of $10.0 million during the fourth quarter of 2004 and a $2.4 million increase in unallocated general corporate expenses.
Because AFJP claims payments are linked to the AFJP fund units and the AFJP funds are heavily invested in Argentine government securities, the economic crisis in Argentina should have significantly reduced the AFJP fund unit values, and hence the claims payable. However, the opposite effect has occurred because of regulatory intervention of the Argentine government in the AFJP system, including the pesofication of the Argentine economy as it relates to AFJPs. Specifically, we believe AFJP fund unit values are still artificially high, inflating AFJP yields. These AFJP fund unit values adversely affect reinsurers like RGA Reinsurance by inflating the cost of claims payments on quota share reinsurance contracts, prematurely triggering attachment points on stop loss reinsurance contracts, and prematurely triggering excess of retention reinsurance contracts. Additionally, the previous delay in paying disability claims, coupled with the high AFJP fund unit values, has the effect of inflating the disability claims payments that will ultimately have to be made by reinsurers. The passage of regulations in 2004 by the Argentine government has accelerated payment of these deferred disability claims at the inflated AFJP fund unit values.
It is the Company's position that these actions of the Argentine government constitute violations of the Treaty on Encouragement and Reciprocal Protection of Investments, between the Argentine Republic and the United States of America, dated November 14, 1991 (the "Treaty"). RGA Reinsurance has filed a request for arbitration of its dispute relating to these violations pursuant to the Washington Convention of 1965 on the Settlement of Investment Disputes under the auspices of the International Centre for Settlement of Investment Disputes of the World Bank (the "ICSID Arbitration"). The request for arbitration was officially registered in November of 2004.
In addition, because of an Argentine regulatory action that has accelerated payment of the deferred disability claims, during the third quarter of 2004, the Company formally notified the AFJP ceding companies that it will no longer make artificially inflated claim payments, as it has been doing for some time under a reservation of rights, but rather will pay claims only on the basis of the market value of the AFJP fund units. This formal notification could result in litigation or arbitrations in the future. In the fourth quarter of 2004, the Company increased the amount of liabilities associated with the AFJP business by $10.0 million, so that the overall amount of the liabilities reflects the Company's current estimate of the value of its obligations, and reflects the uncertainty regarding the amount and timing of claims payments and the outcome of any negotiated settlements. While it is not feasible to predict or determine the ultimate outcome of the ICSID Arbitration, or litigation or arbitrations that may occur in Argentina in the future, or provide reasonable ranges of potential losses if the Argentine government continues with its present course of action, it is the opinion of management, after consultation with counsel, that their outcomes, after consideration of the provisions made in the Company's consolidated financial statements, would not have a material adverse effect on its consolidated financial position. However, it is possible that an adverse outcome could, from time to time, have a material adverse effect on the Company's consolidated net income or cash flows in particular quarterly or annual periods.
While it is not feasible to predict the ultimate outcome of pending arbitrations and litigation involving LMX reinsurance programs, any indirect workers' compensation carve-out exposure, other accident and health risks, or provide reasonable ranges of potential losses, it is the opinion of management, after consultation with counsel, that their outcomes, after consideration of the provisions made in the Company's consolidated financial statements, would not have a material adverse effect on its consolidated financial position. However, it is possible that an adverse outcome could, from time to time, have a material adverse effect on the Company's consolidated net income or cash flows in particular quarterly or annual periods.
The loss from discontinued accident and health operations, net of income taxes, increased to $23.0 million in 2004 from $5.7 million in 2003 and 2002. The increase in 2004 is due primarily to a negotiated settlement of all disputed claims
DAC related to interest-sensitive life and investment-type contracts are amortized over the lives of the contracts, in relation to the present value of estimated gross profits (EGP) from mortality, investment income, and expense margins. The EGP for asset-intensive products include the following components: (1) estimates of fees charged to policyholders to cover mortality, surrenders and maintenance costs; (2) expected interest rate spreads between income earned and amounts credited to policyholder accounts; and (3) estimated costs of administration. EGP is also reduced by our estimate of future losses due to defaults in fixed maturity securities. DAC is sensitive to changes in assumptions regarding these EGP components, and any change in such an assumption could have an impact on our profitability.
The following table displays DAC balances for asset-intensive business and non-asset-intensive business by segment as of December 31, 2004:
The Company believes that it has sufficient liquidity to fund its cash needs under various scenarios that include the potential risk of the early recapture of a reinsurance treaty by the ceding company and significantly higher than expected death claims. Historically, the Company has generated positive net cash flows from operations. However, in the event of significant unanticipated cash requirements beyond normal liquidity, the Company has multiple liquidity alternatives available based on market conditions and the amount and timing of the liquidity need. These options include borrowings under committed credit facilities, secured borrowings, the ability to issue long-term debt, capital securities or common equity and, if necessary, the sale of invested assets subject to market conditions.
RGA has repurchased shares in the open market in the past primarily to satisfy obligations under its stock option program. In 2001, the Board of Directors approved a repurchase program authorizing RGA to purchase up to $50 million of its shares of stock, as conditions warrant. During 2002, RGA purchased approximately 0.2 million shares of treasury stock under the program at an aggregate cost of $6.6 million. The Company did not purchase any treasury stock during 2004 or 2003 and currently does not anticipate making any purchases during 2005.
RCM and RGA Reinsurance are subject to statutory provisions that restrict the payment of dividends. They may not pay dividends in any 12-month period in excess of the greater of the prior year's statutory operating income or 10% of capital and surplus at the preceding year-end, without regulatory approval. The applicable statutory provisions only permit an insurer to pay a shareholder dividend from unassigned surplus. Any dividends paid by RGA Reinsurance would be paid to RCM, its
Historically, RGA has paid quarterly dividends ranging from $0.027 per share in 1993 to $0.09 per share in 2004. All future payments of dividends are at the discretion of the Company's Board of Directors and will depend on the Company's earnings, capital requirements, insurance regulatory conditions, operating conditions, and such other factors as the Board of Directors may deem relevant. The amount of dividends that the Company can pay will depend in part on the operations of its reinsurance subsidiaries.
Certain of the Company's debt agreements contain financial covenant restrictions related to, among others, liens, the issuance and disposition of stock of restricted subsidiaries, minimum requirements of net worth ranging from $600.0 million to $700.0 million, change in control provisions, and minimum rating requirements. A material ongoing covenant default could require immediate payment of the amount due, including principal, under the various agreements. Additionally, the Company's debt agreements contain cross-default covenants, which would make outstanding borrowings immediately payable in the event of a material covenant default under any of the agreements which remains uncured, including, but not limited to, non-payment of indebtedness when due for amounts greater than $10.0 million or $25.0 million depending on the agreement, bankruptcy proceedings, and any event which results in the acceleration of the maturity of indebtedness. The facility fee and interest rate for the Company's credit facilities is based on its senior long-term debt ratings. A decrease in those ratings could result in an increase in costs for the credit facilities. As of December 31, 2004, the Company had $405.8 million in outstanding borrowings under its debt agreements and was in compliance with all covenants under those agreements. The ability of the Company to make debt principal and interest payments depends primarily on the earnings and surplus of subsidiaries, investment earnings on undeployed capital proceeds, and the Company's ability to raise additional funds.
Based on the historic cash flows and the current financial results of the Company, subject to any dividend limitations which may be imposed by various insurance regulations, management believes RGA's cash flows from operating activities, together with undeployed proceeds from its capital raising efforts, including interest and investment income on those proceeds, interest income received on surplus notes with RGA Reinsurance and RCM, and its ability to raise funds in the capital markets, will be sufficient to enable RGA to make dividend payments to its shareholders, make interest payments on its senior indebtedness and junior subordinated notes, repurchase RGA common stock under the board of director approved plan, and meet its other obligations.
Reinsurance agreements, whether facultative or automatic, may provide for recapture rights on the part of the ceding company. Recapture rights permit the ceding company to reassume all or a portion of the risk formerly ceded to the reinsurer after an agreed-upon period of time (generally 10 years) or in some cases due to changes in the financial condition or ratings of the reinsurer. Recapture of business previously ceded does not affect premiums ceded prior to the recapture of such business, but would reduce premiums in subsequent periods.
Additional sources of liquidity to meet unexpected cash outflows in excess of operating cash inflows include selling short-term investments or fixed maturity securities and drawing additional funds under existing credit facilities, under which the Company had availability of $125.0 million as of December 31, 2004.
Net cash provided by financing activities was $120.9 million, $704.1 million and $287.7 million in 2004, 2003 and 2002, respectively. The Company's stock offering contributed to the amount of cash provided by financing activities during 2003. Changes in cash provided by financing activities primarily relate to the issuance of equity or debt securities, borrowings or payments under the Company's existing credit agreements, treasury stock activity and excess deposits under investment-type contracts.
(2) Included in the "Other policy claims and benefits" line item in the consolidated balance sheet.
See Note 9 - "Income Tax," Note 10 - "Employee Benefits" and Note 15 - "Long-Term Debt" in Notes to Consolidated Financial Statements for information related to the Company's obligations for taxes, funding requirements for retirement and other post-employment benefits, and interest on long-term debt.
The Company has obtained letters of credit, issued by banks, in favor of various affiliated and unaffiliated insurance companies from which the Company assumes business. These letters of credit represent guarantees of performance under the reinsurance agreements and allow ceding companies to take statutory reserve credits. Certain of these letters of credit contain financial covenant restrictions similar to those described in the Debt and Preferred Securities discussion above. At December
31, 2004, there were approximately $32.6 million of outstanding bank letters of credit in favor of third parties. Additionally, the Company utilizes letters of credit to secure reserve credits when it retrocedes business to its offshore subsidiaries, including RGA Americas and RGA Barbados. The Company cedes business to its offshore affiliates to help reduce the amount of regulatory capital required in certain jurisdictions such as the U.S. and the United Kingdom. The capital required to support the business in the offshore affiliates reflects more realistic expectations than the original jurisdiction of the business, where capital requirements are often considered to be quite conservative. As of December 31, 2004, $370.5 million in letters of credit from various banks were outstanding between the various subsidiaries of RGA. Based on the growth of the Company's business and the pattern of reserve levels under Regulation XXX associated with term life business, the amount of ceded reserve credits is expected to grow. This growth will require the Company to obtain additional letters of credit, put additional assets in trust, or utilize other mechanisms to support the reserve credits. If the Company is unable to support the reserve credits, the regulatory capital levels of several of its subsidiaries may be significantly reduced. The reduction in regulatory capital would not directly impact the Company's consolidated shareholders' equity under Generally Accepted Accounting Principles; however, it could effect the Company's ability to write new business and retain existing business. Fees associated with letters of credit are not fixed and are based on the Company's ratings and the general availability of these instruments in the marketplace.
The Company had total cash and invested assets of $10.7 billion and $9.0 billion at December 31, 2004 and 2003, respectively. All investments held by RGA and its subsidiaries are monitored for conformance to the qualitative and quantitative limits prescribed by the applicable jurisdiction's insurance laws and regulations. In addition, the operating companies' Boards of Directors periodically review their respective investment portfolios. The Company's investment strategy is to maintain a predominantly investment-grade, fixed maturity portfolio, to provide adequate liquidity for expected reinsurance obligations, and to maximize total return through prudent asset management. The Company's asset/liability duration matching differs between the U.S. and Canada operating segments. The target duration for U.S. portfolios, which are segmented along product lines, range between four and seven years. Based on Canadian reserve requirements, a portion of the Canadian liabilities is strictly matched with long-duration Canadian assets, with the remaining assets invested to maximize the total rate of return, given the characteristics of the corresponding liabilities and Company liquidity needs. The duration of the Canadian portfolio exceeds twenty years. The Company's earned yield on invested assets was 5.91% in 2004, compared with 6.39% in 2003, and 6.51% in 2002. See Note 5 - "Investments" in the Notes to Consolidated Financial Statements for additional information regarding the Company's investments.
Within the fixed maturity security portfolio, the Company holds approximately $1,403.8 million in mortgage-backed securities at December 31, 2004, that include agency-issued pass-through securities, collateralized mortgage obligations guaranteed or otherwise supported by the Federal Home Loan Mortgage Corporation, Federal National Mortgage Association, or the Government National Mortgage Association, and commercial mortgage-backed securities. All of these securities were investment-grade. The principal risks inherent in holding residential mortgage-backed securities are prepayment and extension risks, which will affect the timing of when cash will be received and are dependent on the level of mortgage interest rates. Prepayment risk is the unexpected increase in principal payments, primarily as a result of homeowner refinancing. Extension risk relates to the unexpected slowdown in principal payments. The Company monitors its residential mortgage-backed securities to mitigate exposure to the cash flow uncertainties associated with these risks.
The Company monitors its investment securities to determine impairments in value. The Company evaluates factors such as financial condition of the issuer, payment performance, the length of time and the extent to which the market value has been below amortized cost, compliance with covenants, general market conditions and industry sector, intent and ability to hold securities and various other subjective factors. As of December 31, 2004, the Company held fixed maturities with a cost basis of $15.7 million and a market value of $19.0 million, representing 0.3% of fixed maturities at December 31, 2004, that were non-income producing. Based on management's judgment, securities with an other-than-temporary impairment in value are written down to management's estimate of fair value. The Company recorded other-than-temporary write-downs of fixed maturities totaling $8.5 million, $20.1 million and $33.9 million in 2004, 2003 and 2002, respectively. The circumstances that gave rise to these impairments were bankruptcy proceedings or deterioration in collateral value supporting certain asset-backed securities. During 2004 and 2003, the Company sold fixed maturity securities with fair values of $394.0 million and $460.3 million at losses of $20.6 million and $25.2 million, respectively, or at 95.0% and 94.8% of book value, respectively.
The following tables present the estimated fair values and gross unrealized losses for the 403 fixed maturity securities and equity securities that have estimated fair values below amortized cost as of December 31, 2004. These investments are presented by class and grade of security. The length of time the related market value has remained below amortized cost is provided for fixed maturity securities as of December 31, 2004.
Mortgage loans represented approximately 5.8% and 5.4% of the Company's investments as of December 31, 2004 and 2003, respectively. As of December 31, 2004, all mortgages were U.S.-based. The Company invests primarily in mortgages on commercial offices, industrial properties and retail locations. The Company's mortgage loans generally range in size from $0.3 million to $11.2 million, with the average mortgage loan investment as of December 31, 2004 totaling approximately $4.7 million. The mortgage loan portfolio was diversified by geographic region and property type as discussed further in Note 5 of the Notes to Consolidated Financial Statements. Substantially all mortgage loans are performing and no valuation allowance has been established as of December 31, 2004 or 2003.
Based on data provided by ceding companies as of December 31, 2004, funds withheld at interest were approximately (in thousands):
In order to reduce the exposure of changes in fair values from interest rate fluctuations, RGA has developed strategies to manage its liquidity and increase the interest rate sensitivity of its asset base. From time to time, RGA has utilized the swap market to manage the volatility of cash flows to interest rate fluctuations.
Interest rate sensitivity analysis is used to measure the Company's interest rate price risk by computing estimated changes in fair value of fixed rate assets and liabilities in the event of a hypothetical 10% change in market interest rates. The Company does not have fixed-rate instruments classified as trading securities. The Company's projected loss in fair
Interest rate sensitivity analysis is also used to measure the Company's interest rate cash flow risk by computing estimated changes in the cash flows expected in the near term attributable to floating rate assets and liabilities in the event of a range of assumed changes in market interest rates. This analysis assesses the risk of loss in cash flows in the near term in market risk sensitive floating rate instruments in the event of a hypothetical 10% change (increase or decrease) in market interest rates. The Company does not have variable-rate instruments classified as trading securities. The Company's projected decrease in cash flows in the near term associated with floating-rate instruments in the event of a 10% unfavorable change in market interest rates at its fiscal years ended December 31, 2004 and 2003 was $0.3 million and $0.1 million, respectively.
The Company is subject to foreign currency translation, transaction, and net income exposure. The Company manages its exposure to currency principally by matching invested assets with the underlying reinsurance liabilities to the extent possible, but generally does not hedge the foreign currency translation or net investment exposure related to its investment in foreign subsidiaries as it views these investments to be long-term. Translation differences resulting from translating foreign subsidiary balances to U.S. dollars are reflected in stockholders' equity on the consolidated balance sheets. The Company generally does not hedge the foreign currency exposure of its subsidiaries transacting business in currencies other than their functional currency (transaction exposure). The majority of the Company's foreign currency transactions are denominated in Australian dollars, Argentine pesos, Canadian dollars, and British pounds.
Currently, the Company believes its foreign currency transaction exposure, with the possible exception of its Argentine peso exposure, to be immaterial to the consolidated results of operations. In an effort to reduce its exposure to the Argentine peso, the Company liquidated substantially all its Argentine based investment securities and reinvested the proceeds into investment securities denominated in U.S. dollars during 2001. The Company's obligations under its insurance and reinsurance contracts continue to be denominated in Argentine pesos, which is the functional currency for this business. Those net contract liabilities totaled approximately 14.8 million Argentine pesos as of December 31, 2004. A net unrealized foreign currency gain of $6.6 million related to these contracts is reflected in accumulated other comprehensive income on the consolidated balance sheet as of December 31, 2004. Because the Company cannot reasonably predict the timing of its claim settlements and what the exchange rate will be at settlement, reported results may be volatile in the future. Net income exposure that may result from the strengthening of the U.S. dollar to foreign currencies will adversely affect results of operations since the income earned in the foreign currencies is worth less in U.S. dollars. When evaluating investments in foreign countries, the Company considers the stability of the political and currency environment. Devaluation of the
currency after an investment decision has been made will affect the value of the investment when translated to U.S. dollars for financial reporting purposes.
In April 2003, the FASB cleared SFAS No. 133 Implementation Issue No. B36, "Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk Exposures That Are Unrelated or Only Partially Related to the Creditworthiness of the Obligor under Those Instruments." Issue B36 concluded that (i) a company's funds withheld payable and/or receivable under certain reinsurance arrangements and (ii) a debt instrument that incorporates credit risk exposures that are unrelated or only partially related to the creditworthiness of the obligor include an embedded derivative feature that is not clearly and closely related to the host contract. Therefore, the embedded derivative feature must be measured at fair value on the balance sheet and changes in fair value reported in income. The Company adopted the provisions of Issue B36 during the fourth quarter of 2003 and recorded a net gain of $0.5 million as a cumulative effect of change in accounting principle.
recorded pre-tax stock-based compensation expense of approximately $3.9 million and $1.7 million, respectively. See Note 17 -- "Stock Options" for pro forma information.
REINSURANCE GROUP OF AMERICA, INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS)
For each of its reinsurance contracts, the Company must determine if the contract provides indemnification against loss or liability relating to insurance risk, in accordance with applicable accounting standards. The Company must review all contractual features, particularly those that may limit the amount of insurance risk to which the Company is subject to or features that delay the timely reimbursement of claims. If the Company determines that a contract does not expose it to a reasonable possibility of a significant loss from insurance risk, the Company records the contract on a deposit method of accounting with the net amount payable/receivable reflected in other reinsurance assets or liabilities on the consolidated balance sheet. Fees earned on the contracts are reflected as other revenues, as opposed to premiums, on the consolidated statements of income.
The accompanying consolidated financial statements include the accounts of RGA and its subsidiaries, both direct and indirect, subject to an ownership position greater than fifty percent. Entities in which the Company has an ownership position greater than twenty percent, but less than or equal to fifty percent are reported under the equity method of accounting. All significant intercompany balances and transactions have been eliminated.
Impairments in the value of securities held by the Company, considered to be other than temporary, are recorded as a reduction of the book value of the security, and a corresponding realized investment loss is recognized in the consolidated statements of income. The Company's policy is to recognize such impairment when the projected cash flows of these securities have been reduced on an other-than-temporary basis so that the fair value is reduced to an amount less than the book value. The Company evaluates factors such as financial condition of the issuer, payment performance, the length of time and the extent to which the market value has been below amortized cost, compliance with covenants, general market
conditions and industry sector, intent and ability to hold securities, and various other subjective factors. The actual value at which such financial instruments could actually be sold or settled with a willing buyer may differ from such estimated fair values.
The Company has a variety of reasons to use derivative instruments, such as to attempt to protect the Company against possible changes in the market value of its investment portfolio as a result of interest rate changes and to manage the portfolio's effective yield, maturity, and duration. The Company does not invest in derivatives for speculative purposes. The Company uses both exchange-traded and customized over-the-counter derivative financial instruments. The Company's use of derivatives historically has not been significant to its financial position. Income or expense on derivative financial instruments used to manage interest-rate exposure is recorded on an accrual basis as an adjustment to the yield of the related interest-earning assets or interest-bearing liabilities for the periods covered by the contracts. Upon sale, exercise, expiration or termination, gains or losses on derivatives accounted for as cash flow hedges are reclassified from accumulated other comprehensive income into earnings in the same period or periods during which the hedged transaction affects earnings. As of December 31, 2004 and 2003, the Company did not hold any derivatives accounted for as cash flow hedges. At December 31, 2004, the Company held customized over-the-counter derivatives with a notional amount of $6.4 million, which are carried at a fair value of $1.2 million. Changes in the fair value of these derivatives are recorded as investment income on the consolidated statements of income. It is the Company's policy to enter into derivative contracts primarily with highly rated companies.
Premiums Receivable. Premiums are accrued when due and in accordance with information received from the ceding company. When a ceding company fails to report information on a timely basis, the Company reflects accruals based on the terms of the reinsurance treaty as well as historical experience. Other management estimates include adjustments for lapsed premiums given historical experience, the financial health of specific ceding companies, collateral value and the legal right of offset on related amounts (i.e. allowances and claims) owed to the ceding company. Under the legal right of offset provisions in its reinsurance treaties, the Company can withhold payments for allowances and claims for unpaid premiums. Based on its review of these factors and historical experience, the Company did not believe a provision for doubtful accounts was necessary as of December 31, 2004 or 2003.
Future Policy Benefits and Interest-Sensitive Contract Liabilities. Liabilities for future benefits on life policies are established in an amount adequate to meet the estimated future obligations on policies in force. Liabilities for future policy benefits under long-term life insurance policies have been computed based upon expected investment yields, mortality and withdrawal (lapse) rates, and other assumptions. These assumptions include a margin for adverse deviation and vary with the
The Company reinsures asset-intensive products, including annuities and corporate-owned life insurance. The investment portfolios for these products are segregated for management purposes within the general account of RGA Reinsurance. The liabilities under asset-intensive reinsurance contracts are included in interest-sensitive contract liabilities on the consolidated balance sheet.
Other Policy Claims and Benefits. Claims payable for incurred but not reported losses are determined using case basis estimates and lag studies of past experience. The time lag from the date of the claim or death to when the ceding company reports the claim to the Company can vary significantly by ceding company and business segment, but generally averages around 2.5 months on a consolidated basis. The Company updates its analysis of incurred but not reported, including lag studies, on a quarterly basis and adjusts its claim liabilities accordingly. The adjustments in a given period are generally not significant relative to the overall policy liabilities and may result in an increase or decrease in liabilities.
Warrants. The market value of the detachable warrants on the date the PIERS units were issued is recorded in stockholders' equity on the consolidated balance sheets under the caption "Warrants." In the aggregate as of December 31, 2004, 4.5 million warrants to purchase approximately 5.6 million shares of Company common stock at a price per share of $39.98 were outstanding. If on any date after December 18, 2004, the closing price of RGA common stock exceeds and has exceeded a price per share equal to $47.97 for at least 20 trading days within the immediately preceding 30 consecutive trading days, the Company may redeem the warrants in whole for cash, RGA common stock, or a combination of cash and RGA common stock.
Revenues for interest-sensitive and investment-type products consist of investment income, policy charges for the cost of insurance, policy administration, and surrenders that have been assessed against policy account balances during the period. Interest-sensitive contract liabilities for these products represent policy account balances before applicable surrender charges. Deferred policy acquisition costs are recognized as expenses over the term of the policies. Policy benefits and claims that are charged to expenses include claims incurred in the period in excess of related policy account balances and interest credited to policy account balances. The weighted average interest-crediting rates for interest-sensitive products were 4.5%, 4.7% and 4.2%, during 2004, 2003 and 2002, respectively. Interest crediting rates for U.S. dollar-denominated investment-type
Effective July 1, 2004 the Company adopted FASB Staff Position ("FSP") No. 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003" ("FSP 106-2"),
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure, an amendment of FASB Statement No. 123." Effective January 1, 2003, the Company prospectively adopted the fair value-based employee stock-based compensation expense recognition provisions of SFAS No. 123, as amended by SFAS No. 148. The Company formerly applied the intrinsic value-based expense provisions set forth in APB Opinion No. 25, Accounting for Stock Issued to Employees, ("APB 25"). For the year ended December 31, 2004 and 2003, the Company recorded pre-tax stock-based compensation expense of approximately $3.9 million and $1.7 million, respectively. See Note 17 -- "Stock Options" for pro forma information.
Reclassification. The Company has reclassified the presentation of certain prior period information to conform to the 2004 presentation.
During December 2003, the Company completed a large coinsurance agreement with Allianz Life Insurance Company of North America ("Allianz Life"). Under this agreement, RGA Reinsurance assumed the traditional life reinsurance business of Allianz Life, including yearly renewable term reinsurance and coinsurance of term policies. The business assumed does not include any accident and health risk, annuities or related guaranteed minimum death benefits or guaranteed minimum income benefits. This transaction adds additional scale to the Company's U.S. traditional business, but does not significantly add to the Company's client base since most of the underlying ceding companies are already our clients. The Company agreed to use commercially reasonable efforts to novate the underlying treaties from Allianz Life to RGA Reinsurance and as of December 31, 2004, approximately 96.2% of the client companies, representing approximately 95.7% of the business in force, had novated. Novation results in the underlying client companies reinsuring the business directly to RGA Reinsurance versus passing through Allianz Life. Once novated, it becomes more difficult for the Company to distinguish the performance of the novated treaties from the rest of the Company's traditional life reinsurance business.
The amortized cost, gross unrealized gains and losses, and estimated fair values of investments in fixed maturity securities and equity securities at December 31, 2004 and 2003 are as follows (in thousands):
As of December 31, 2004, the Company held securities with a market value of $535.7 million issued by the Federal Home Loan Mortgage Corporation, $290.5 million issued by the Federal National Mortgage Corporation, $318.4 million in one entity that were guaranteed by a Canadian province and $260.2 million that were issued by a Canadian province, all of which exceeded 10% of consolidated stockholders' equity. As of December 31, 2003, the Company held securities with a market value of $339.7 million issued by the Federal Home Loan Mortgage Corporation, $221.9 million issued by the Federal National Mortgage Corporation, and $269.6 million in one entity that was guaranteed by a Canadian province, all of which exceeded 10% of consolidated stockholders' equity.
Common and non-redeemable preferred equity investments and derivative financial instruments are included in other invested assets in the Company's consolidated balance sheet. Derivative financial instruments are carried at market value, approximately $1.2 million and $6.7 million at December 31, 2004 and 2003, respectively.
At December 31, 2004, the contractual maturities of investments in fixed maturity securities were as follows (in thousands):
Net realized investment gains (losses) consist of the following (in thousands):
The following table presents the total gross unrealized losses for 403 and 450 fixed maturity securities and equity securities as of December 31, 2004 and 2003, respectively, where the estimated fair value had declined and remained below amortized cost by the indicated amount (in thousands):
The Company believes that the analysis of each security whose price has been below market for greater than twelve months indicated that the financial strength, liquidity, leverage, future outlook, and the Company's ability and intent to hold the security until recovery support the view that the security was not other-than-temporarily impaired as of December 31, 2004.
All of the Company's mortgage loans are amortizing loans. As of December 31, 2004 and 2003, the Company's mortgage loans were distributed as follows (in thousands):
The maturities of the mortgage loans are as follows (in thousands):
Policy loans comprised approximately 9.1% and 10.2% of the Company's investments as of December 31, 2004 and 2003, respectively. These policy loans present no credit risk because the amount of the loan cannot exceed the obligation due the ceding company upon the death of the insured or surrender of the underlying policy. The provisions of the treaties in force and the underlying policies determine the policy loan interest rates. Because policy loans represent premature distributions of policy liabilities, they have the effect of reducing future disintermediation risk. In addition, the Company earns a spread between the interest rate earned on policy loans and the interest rate credited to corresponding liabilities.
Funds withheld at interest comprised approximately 25.9% and 30.6% of the Company's investments as of December 31, 2004 and 2003, respectively. For agreements written on a modified coinsurance basis and certain agreements written on a coinsurance funds withheld basis, assets equal to the net statutory reserves are withheld and legally owned and managed by the ceding company and are reflected as funds withheld at interest on RGA's consolidated balance sheet. In the event of a ceding company's insolvency, RGA would need to assert a claim on the assets supporting its reserve liabilities. However, the risk of loss to RGA is mitigated by its ability to offset amounts it owes the ceding company for claims or allowances with amounts owed to RGA from the ceding company. Interest accrues to these assets at rates defined by the treaty terms. In most cases, the Company is subject to the investment performance on the funds withheld assets, although it does not control them. To mitigate this risk, the Company helps set the investment guidelines followed by the ceding company and monitors compliance.
At December 31, 2004 and 2003, there were no reinsurance ceded receivables associated with a single reinsurer with a carrying value in excess of 5% of total assets.
Some reinsurance agreements involve reimbursing the ceding company for allowances and commissions in excess of first-year premiums. These amounts represent acquisition costs and are capitalized to the extent deemed recoverable from the future premiums and amortized against future profits of the business. This type of agreement presents a risk to the extent that the business lapses faster than originally anticipated, resulting in future profits being insufficient to recover the Company's investment.
The provision for income tax expense attributable to income from continuing operations consists of the following (in thousands):
The tax effects of temporary differences that give rise to significant portions of the deferred income tax assets and liabilities at December 31, 2004 and 2003, are presented in the following tables (in thousands):
The Company expects to contribute $1.8 million in pension benefits and $0.1 million in other benefits during 2005.
2005 target range of allocation by asset type of the Pension Plan's total plan fair value on a weighted average basis:
RGA Reinsurance also has a product license and service agreement with MetLife. Under this agreement, RGA has licensed the use of its electronic underwriting product to MetLife and provides Internet hosting services, installation and modification services for the product. The Company recorded revenue under the agreement for the years ended December 31, 2004, 2003 and 2002 of approximately $3.5 million, $3.2 million and $0.4 million, respectively.
The amounts above are net of expected sublease income of approximately $0.4 million annually through 2010. Rent expenses amounted to approximately $8.0 million, $6.8 million and $6.0 million for the years ended December 31, 2004, 2003 and 2002, respectively.
The total capital and surplus positions of RCM, RGA Reinsurance and RGA Canada exceed the risk-based capital requirements of the applicable regulatory bodies. RCM and RGA Reinsurance are subject to statutory provisions that restrict the payment of dividends. They may not pay dividends in any 12-month period in excess of the greater of the prior year's statutory operating income or 10% of capital and surplus at the preceding year-end, without regulatory approval. The applicable statutory provisions only permit an insurer to pay a shareholder dividend from unassigned surplus. Any dividends paid by RGA Reinsurance would be paid to RCM, its parent company, which in turn has restrictions related to its ability to pay dividends to RGA. The assets of RCM consist primarily of its investment in RGA Reinsurance. As of January 1, 2005, RCM and RGA Reinsurance could pay maximum dividends, without prior approval, equal to their unassigned surplus, approximately $43.7 million and $88.6 million, respectively. Dividend payments from other subsidiaries are subject to regulations in the country of domicile.
In addition, because of the regulatory action that has accelerated payment of the deferred disability claims, during the third quarter of 2004, the Company formally notified the AFJP ceding companies that it will no longer make claim payments it believes to be artificially inflated, as it has been doing for some time under a reservation of rights, but rather will pay claims only on the basis of the market value of the AFJP fund units. This formal notification could result in litigation or arbitrations in the future. While it is not feasible to predict or determine the ultimate outcome of the contemplated ICSID Arbitration, or litigation or arbitrations that may occur in Argentine in the future, or provide reasonable ranges of potential losses if the Argentine government continues with its present course of action, it is the opinion of management, after consultation with counsel, that their outcomes, after consideration of the provisions made in the Company's financial statements, would not have a material adverse effect on its consolidated financial position. However, it is possible that an adverse outcome could, from time to time, have a material adverse effect on the Company's consolidated net income or cash flows in particular quarterly or annual periods.
In addition, the Company indemnifies its directors and officers as provided in its charters and by-laws. Since this indemnity generally is not subject to limitation with respect to duration or amount, the Company does not believe that it is possible to determine the maximum potential amount due under this indemnity in the future.
Certain of the Company's debt agreements contain financial covenant restrictions related to, among others, liens, the issuance and disposition of stock of restricted subsidiaries, minimum requirements of consolidated net worth ranging from $600 million to $700 million, change of control provisions, and minimum rating requirements. A material ongoing covenant default could require immediate payment of the amount due, including principal, under the various agreements. Additionally, the Company's debt agreements contain cross-default covenants, which would make outstanding borrowings immediately payable in the event of a material uncured covenant default under any of the agreements, including, but not limited to, non-payment of indebtedness when due for amounts greater than $10 million or $25 million depending on the agreement, bankruptcy proceedings, and any other event which results in the acceleration of the maturity of indebtedness. As of December 31, 2004, the Company had $405.8 million in outstanding borrowings under its debt agreements and was in compliance with all covenants under those agreements. The ability of the Company to make debt principal and interest payments depends on the earnings and surplus of subsidiaries, investment earnings on undeployed capital proceeds, and the Company's ability to raise additional funds.
The accounting policies of the segments are the same as those described in the Summary of Significant Accounting Policies in Note 2. The Company measures segment performance primarily based on profit or loss from operations before income taxes. There are no intersegment reinsurance transactions and the Company does not have any material long-lived assets. Investment income is allocated to the segments based upon average assets and related capital levels deemed appropriate to support the segment business volumes.
The Company's reportable segments are strategic business units that are primarily segregated by geographic region. Information related to revenues, income (loss) before income taxes, interest expense, depreciation and amortization, and assets of the Company's continuing operations are summarized below (in thousands).
In general, options granted under the Plan become exercisable over vesting periods ranging from one to eight years while options granted under the Directors Plan become exercisable after one year. Options are generally granted with an exercise price equal to the stock's fair value at the date of grant and expire 10 years after the date of grant. Information with respect to option grants under the Stock Plans follows.
The per share weighted-average fair value of stock options granted during 2004, 2003 and 2002 was $12.81, $9.51 and $11.71 on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: 2004-expected dividend yield of 0.61%, risk-free interest rate of 3.30%, expected life of 6.0 years, and an expected rate of volatility of the stock of 28.7% over the expected life of the options; 2003-expected dividend yield of 0.95%, risk-free interest rate of 2.79%, expected life of 6.0 years, and an expected rate of volatility of the stock of 35% over the expected life of the options; and 2002-expected dividend yield of 0.8%, risk-free interest rate of 5.00%, expected life of 5.0 years, and an expected rate of volatility of the stock of 35% over the expected life of the options.
During 2004, the Company issued a combination of stock options and performance contingent units ("PCUs") to key employees. The stock option portion is included in the preceding table. The Company also issued 128,693 PCUs. Each PCU represents the right to receive from zero to two shares of Company common stock depending on the results of certain performance measures over a three-year period.
Prior to January 1, 2003, the Company applied APB Opinion No. 25 in accounting for its Stock Plans and, accordingly, no compensation cost was recognized for its stock options in the financial statements. For grants during 2003 and 2004, the Company determined compensation cost based on the fair value at the grant date for its stock options using the "prospective" approach under FASB Statement No. 123, as amended by SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure, an amendment of FASB Statement No. 123." Beginning July 1, 2005, the Company is required to use the "modified prospective" method for recording compensation expense. The modified prospective approach will require compensation cost on all unvested options to be recorded in the income statement over its remaining vesting period, regardless of when the options were granted. Had the Company realized compensation expense based on the fair value at the grant date for all stock grants, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below. The effects of applying SFAS No. 148 may not be representative of the effects on reported net income for future years.
In January 2005, the Board approved an incentive compensation package including 289,310 incentive stock options at $47.47 per share, 124,753 PCUs, and 4,800 shares of restricted stock under the Company's Stock Plans.
The calculation of equivalent shares from outstanding stock options does not include the impact of options having a strike price that exceeds the average stock price for the earnings period, as the result would be antidilutive. All outstanding options were included in the calculation during 2004, while approximately 0.3 million and 1.4 million outstanding stock options were not included in the calculation of common equivalent shares during 2003 and 2002, respectively. Diluted earnings per share also exclude the antidilutive effect in 2003 and 2002 of 5.6 million shares that would be issued upon exercise of the outstanding warrants associated with the PIERS units, as the Company could repurchase more shares than it issues with the exercise proceeds.
The following table presents the components of the Company's accumulated other comprehensive income for the years ended December 31, 2004, 2003 and 2002 (in thousands):
At the time it was accepting accident and health risks, the Company directly underwrote certain business provided by brokers using its own staff of underwriters. Additionally, it participated in pools of risks underwritten by outside managing general underwriters, and offered high level common account and catastrophic protection coverages to other reinsurers and retrocessionaires. Types of risks covered included a variety of medical, disability, workers' compensation carve-out, personal accident, and similar coverages.
The calculation of the claim reserve liability for the entire portfolio of accident and health business requires management to make estimates and assumptions that affect the reported claim reserve levels. The net reserve balance as of December 31, 2004 and 2003 was $57.4 million and $54.5 million, respectively. Management must make estimates and assumptions based on historical loss experience, changes in the nature of the business, anticipated outcomes of claim disputes and claims for rescission, anticipated outcomes of arbitrations, and projected future premium run-off, all of which may affect the level of the claim reserve liability. Due to the significant uncertainty associated with the run-off of this business, net income in future periods could be affected positively or negatively. The consolidated statements of income for all periods presented reflect this line of business as a discontinued operation. Revenues associated with discontinued operations, which are not reported on a gross basis in the Company's consolidated statements of income, totaled $1.4 million, $4.8 million, and $3.3 million for 2004, 2003, and 2002, respectively.
On January 31, 2005, MetLife announced an agreement to purchase Travelers Life & Annuity and substantially all of Citigroup's international insurance business. To help finance that transaction, MetLife indicated that it would consider select asset sales, including its holdings of RGA's common stock.
We have audited the accompanying consolidated balance sheets of Reinsurance Group of America, Incorporated and subsidiaries (the "Company") as of December 31, 2004 and 2003, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2004. Our audits also included the financial statement schedules listed in the Index at Item 15. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company's internal control over financial reporting as of December 31, 2004, based on the criteria established in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 2, 2005 expressed an unqualified opinion on management's assessment of the effectiveness of the Company's internal control over financial reporting and an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.
(2) The fourth quarter of 2003 contains six-months of results due to the coinsurance agreement with Allianz Life. See Note 4, "Significant Transactions" in Notes to Consolidated Financial Statements.