The Company’s headquarters is located at 16600 Swingley Ridge Road, Chesterfield, Missouri, which comprises approximately 400,000 square feet. In addition, the Company leases approximately 405,000 square feet of office space in 50 locations throughout the world.
Most of the Company’s leases have terms of three to five years; while some leases have longer terms, none exceed 15 years. As provided in Note 12 - “Commitments, Contingencies and Guarantees” in the Notes to Consolidated Financial Statements, the rental expense on operating leases for office space and equipment totaled $17.5 million for 2018.
The following selected financial data has been derived from the Company’s audited consolidated financial statements. The consolidated statement of income data for the years ended December 31, 2018, 2017 and 2016, and the consolidated balance sheet data at December 31, 2018 and 2017 have been derived from the Company’s audited consolidated financial statements included elsewhere herein. The consolidated statement of income data for the years ended December 31, 2015 and 2014, and the consolidated balance sheet data at December 31, 2016, 2015 and 2014 have been derived from the Company’s audited consolidated financial statements not included herein. The selected financial data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes included elsewhere herein.
The Company is among the leading global providers of life reinsurance and financial solutions, with $3.3 trillion of life reinsurance in force and assets of $64.5 billion as of December 31, 2018. Traditional reinsurance includes individual and group life and health, disability, and critical illness reinsurance. Financial solutions includes longevity reinsurance, asset-intensive reinsurance, financial reinsurance and stable value products. The Company derives revenues primarily from renewal premiums from existing reinsurance treaties, new business premiums from existing or new reinsurance treaties, fee income from financial solutions business and income earned on invested assets.
The Company’s underwriting expertise and industry knowledge has allowed it to expand into international markets and now has operations in over 25 countries including locations in the Asia Pacific region, Europe, the Middle East, Africa and Latin America. The Company generally starts operations from the ground up in new markets as opposed to acquiring existing operations,
and it often enters new markets to support its clients as they expand internationally. Based on the compilation of information from competitors’ annual reports, the Company believes it is the third-largest global life and health reinsurer in the world based on 2017 life and health reinsurance revenues. 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 longevity risks, asset-intensive products (primarily annuities and corporate-owned life insurance) and financial reinsurance. More recently, the Company has increased its investment and expenditures in client service and technology oriented initiatives to both support its clients and generate new future revenue streams.
Historically, the Company’s primary business has been traditional life reinsurance, which involves reinsuring life insurance policies that are often in force for the remaining lifetime of the underlying individuals insured, with premiums earned typically over a period of 10 to 30 years. Each year, however, a portion of the business under existing treaties terminates due to, among other things, lapses or voluntary surrenders of underlying policies, deaths of insureds, and the exercise of recapture options by ceding companies. The Company has expanded its financial solutions business, including significant asset-intensive and longevity risk transactions, which allow its clients to take advantage of growth opportunities and manage their capital, longevity and investment risk.
Segment revenue levels can be significantly influenced by currency fluctuations, large transactions, mix of business and reporting practices of ceding companies, and therefore may fluctuate from period to period. Although reasonably predictable over a period of years, segment claims experience can be volatile over shorter periods.
Reinsurance business in force reflects the addition or acquisition of new life reinsurance business, offset by terminations (e.g., life and group contract terminations, lapses of underlying policies, deaths of insureds, and recapture), changes in foreign currency exchange, and any other changes in the amount of insurance in force. As a result of terminations and other changes, assumed in force amounts at risk of $374.8 billion, $160.6 billion, and $337.4 billion were released in 2018, 2017 and 2016, respectively.
See “Results of Operations by Segment” below for further information about the Company’s segments.
Outsourcing of Mortality and Morbidity. The Company believes life insurance companies will continue to utilize reinsurance to manage capital and mortality/morbidity risk and to develop competitive products. The Company believes there has been a decline in the percentage of new business being reinsured in recent years, which has caused premium growth rates in select markets, notably in North America, to moderate. The Company believes a decline in new business being reinsured is likely a reaction by ceding companies to a broad-based increase in reinsurance rates in the market, stronger capital positions maintained by ceding companies in recent years and a desire by ceding companies to adjust their risk profiles. However, the Company believes reinsurers will continue to be an integral part of the life insurance market due to their ability 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/morbidity trends, creating more efficient pricing for mortality/morbidity risk.
manage risk-based capital by shifting mortality and other risks to reinsurers, thereby reducing amounts of reserves and capital they need to maintain;
unlock the capital supporting, and value embedded in, non-core product lines; and
Consolidation and Reorganization within the Life Reinsurance and Life Insurance Industry. As a result of consolidations over the last decade within the life reinsurance industry, there are fewer competitors. As a consequence, the Company believes the life reinsurance pricing environment will remain attractive for the remaining life reinsurers, particularly those with a significant market presence and strong ratings.
1) Continue Growth of North American Mortality Business. The Company’s strategy includes continuing to grow each of the following components of its North American mortality operations:
International Markets. Management believes that international markets continue to offer opportunities for long-term growth, and the Company intends to capitalize on these opportunities by growing its presence in selected markets. Since 1994, the Company has entered new markets internationally, including, in the mid-to-late 1990s, Australia, Hong Kong, Japan, Malaysia, New Zealand, South Africa, Spain, Taiwan and the UK, and beginning in 2002, China, India and South Korea. The Company received regulatory approval to open a representative office in China in 2005 and received its branch license there in 2014; opened representative offices in Poland and Germany in 2006; opened new offices in France and Italy in 2007; opened a representative office in the Netherlands in 2009; and commenced operations in the UAE in 2011 and in Brazil in 2015. Before entering new markets, the Company evaluates several factors including:
Consolidated income before income taxes decreased $297.0 million in 2018, or 26.0%, and increased $98.9 million, or 9.5%, in 2017. The decrease in income before income taxes in 2018 was due to investment related losses, unfavorable claims experience in the individual and group businesses in the U.S., and unfavorable results in the Company’s Australian disability business due to adverse claims development and an increase in claims incurred in the current year. The increase in income before income taxes in 2017 was primarily due to higher investment income, increased other revenues and improved claims experience in Europe, Middle East and Africa (“EMEA”) partially offset by higher interest expense. Foreign currency exchange fluctuations resulted an increase to income before income taxes of approximately $9.7 million and a decrease of $1.4 million in 2018 and 2017, respectively.
The Company recognizes in consolidated income, any changes in the fair value of embedded derivatives on modified coinsurance (“modco”) or funds withheld treaties, equity-indexed annuity treaties (“EIAs”) and variable annuities with guaranteed minimum benefit riders. The Company utilizes freestanding derivatives to minimize the income statement volatility due to changes in the fair value of embedded derivatives associated with guaranteed minimum benefit riders. The following table presents the effect of embedded derivatives and related freestanding derivatives on income before income taxes for the periods indicated (dollars in thousands):
Consolidated investment income, net of related expenses, decreased $16.1 million, or 0.7% in 2018, and increased $242.8 million, or 12.7%, in 2017. The decrease in 2018 is primarily the result of decreases in investment yield and funds withheld at interest, partially offset by increases in the average invested asset base. The increase in 2017 was primarily due to an increase in the average invested asset base. Investment income is affected by changes in the fair value of the Company’s funds withheld at interest assets associated with the reinsurance of certain EIA products. The re-measurement of these funds withheld assets decreased investment income by $133.0 million in 2018 and increased investment income by $117.0 million in 2017 when compared to prior periods. The effect on investment income of the EIAs’ market value changes is substantially offset by a corresponding change in interest credited to policyholder account balances resulting in an insignificant effect on net income.
The Company tests the recoverability for each year of business at issue before establishing additional DAC. The Company also performs annual tests to establish that DAC remain recoverable at all times, and if financial performance significantly deteriorates to the point where a deficiency exists, a cumulative charge to current operations will be recorded. No such adjustments related to DAC recoverability were made in 2018, 2017 and 2016.
DAC related to interest-sensitive life and investment-type contracts is 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, less amount of risk upon death; (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 the Company’s estimate of future losses due to defaults in fixed maturity securities as well as the change in reserves for embedded derivatives.
In general, a change in assumption that improves the Company’s expectations regarding EGP is going to have the effect of deferring the amortization of DAC into the future, thus increasing earnings and the current DAC balance. DAC can be no greater than the initial DAC balance plus interest and would be subject to recoverability testing, which is ignored for purposes of this analysis. Conversely, a change in assumption that decreases EGP will have the effect of speeding up the amortization of DAC, thus reducing earnings and lowering the DAC balance. The Company also adjusts DAC to reflect changes in the unrealized gains and losses on available-for-sale fixed maturity securities since these changes affect EGP. This adjustment to DAC is reflected in accumulated other comprehensive income.
The following table displays DAC balances for the Traditional and Financial Solutions segments as of December 31, 2018:
As of December 31, 2018, the Company estimates that all 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.
The Company primarily invests in fixed maturity securities, mortgage loans, short-term investments, and other invested assets. For investments reported at fair value, the Company utilizes, when available, fair values based on quoted prices in active markets that are regularly and readily obtainable. Generally, these are very liquid investments and the valuation does not require management judgment. When quoted prices in active markets are not available, fair value is based on market valuation techniques, market comparable pricing and the income approach. The Company may utilize information from third parties, such as pricing services and brokers, to assist in determining the fair value for certain investments; however, management is ultimately responsible for all fair values presented in the Company’s consolidated financial statements. This includes responsibility for monitoring the fair value process, ensuring objective and reliable valuation practices and pricing of assets and liabilities, and approving changes to valuation methodologies and pricing sources. The selection of the valuation technique(s) to apply considers the definition of an exit price and the nature of the investment being valued and significant expertise and judgment is required.
Deferred tax assets and liabilities are measured by applying the relevant jurisdictions’ enacted tax rate to the temporary difference in the period in which the temporary differences are expected to reverse. The Company will establish a valuation allowance if management determines, based on available information, that it is more likely than not that deferred income tax assets will not be realized. The Company has deferred tax assets including those related to net operating and capital losses. The Company has projected its ability to utilize its U.S. and foreign deferred tax assets and has determined that all of the U.S. assets including losses are expected to be utilized and established a valuation allowance on the portion of the foreign deferred tax assets the Company believes more likely than not will not be realized.
The Company reports uncertain tax positions in accordance with generally accepted accounting principles. In order to recognize the benefit of an uncertain tax position, the position must meet the more likely than not criteria of being sustained. Unrecognized tax benefits due to tax uncertainties that do not meet the more likely than not criteria are included within other liabilities and are charged to earnings in the period that such determination is made. The Company classifies interest related to tax uncertainties as interest expense whereas penalties related to tax uncertainties are classified as a component of income tax.
The U.S. and Latin America operations include business generated by its offices in the U.S., Mexico and Brazil. The offices in Mexico and Brazil provide services to clients in other Latin American countries. U.S. and Latin America operations consist of two major segments: Traditional and Financial Solutions. The Traditional segment primarily specializes in the reinsurance of individual mortality-risk, health and long-term care and to a lesser extent, group reinsurance. The Financial Solutions segment consists of Asset-Intensive and Financial Reinsurance. Asset-Intensive within the Financial Solutions segment includes coinsurance of annuities and corporate-owned life insurance policies and to a lesser extent, fee-based synthetic guaranteed investment contracts, which include investment-only, stable value contracts. Financial Reinsurance within the Financial Solutions segment primarily involves assisting ceding companies in meeting applicable regulatory requirements by enhancing the ceding companies’ financial strength and regulatory surplus position through relatively low risk reinsurance transactions. Typically these transactions do not qualify as reinsurance under GAAP, due to the low-risk nature of the transactions, so only the related net fees are reflected in other revenues on the consolidated statements of income.
Income before income taxes for the U.S. and Latin America Traditional segment decreased by $87.0 million, or 23.3%, and increased by $2.3 million, or 0.6% in 2018 and 2017, respectively. The decrease in 2018 reflects unfavorable claims experience from the group disability and healthcare excess business as well as higher individual life claims, in part relating to the severe influenza season. The increase in 2017 was primarily due to higher investment income from variable investment income and a growing asset base offset somewhat by lower investment yields and a slightly lower underwriting margin.
Net premiums increased $176.9 million, or 3.3%, and $106.8 million, or 2.0% in 2018 and 2017, respectively. The increase in 2018 and 2017 was primarily due to organic premium growth in yearly renewable term and coinsurance business. The segment added new life business production, measured by face amount of insurance in force, of $106.5 billion, $99.4 billion and $126.4 billion during 2018, 2017 and 2016, respectively. Total face amount of life business in force was $1,610.1 billion, $1,609.8 billion and $1,609.3 billion as of December 31, 2018, 2017 and 2016, respectively.
Claims and other policy benefits as a percentage of net premiums (“loss ratios”) were 91.2%, 88.9% and 88.3% in 2018, 2017 and 2016, respectively. The increase in the loss ratio for 2018 was primarily due to unfavorable claims experience in the individual line of business and higher claims from the group disability and healthcare excess lines of business. Similarly, the increase in the loss ratio for 2017 was primarily related to unfavorable claims experience in the individual mortality and group health lines of business.
Interest credited expense decreased by $0.2 million, or 0.2%, in 2018 and $2.8 million, or 3.3%, in 2017. There was a minimal decrease in interest credited expense in 2018, while the decrease in 2017 relates primarily to one treaty in which the interest credited varies depending on the number of deaths in any given year. The decrease is primarily offset by a decrease in investment income. The variances in interest credited expense are largely offset by variances in investment income. Interest credited in this segment relates to amounts credited on cash value products, which also have a significant mortality component. Income before income taxes is affected by the spread between the investment income and the interest credited on the underlying products.
Policy acquisition costs and other insurance expenses as a percentage of net premiums were 13.3%, 14.1% and 14.3% in 2018, 2017 and 2016, respectively. Overall, these ratios are expected to remain in a predictable range and 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. In recent years, reinsurance treaties weighted toward yearly renewable term structures have contributed to relatively stable rates.
The change in fair value of the embedded derivatives - modco/funds withheld treaties increased (decreased) income before income taxes by $(6.3) million, $75.9 million and $18.7 million in 2018, 2017 and 2016, respectively. The decrease in income for 2018 was primarily due to the repositioning in the funds withheld portfolio. The increases in income in 2017 and 2016 were primarily due to tightening credit spreads.
Income before income taxes and certain derivatives decreased by $70.8 million and increased by $20.3 million in 2018 and 2017, respectively. The decrease in income in 2018 was primarily due to lower investment related gains (losses,) partially due to the repositioning of coinsurance portfolios associated with new transactions, net of the corresponding impact to deferred acquisition costs. The increase in income in 2017, was primarily due to the impact of rising equity markets associated with the Company’s reinsurance of EIAs and variable annuities and higher variable investment income.
Benefits and expenses before certain derivatives decreased by $25.4 million and increased by $152.1 million in 2018 and 2017, respectively. The decrease in benefits and expenses in 2018 was primarily due to lower interest credited associated with the reinsurance of EIAs, partially offset by the impact from new transactions. The increase in 2017 was primarily due to higher interest credited associated with the reinsurance of EIAs, interest credited from a new coinsurance transaction in 2017 and the corresponding impact to deferred acquisition costs from investment related gains (losses) in coinsurance and funds withheld portfolios. The effect on interest credited related to equity options is substantially offset by a corresponding change in investment income.
Income before income taxes decreased by $15.0 million, or 10.9%, and $5.8 million, or 4.1%, in 2018 and 2017, respectively. The decrease in income for 2018 was primarily due to unfavorable traditional individual life mortality experience as compared to 2017. The decrease in income for 2017 was primarily due to unfavorable traditional individual life mortality experience compared to favorable experience in 2016, partially offset by favorable experience on longevity business. Foreign currency exchange fluctuation in the Canadian dollar resulted in a decrease in income before income taxes of $1.0 million and an increase of $3.7 million in 2018 and 2017, respectively.
Net investment income increased $10.4 million, or 5.5%, and $10.1 million, or 5.6%, in 2018 and 2017, respectively. The effect of changes in the Canadian dollar exchange rates had a negligible effect on net investment income in 2018 and resulted in an increase of $4.0 million in 2017. Increases in the invested asset base increased net investment income in 2018 and 2017.
Loss ratios for the segment were 82.8%, 84.0% and 76.2% in 2018, 2017 and 2016, respectively. The decrease in the 2018 loss ratio was due to the aforementioned new inforce block transactions completed during of 2018 partially offset by unfavorable traditional life mortality experience compared to the prior year. The increase in the 2017 loss ratio was due to unfavorable traditional life mortality experience compared to favorable experience in 2016 and a decrease in creditor business premiums. Loss ratios for the individual life mortality business were 91.6%, 97.2% and 93.5% in 2018, 2017 and 2016, respectively. The aforementioned new inforce block transactions reduced the traditional individual life mortality business loss ratio in 2018 by 8.3%. Historically, the loss ratio increased annually primarily as the result of several large permanent level premium in force blocks assumed in 1997 and 1998. These blocks are mature blocks of long-term permanent level premium business in which mortality as a percentage of net premiums is expected to be higher than historical ratios. The nature of permanent level premium policies requires the Company to set up actuarial liabilities and invest the amounts received in excess of early-year claims costs to fund claims in later years when premiums, by design, continue to be level as compared to expected increasing mortality or claim costs. As such, investment income becomes a more significant component of profitability of these in force blocks. Excluding creditor business, claims and other policy benefits, as a percentage of net premiums and investment income were 74.2%, 76.5% and 73.7% in 2018, 2017 and 2016, respectively.
Policy acquisition costs and other insurance expenses as a percentage of net premiums for traditional individual life business were 22.6%, 21.3% and 25.7% in 2018, 2017 and 2016, respectively. Overall, while these ratios are expected to remain in a predictable range, and may fluctuate from period to period due to varying allowance levels and product mix. The decrease in 2017 reflects a lower level of creditor business, which typically has a higher level of acquisition costs. In addition, the amortization
Net premiums increased by $121.6 million, or 9.3%, and $161.6 million, or 14.2%, in 2018 and 2017, respectively. The increase in 2018 was primarily due to increased volumes of mostly individual life business as well as increased health business. The increase in 2017 was primarily due to increased business volumes, most notably in Italy, South Africa, the Middle East and the Netherlands related to new treaties in 2017 and favorable growth from existing treaties. The segment added new business production, measured by face amount of insurance in force, of $190.2 billion, $181.5 billion and $169.8 billion during 2018, 2017 and 2016, respectively. The face amount of reinsurance in force totaled $716.3 billion, $739.0 billion, and $603.0 billion at December 31, 2018, 2017 and 2016, respectively. Foreign currency fluctuations unfavorably affected the face amount of reinsurance in force by $41.4 billion and favorably by $64.7 billion in 2018 and 2017, respectively. Foreign currency exchange fluctuations resulted in an increase in net premiums of $40.6 million and a decrease of $8.3 million in 2018 and 2017, respectively. The segment’s primary currencies are the British pound, the Euro and the South African rand.
Loss ratios for this segment were 86.7%, 84.2% and 87.6% in 2018, 2017 and 2016, respectively. The decrease in loss ratio in 2017 was primarily due to favorable claims experience and changes in the mix of business reflecting increased volumes of new business with lower loss ratios, but with higher commissions. These higher commissions are reflected in the increase of the 2017 policy acquisition cost ratio below.
Interest credited expense decreased by $17.7 million, or 160.1%, and $2.1 million, or 15.6%, in 2018 and 2017, respectively. Interest credited in this segment relates to amounts credited to the contractholders of unit-linked products. This amount will fluctuate according to contractholder investment selections, equity returns and interest rates. The effect on interest credited related to unit-linked products is substantially offset by a corresponding change in investment income.
Net premiums increased by $243.4 million, or 11.9%, and $371.5 million, or 22.1%, in 2018 and 2017, respectively. The increase in premiums for 2018 was primarily driven by new business written in Asian markets partially offset by the effect of three treaties recaptured in Australia in the fourth quarter of 2017. The increase in premiums for 2017 was driven by both new and existing business written throughout the segment. The segment added new business production, measured by face amount of insurance in force, of $66.9 billion, $78.9 billion and $73.7 billion during 2018, 2017 and 2016, respectively. The face amount of reinsurance in force totaled $616.9 billion, $552.3 billion, and $492.2 billion at December 31, 2018, 2017 and 2016, respectively. Foreign currency fluctuations unfavorably affected the face amount of reinsurance in force by $28.0 billion and favorably by $30.6 billion in 2018 and 2017, respectively. Foreign currency exchange fluctuations resulted in a decrease in net premiums of $2.8 million and an increase of $22.7 million in 2018 and 2017, respectively.
A portion of the net premiums for the segment, in each period presented, relates to reinsurance of critical illness coverage. This coverage provides a benefit in the event of the diagnosis of a pre-defined critical illness. Reinsurance of critical illness in the Asia Pacific operations is offered primarily in South Korea, Australia, China and Hong Kong. Net premiums from this coverage totaled $806.1 million, $611.0 million, and $398.3 million in 2018, 2017 and 2016, respectively.
Net investment income increased $3.8 million, or 4.2%, and $8.6 million, or 10.4%, in 2018 and 2017, respectively. The increase in 2018 was primarily due to higher investment yields, largely offset by a lower invested asset base. The increase in 2017 was primarily due to a higher invested asset base. Foreign currency exchange fluctuations resulted in a decrease in net investment income of $1.2 million and an increase of $1.7 million in 2018 and 2017, respectively.
Other revenues decreased by $41.1 million, or 62.3%, and increased by $59.4 million, or 902.6%, in 2018 and 2017, respectively. The decrease in other revenues in 2018 was primarily due to $57.9 million in recapture fees recognized in 2017 associated with the recapture of three treaties in Australia, compared to $9.7 million of recapture fees in 2018 associated with the recapture of one treaty in Australia. The increase in other revenues in 2017 was primarily due to the aforementioned recapture fees associated with three treaties recaptured in Australia.
Other operating expenses increased $10.7 million, or 7.2%, and $0.4 million, or 0.2%, in 2018 and 2017, respectively. The 2018 increase in other operating expenses is mainly due to increased compensation costs, primarily in the growing Asian operations. Foreign currency exchange fluctuations resulted in a decrease in operating expenses of $0.3 million and an increase of $1.2 million in 2018 and 2017, respectively. Other operating expenses as a percentage of net premiums totaled 6.9%, 7.2% and 8.8% in 2018, 2017 and 2016, respectively. The timing of premium flows and the level of costs associated with the entrance into and development of new markets in the Asia Pacific segment may cause other operating expenses as a percentage of net premiums to fluctuate over periods of time.
Net investment income increased $6.2 million, or 18.0%, and $10.9 million, or 46.0%, in 2018 and 2017, respectively. The increase in investment income in 2018 was primarily due to higher investment yields, partially offset by a lower invested asset base. The increase in investment income in 2017 was primarily due to a higher invested asset base.
Other revenues increased by $0.3 million, or 1.2%, and decreased by $2.0 million, or 8.0%, in 2018 and 2017, respectively. The decrease in other revenues in 2017 was primarily due to run-off of the previously mentioned treaty in Japan. The amount of reinsurance assumed from client companies, as measured by pre-tax statutory surplus, risk based capital and other financial reinsurance structures was $2.9 billion and $2.6 billion at December 31, 2018 and 2017, respectively. Fees earned from this business can vary significantly depending on the size of the transactions and the timing of their completion and therefore can fluctuate from period to period.
Claims and other policy benefits decreased by $4.7 million, or 26.0%, and $7.2 million, or 28.4%, in 2018 and 2017, respectively. The decrease in 2018 was attributable to lower lapses on the aforementioned closed treaty in Japan, partially offset by higher claims and policy benefits from new business. The decrease in 2017 was attributable to lower lapses from policies from a closed block of business in Japan. Management views recent experience as normal short-term volatility that is inherent in the business.
Loss before income taxes increased by $111.0 million and $85.7 million in 2018 and 2017, respectively. The increase in loss before income taxes for 2018 was primarily due to investment related losses and higher other operating expenses partially offset by increased other revenue. The increase in loss before income taxes for 2017 was primarily due to decreased net investment related gains, decreased other revenues and higher other operating expenses partially offset by increased investment income.
Net investment related losses increased by $105.5 million and $56.2 million in 2018 and 2017, respectively. The increase in net investment related losses in 2018 was due to net losses on the sale of fixed maturity securities of $55.2 million compared to gains in the prior year of $36.7 million and a decline in the fair value of equity securities of $23.6 million, which were offset by a $18.3 million decrease in other-than-temporary impairments on fixed maturity securities. Net investment related losses in 2017 reflect higher impairments on fixed maturity and other securities of $21.3 million and a reduction in net gains on the sale of fixed maturity securities of $29.7 million, compared to 2016.
Interest expense increased by $1.3 million, or 0.9%, and $8.4 million, or 6.1%, in 2018 and 2017, respectively. The increase in interest expense was primarily due to variability in tax-related interest expense. The $8.4 million increase in interest expense during 2017 was primarily due to the issuance of $800.0 million in long-term debt in June 2016, which was partially offset by the repayment of $300.0 million of long-term debt in 2017.
RGA, through wholly-owned subsidiaries, has committed to provide statutory reserve support to third parties, in exchange for a fee, by funding loans if certain defined events occur. Such statutory reserves are required under the U.S. Valuation of Life Policies Model Regulation (commonly referred to as Regulation XXX for term life insurance policies and Regulation A-XXX for universal life secondary guarantees). The third-parties have recourse to RGA should the subsidiary fail to provide the required funding, however, as of December 31, 2018, the Company does not believe that it will be required to provide any funding under these commitments as the occurrence of the defined events is considered remote. See Note 12 - “Commitments, Contingencies and Guarantees” in the Notes to Consolidated Financial Statements for a table that presents these commitments by period and maximum obligation.
with the intercompany revolving credit facility, RGA and its subsidiary, RGA Capital LLC, provided loans to RGA Australian Holdings Pty Limited with a total outstanding balance of $42.3 million and $46.9 million as of December 31, 2018 and 2017, respectively.
Undistributed earnings of the Company’s foreign subsidiaries are targeted for reinvestment outside of the U.S. As of December 31, 2018, the amount of cash and cash equivalents and short-term investments held by the Company’s subsidiaries that are taxed in a foreign jurisdiction was $913.8 million. The GILTI provision generally eliminates U.S. federal income tax deferral on earnings of foreign subsidiaries, therefore the Company does not expect to incur any material incremental U.S. federal income tax on repatriation of these earnings. Incremental foreign withholding taxes are not expected to be material.
RGA endeavors to maintain a capital structure that provides financial and operational flexibility to its subsidiaries, credit ratings that support its competitive position in the financial services marketplace, and shareholder returns. As part of the Company’s capital deployment strategy, it has in recent years repurchased shares of RGA common stock and paid dividends to RGA shareholders, as authorized by the board of directors. In January 2017, RGA’s board of directors authorized a share repurchase program, with no expiration date, to repurchase up to $400.0 million of RGA’s outstanding common stock. The pace of repurchase activity depends on various factors such as the level of available cash, an evaluation of the costs and benefits associated with alternative uses of excess capital, such as acquisitions and in force reinsurance transactions, and RGA’s stock price. Details underlying dividend and share repurchase program activity were as follows (in thousands, except share data):
(1) Excludes shares utilized to execute and settle certain stock incentive awards.
RGA declared dividends totaling $2.20 per share in 2018. All future payments of dividends are at the discretion of RGA’s board of directors and will depend on the Company’s earnings, capital requirements, insurance regulatory conditions, operating conditions, and other such factors as the board of directors may deem relevant. The amount of dividends that RGA can pay will depend in part on the operations of its reinsurance subsidiaries.
As of December 31, 2018 and 2017, the Company had $2.8 billion in outstanding borrowings under its debt agreements and was in compliance with all covenants under those agreements. As of December 31, 2018 and 2017, the average interest rate on long-term debt outstanding was 5.24%. 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, available liquidity at the holding company, and the Company’s ability to raise additional funds.
The Company has obtained bank letters of credit 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” discussion above. At December 31, 2018, there were approximately $105.6 million of outstanding bank letters of credit in favor of third parties. Additionally, in accordance with applicable regulations, the Company utilizes letters of credit to secure statutory reserve credits when it retrocedes business to its affiliated subsidiaries. The Company cedes business to its affiliates to help reduce the amount of regulatory capital required in certain jurisdictions, such as the U.S. and the UK. The Company believes the capital required to support the business in the 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, 2018, $1.4 billion in letters of credit from various banks were outstanding, but undrawn, backing reinsurance between the various subsidiaries of the Company. See Note 13-“Debt” in the Notes to Consolidated Financial Statements for information regarding the Company’s letter of credit facilities.
The Company has issued both collateral finance and securitization notes. The consolidated balance sheets include outstanding notes of $682.0 million and $783.9 million as of December 31, 2018 and 2017, respectively. See Note 14 - “Collateral Finance and Securitization Notes” in the Notes to Consolidated Financial Statements for additional information regarding the Company’s collateral finance and securitization notes.
Some treaties give ceding companies the right to request that the Company place assets in trust for the benefit of the cedant to support statutory reserve credits in the event of a downgrade of the Company’s ratings to specified levels, generally non-investment grade levels, or if minimum levels of financial condition are not maintained. As of December 31, 2018, these treaties had approximately $3.4 billion in statutory reserves. Assets placed in trust continue to be owned by the Company, but their use is restricted based on the terms of the trust agreement. Securities with an amortized cost of $2.3 billion were held in trust for the benefit of certain RGA subsidiaries to satisfy collateral requirements for reinsurance business at December 31, 2018. Additionally,
RGA has issued guarantees to third parties on behalf of its subsidiaries for the payment of amounts due under certain reinsurance treaties, securities borrowing arrangements, financing arrangements and office lease obligations, whereby if a subsidiary fails to meet an obligation, RGA or one of its other subsidiaries will make a payment to fulfill the obligation. In limited circumstances, treaty guarantees are granted to ceding companies in order to provide additional security, particularly in cases where RGA’s subsidiary is relatively new, unrated, or not of significant size, relative to the ceding company. Potential guaranteed amounts of future payments will vary depending on production levels and underwriting results. Guarantees related to borrowed securities provide additional security to third parties should a subsidiary fail to return the borrowed securities when due. 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. See Note 12 - “Commitments, Contingencies and Guarantees” in the Notes to Consolidated Financial Statements for a table that presents the amounts for guarantees, by type, issued by the Company.
The Company’s principal cash outflows relate to the payment of claims liabilities, interest credited, operating expenses, income taxes, dividends to shareholders, purchases of treasury stock, and principal and interest under debt and other financing obligations. The Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to other insurance enterprises or reinsurers under excess coverage and coinsurance contracts (See Note 2, “Significant Accounting Policies and Pronouncements” of the Notes to Consolidated Financial Statements). The Company performs annual financial reviews of its retrocessionaires to evaluate financial stability and performance. The Company has never experienced a material default in connection with retrocession arrangements, nor has it experienced any difficulty in collecting claims recoverable from retrocessionaires; however, no assurance can be given as to the future performance of such retrocessionaires nor to the recoverability of future claims. The Company’s management believes its current sources of liquidity are adequate to meet its cash requirements for the next 12 months.
Cash Flows from Investments - The principal cash inflows from the Company’s investment activities come from repayments of principal on invested assets, proceeds from sales and maturities of invested assets, and settlements of freestanding derivatives. The principal cash outflows relate to purchases of investments, issuances of policy loans and settlements of freestanding derivatives. The Company typically has a net cash outflow from investing activities because cash inflows from insurance operations
are reinvested in accordance with its asset/liability management discipline to fund insurance liabilities. The Company closely monitors and manages these risks through its credit risk management process. The primary liquidity concerns with respect to these cash flows are the risk of default by debtors and market disruption, which could make it difficult for the Company to sell investments.
Future policyholder benefits include liabilities related primarily to the Company’s reinsurance of life and health insurance products. Amounts presented in the table above represent the estimated obligations as they become due to ceding companies for benefits under such contracts, and also include future premiums, allowances and other amounts due to or from the ceding companies as the result of the Company’s assumptions of mortality, morbidity, policy lapse and surrender risk as appropriate to the respective product. Total payments may vary materially from prior years due to the assumption of new treaties or as a result of changes in projections of future experience. All estimated cash payments presented in the table above are undiscounted as to interest, net of estimated future premiums on policies currently in force and gross of any reinsurance recoverable. The sum of the undiscounted estimated cash flows shown for all years in the table is an obligation of $7,550.0 million compared to the discounted liability amount of $25,285.4 million included on the consolidated balance sheets, substantially all due to the effects of discounting the estimated cash flows in the balance sheet liability. The time value of money is not factored into the calculations in the table above. In addition, differences will arise due to changes in the projection of future benefit payments compared with those developed when the reserve was established. Expected premiums can exceed expected policy benefit payments and allowances due to the nature of the reinsurance treaties, which generally have increasing premium rates that exceed the increasing benefit payments.
Interest-sensitive contract liabilities include amounts related to the Company’s reinsurance of asset-intensive products, primarily deferred annuities and corporate-owned life insurance. Amounts presented in the table above represent the estimated obligations as they become due both to and from ceding companies relating to activity of the underlying policyholders. Amounts presented in the table above represent the estimated obligations under such contracts undiscounted as to interest, including assumptions related to surrenders, withdrawals, premium persistency, partial withdrawals, surrender charges, annuitizations, mortality, future interest credited rates and policy loan utilization. The sum of the obligations shown for all years in the table of $31,175.4 million exceeds the liability amount of $18,004.5 million included on the consolidated balance sheets principally due to the lack of discounting and accounting for separate account contracts.
Excluded from the table above are net deferred income tax liabilities, unrecognized tax benefits, and accrued interest related to unrecognized tax benefits of $2,079.9 million, for which the Company cannot reliably determine the timing of payment. Current income tax payable is also excluded from the table.
tax, risk-adjusted investment income and after-tax, risk-adjusted total return while managing the assets and liabilities on a cash flow and duration basis.
The Company’s liquidity position (cash and cash equivalents and short-term investments) was $2,032.3 million and $1,396.8 million at December 31, 2018 and 2017, respectively. Liquidity needs are determined from valuation analyses conducted by operational units and are driven by product portfolios. Periodic evaluations of demand liabilities and short-term liquid assets are designed to adjust specific portfolios, as well as their durations and maturities, in response to anticipated liquidity needs.
The Company had total cash and invested assets of $56.1 billion and $53.0 billion as of December 31, 2018 and 2017, respectively, as illustrated below (dollars in thousands):
See “Fixed Maturity and Equity Securities Available-for-Sale” in Note 4 - “Investments” in the Notes to Consolidated Financial Statements for tables that provide the amortized cost, unrealized gains and losses, estimated fair value of these securities, and the other-than-temporary impairments in AOCI by sector as of December 31, 2018 and 2017.
As of December 31, 2018, the Company’s investments in Canadian and Canadian provincial government securities represented 9.7% of the fair value of total fixed maturity securities compared to 11.1% of the fair value of total fixed maturity securities as of December 31, 2017. These assets are primarily high quality, long duration provincial strips, the valuation of which is closely linked to the interest rate curve. These assets are longer in duration and held primarily for asset/liability management to meet Canadian regulatory requirements. See “Fixed Maturity and Equity Securities Available-for-Sale” in Note 4 - “Investments” in the Notes to Consolidated Financial Statements for tables showing the various sectors as of December 31, 2018 and 2017.
securities (mortgage-backed and asset-backed securities) held by the Company’s insurance subsidiaries that maintain the NAIC statutory basis of accounting utilize the NAIC rating methodology. The NAIC assigns designations to publicly traded as well as privately placed securities. The designations assigned by the NAIC range from class 1 to class 6, with designations in classes 1 and 2 generally considered investment grade (BBB or higher rating agency designation). NAIC designations in classes 3 through 6 are generally considered below investment grade (BB or lower rating agency designation).
The Company’s fixed maturity portfolio includes structured securities. The following table shows the types of structured securities the Company held as of December 31, 2018 and 2017 (dollars in thousands):
The Company monitors its fixed maturity securities to determine impairments in value and 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 and industry sector conditions, current intent and ability to hold securities, and various other subjective factors. Based on management’s judgment, securities determined to have an other-than-
temporary impairment in value are written down to fair value. See “Investments - Other-than-Temporary Impairment” in Note 2 - “Significant Accounting Policies and Pronouncements” in the Notes to Consolidated Financial Statements for additional information. The table below summarizes other-than-temporary impairments and changes in the mortgage loan provision for 2018, 2017 and 2016 (dollars in thousands):
The fixed maturity impairments in 2018, 2017 and 2016 were largely related to high-yield and emerging market corporate securities. The equity impairments in 2017 were related to an equity position received as part of a debt restructuring. In addition, other impairment losses in 2018, 2017 and 2016 were primarily due to impairments on real estate joint ventures and limited partnerships.
As of December 31, 2018 and 2017, the Company had $748.5 million and $113.3 million, respectively, of gross unrealized losses related to its fixed maturity securities. The distribution of the gross unrealized losses related to these securities is shown below:
Financial Statements for additional information). These securities primarily consist of private placement corporate securities, bank loans and Canadian provincial strips with inactive trading markets.
As of December 31, 2018 and 2017, the Company’s mortgage loans, gross of unamortized deferred loan origination fees and expenses and valuation allowances, were distributed geographically as follows (dollars in thousands):
Based on data provided by the ceding company as of December 31, 2018 and 2017, segregated portfolios contained primarily corporate, municipal, government and asset-backed securities as well as derivative securities and reverse repurchase obligations. These assets pose risks similar to the fixed maturity securities the Company directly owns. Derivatives consist primarily of S&P 500 options that are used to hedge liabilities and interest credited for EIAs reinsured by the Company. The securities held within the segregated portfolios are primarily investment-grade, with an average rating of “A.” The average maturity for investments held within the segregated portfolios of funds withheld at interest is ten years or more. Interest accrues to the total funds withheld at interest assets at rates defined by the treaty terms and the Company estimated the yields were approximately 5.43%, 7.78% and 5.89% for the years ended December 31, 2018, 2017 and 2016, respectively. Changes in these estimated yields are affected by changes in the fair value of equity options held in the funds withheld portfolio associated with EIAs. Additionally, under certain treaties the Company is subject to the investment performance on the withheld assets, although it does not directly control them. To mitigate this risk, the Company helps set the investment guidelines followed by the ceding company and monitors compliance.
Other invested assets include limited partnership interests, joint ventures (other than operating joint ventures), equity release mortgages, derivative contracts, fair value option (“FVO”) contractholder-directed unit-linked investments and FHLB common stock. Other invested assets represented approximately 3.4% and 2.8% of the Company’s cash and invested assets as of December 31, 2018 and 2017, respectively. See “Other Invested Assets” in Note 4 - “Investments” in the Notes to Consolidated Financial Statements for a table that presents the carrying value of the Company’s other invested assets by type as of December 31, 2018 and 2017.
The Board of Directors (“the Board”) oversees enterprise risk through its standing committees. The Finance, Investments, and Risk Management (“FIRM”) Committee of the Board oversees the management of the Company’s ERM program and policies. The FIRM receives regular reports and assessments that describe the Company’s key risk exposures and include quantitative and qualitative assessments and information about breaches, exceptions, and waivers.
Risk Appetite Statement: A general and high level overview of the risk profile RGA aims to achieve to meet its strategic objectives. This statement is then supported by more granular risk limits guiding the businesses to achieve this Risk Appetite Statement.
Proactive risk monitoring and reporting enable early detection and mitigation of emerging risks. The RMSC and its subcommittees monitor adherence to risk limits through the ERM function, which reports regularly to the RMSC and FIRM Committee. The frequency of monitoring is tailored to the volatility assessment and relative priority of each risk. Risk escalation channels coupled with open communication lines enhance the mitigations explained above. The Company has devoted significant resources to developing its ERM program and expects to continue to do so in the future. Nonetheless, the Company’s policies and procedures to identify, manage, and monitor risks may not be fully effective. Many of the Company’s methods for managing risk are based on historical information, which may not be a good predictor of future risk exposures, such as the risk of a pandemic causing a large number of deaths. Management of operational, legal, and regulatory risk relies on policies and procedures that may not be fully effective under all scenarios.
The Company retains most of the inbound insurance risk. The Company manages the retained exposure proactively using various mitigating factors such as diversification and limits. Diversification is the primary mitigating factor of short term volatility risk, but it also mitigates adverse impacts of changes in long term trends and catastrophic events. The Company’s insured populations are dispersed globally, diversifying the insurance exposure because factors that cause actual experience to deviate materially from expectations do not affect all areas uniformly and synchronously or in close sequence. A variety of limits mitigate retained insurance risk. Examples of these limits include geographic exposure limits, which set the maximum amount of business that can be written in a given country, and jumbo limits, which prevent excessive coverage on a given individual.
Interest Rate risk is risk that changes in the level and volatility of nominal interest rates affect the profitability, value or solvency position of the Company. This includes credit spread changes and inflation but excludes credit quality deterioration. This risk arises from many of the Company’s primary activities, as the Company invests substantial funds in interest-sensitive assets, primarily fixed maturity securities, and also has certain interest-sensitive contract liabilities. A prolonged period where market
yields are significantly below the book yields of the Company’s asset portfolio puts downward pressure on portfolio book yields. The Company has been proactive in its investment strategies, reinsurance structures and overall asset-liability management practices to reduce the risk of unfavorable consequences in this type of environment.
The following table presents the account values, the weighted average interest-crediting rates and minimum guaranteed rate ranges for the contracts containing guaranteed rates by major class of interest-sensitive product as of December 31, 2018 and 2017 (dollars in thousands):
The following table presents the account values by each minimum guaranteed rate, rounded to the nearest percentage, by class of interest-sensitive product as of December 31, 2018 and 2017 (dollars in thousands):
financial instruments in the event of a hypothetical change in interest rates. Interest rate cash flow risk exposure is measured using interest rate sensitivity analysis to determine the Company’s variability in cash flows in the event of a hypothetical change in interest rates.
Interest rate sensitivity analysis is also used to measure the Company’s interest rate cash flow risk by computing estimated changes in the expected cash flows for floating rate assets and liabilities over a one year period following an instantaneous, parallel, hypothetical 100 basis point 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 associated with floating rate instruments in the event of an instantaneous 100 basis point decrease in market interest rates for its fiscal years ended December 31, 2018 and 2017 was $71.3 million and $44.4 million, respectively.
Equity risk is the risk that changes in the level and volatility of equity market valuations affect the profitability, value or solvency position of the Company. This risk includes Variable Annuity and other equity linked exposures and asset related equity exposure. The Company assumes equity risk from alternative investments, fixed indexed annuities and variable annuities. The Company uses derivatives to hedge its exposure to movements in equity markets that have a direct correlation with certain of its reinsurance products.
Investment credit risk is credit risk related to invested assets. The Company manages investment credit risk using per-issuer investment limits. In addition to per-issuer limits, the Company also limits the total amounts of investments per rating category. An automated compliance system checks for compliance for all investment positions and sends warning messages when there is a breach. The Company manages its credit risk related to over-the-counter derivatives by entering into transactions with creditworthy counterparties, maintaining collateral arrangements and through the use of master agreements that provide for a single net payment to be made by one counterparty to another at each due date and upon termination. Because futures are transacted through regulated exchanges, and positions are marked to market on a daily basis, the Company has minimal exposure to credit-related losses in the event of nonperformance by counterparties to such derivative instruments.
Capital risk is the risk of lower/negative earnings, potential reduction in enterprise value, and/or the loss of ability to conduct business due to insufficient financial capacity, including not having the appropriate amount of group or entity-level capital to conduct business today or in the future. The Company monitors capital risk exposure using relevant bases of measurement including but not limited to economic, rating agency, and local regulatory methodologies. Additionally, the Company regularly assesses risk related to collateral, financing, liquidity and tax.
Liquidity risk is the risk that the Company is unable to meet payment obligations at expected costs or in the capacity required. The Company’s traditional liquidity demands include items such as claims, expenses, debt financing and investment
purchases, which are largely known or can be reasonably forecasted. The Company regularly performs liquidity risk modeling, including both market and Company specific stresses, to assess the sufficiency of available resources.
Operational risk is the risk of lower/negative earnings and a potential reduction in enterprise value caused by unexpected losses associated with inadequacy or failure on the part of internal processes, people and systems, or from external events. The Company regularly monitors and assesses the risks related to business conduct and governance, fraud, privacy and security, business disruption, and business operations. Various insurance, market and credit, capital, and strategy risk obligations and concerns often intersect with the Company’s core operational process risk areas. Given the scope of the Company’s business and the number of countries in which it operates, this set of risks has the potential to affect the business locally, regionally, or globally. Operational risks are core to managing the Company’s brand and market confidence as well as maintaining its ability to acquire and retain the appropriate expertise to execute and operate the business.
Fraud risk is the risk related to the deliberate abuse of and/or taking of Company assets in order to secure gain for the perpetrator or inflict harm on the Company or other victim. Ongoing monitoring and an annual fraud risk assessment enables the Company to continually evaluate potential fraud risks within the organization.
See “New Accounting Pronouncements” in Note 2 - “Significant Accounting Policies and Pronouncements” in the Notes to Consolidated Financial Statements.
Equity securities are carried at fair value with the exception of the Company’s investment in the Federal Home Loan Bank of Des Moines (“FHLB”) common stock, which is carried at cost and included in other invested assets. Realized and unrealized gains and losses associated with equity securities carried at fair value are included in investment related gains (losses), net.
The Company participates in a securities lending program whereby securities, reflected as investments on the Company’s consolidated balance sheets, are loaned to a third party. The Company receives securities as collateral, in an amount equal to a minimum of 105% of the fair value of the securities lent. The securities received as collateral are not reflected on the Company’s consolidated balance sheets.
The Company participates in a repurchase program in which securities, reflected as investments on the Company’s consolidated balance sheets, are pledged to a third party. In return, the Company receives cash from the third party, which is reflected as a payable to a third party, included in other liabilities on the consolidated balance sheets. The Company is required to maintain a minimum collateral balance with a fair value of 105% of the cash received.
The Company estimates the amount of the credit loss component of a fixed maturity security impairment as the difference between amortized cost and the present value of the expected cash flows of the security. The present value is determined using the best
estimate cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating rate security. The techniques and assumptions for establishing the best estimate cash flows vary depending on the type of security. The asset-backed securities’ cash flow estimates are based on security-specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity and prepayment speeds and structural support, including subordination and guarantees. The corporate fixed maturity security cash flow estimates are derived from scenario-based outcomes of expected corporate restructurings or the disposition of assets using security specific facts and circumstances including timing, security interests and loss severity.
Under a cash flow hedge, changes in the fair value of the hedging derivative measured as effective are reported within AOCI and the deferred gains or losses on the derivative are reclassified into the consolidated statements of income when the Company’s earnings are affected by the variability in cash flows of the hedged item. Changes in the fair value of the hedging instrument measured as ineffective are reported within investment related gains (losses), net. The fair values of the hedging derivatives are
exclusive of any accruals that are separately reported in the consolidated statements of income within interest income or interest expense to match the location of the hedged item.
Additionally, reinsurance treaties written on a modco or funds withheld basis are subject to the general accounting principles for Derivatives and Hedging related to embedded derivatives. The Company’s funds withheld at interest balances are primarily associated with its reinsurance treaties structured on a modco or funds withheld basis, the majority of which were subject to the general accounting principles for Derivatives and Hedging related to embedded derivatives. Management believes the embedded derivative feature in each of these reinsurance treaties is similar to a total return swap on the assets held by the ceding companies. The valuation of embedded derivatives is sensitive to the investment credit spread environment. Changes in investment credit spreads are also affected by the application of a credit valuation adjustment (“CVA”). The fair value calculation of an embedded derivative in an asset position utilizes a CVA based on the ceding company’s credit risk. Conversely, the fair value calculation of an embedded derivative in a liability position utilizes a CVA based on the Company’s credit risk. Generally, an increase in investment credit spreads, ignoring changes in the CVA, will have a negative impact on the fair value of the embedded derivative (decrease
DAC related to interest-sensitive life and investment-type policies are amortized over the lives of the policies, in proportion to the gross profits realized from mortality, investment income less interest credited, and expense margins.
Goodwill, reported in other assets, is not amortized into results of operations, but instead is reviewed at least annually for impairment and written down only in the periods in which the recorded value of goodwill exceeds its fair value. Goodwill as of December 31, 2018 and 2017 totaled $7.0 million. 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 $5.1 million and $3.3 million, including accumulated amortization of $15.0 million and $14.6 million, as of December 31, 2018 and 2017, respectively. The VOBA amortization expense for the years ended December 31, 2018, 2017 and 2016 was $0.4 million, $0.3 million, and $0.5 million, respectively. These amortized balances are included in other assets on the consolidated balance sheets. Future amortization of the VOBA is not material.
Value of distribution agreements (“VODA”) is reported in other assets and represents the present value of future profits associated with the expected future business derived from the distribution agreements. Value of customer relationships acquired (“VOCRA”) is also reported in other assets and represents the present value of the expected future profits associated with the expected future business acquired through existing customers of the acquired company or business. The VODA is amortized over a useful life of 15 years and the VOCRA is also amortized over a 15 year period in proportion to expected revenues generated, with amortization included in policy acquisition costs and other insurance expenses. Each year the Company reviews VODA and VOCRA to determine the recoverability of these balances. VODA and VOCRA totaled approximately $40.8 million and $49.2 million, including accumulated amortization of $79.8 million and $71.5 million, as of December 31, 2018 and 2017, respectively. The VODA and VOCRA amortization expense for the years ended December 31, 2018, 2017 and 2016 was $8.3 million, $8.7 million and $9.0 million, respectively. Amortization of the VODA and VOCRA is estimated to be $8.1 million, $7.6 million, $6.6 million, $6.4 million and $6.2 million during 2019, 2020, 2021, 2022 and 2023, respectively.
Property, equipment and leasehold improvements, which are included in other assets, are stated at cost, less accumulated depreciation. Depreciation is determined using the straight-line method over the estimated useful lives of the assets, as appropriate. The estimated life is generally 40 years for company occupied real estate property, from one to seven years for leasehold improvements, and from three to seven years for all other property and equipment. The cost basis of the property, equipment and leasehold improvements was $248.7 million and $236.1 million at December 31, 2018 and 2017, respectively. Accumulated depreciation of property, equipment and leasehold improvements was $97.0 million and $79.4 million at December 31, 2018 and 2017, respectively. Related depreciation expense was $18.3 million, $17.2 million and $16.6 million for the years ended December 31, 2018, 2017 and 2016, respectively.
Computer software, which is included in other assets, is stated at cost, less accumulated amortization. Purchased software costs, as well as certain internal and external costs incurred to develop internal-use computer software during the application development stage, are capitalized. Amortization of software costs is recorded on a straight-line basis over periods ranging from three to ten years. Carrying values are reviewed at least annually for indicators of impairment in value. Unamortized computer software costs were $150.4 million and $145.5 million at December 31, 2018 and 2017, respectively. Amortization expense was $26.9 million, $35.7 million, and $10.3 million for the years ended December 31, 2018, 2017 and 2016, respectively. The Company recognized capital project write-offs of $4.7 million, $24.5 million and $0.6 million in 2018, 2017 and 2016, respectively.
The reserving process includes normal periodic reviews of assumptions used and adjustments of reserves to incorporate the refinement of the assumptions. Any such adjustments relate only to policies assumed in recent periods and the adjustments are reflected by a cumulative charge or credit to current operations.
Any such changes could significantly affect the amounts reported in the consolidated financial statements in the year these changes occur.
The Company expenses the fair value of stock awards included in its incentive compensation plans. As of the date stock awards are approved, the fair value of stock options is determined using a Black-Scholes options valuation methodology, and the fair value of other stock awards is based upon the market value of the stock on the grant date. The fair value of the awards is expensed over the performance or service period, which generally corresponds to the vesting period, and is recognized as an increase to additional paid-in-capital in stockholders’ equity, and stock-based compensation expense is reflected in other operating expenses in the consolidated statements of income.
The calculation of common equivalent shares does not include the impact of options having a strike or conversion price that exceeds the average stock price for the earnings period, as the result would be antidilutive. The calculation of common equivalent shares also excludes the impact of outstanding performance contingent shares, as the conditions necessary for their issuance have
The following table provides information relating to investments in fixed maturity and equity securities by sector as of December 31, 2017 (dollars in thousands):
certain third-party reinsurance treaties. The following table includes fixed maturity securities pledged and received as collateral and assets in trust held to satisfy collateral requirements under derivative transactions and certain third-party reinsurance treaties as of December 31, 2018 and 2017 (dollars in thousands):
The amortized cost and estimated fair value of fixed maturity securities classified as available-for-sale as of December 31, 2018 are shown by contractual maturity in the table below (dollars in thousands). Actual maturities can differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Asset and mortgage-backed securities are shown separately in the table below, as they are not due at a single maturity date.
The tables below show the major industry types of the Company’s corporate fixed maturity holdings as of December 31, 2018 and 2017 (dollars in thousands):
As discussed in Note 2 - “Significant Accounting Policies and Pronouncements,” a portion of certain other-than-temporary impairment (“OTTI”) losses on fixed maturity securities is recognized in AOCI. For these securities, the net amount recognized in the consolidated statements of income (“credit loss impairments”) represents the difference between the amortized cost of the security and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt
The following table presents the estimated fair values and gross unrealized losses, including other-than-temporary impairment losses reported in AOCI, for 1,116 fixed maturity and equity securities that have estimated fair values below amortized cost as of December 31, 2017 (dollars in thousands):
ordinary course of managing its portfolio to meet certain diversification, credit quality and liquidity guidelines. Changes in unrealized losses are primarily driven by changes in interest rates.
The following table includes the amount of borrowed securities, securities lent and securities collateral received as part of the securities lending program, repurchased/reverse repurchased securities pledged and received and cash received as of December 31, 2018 and 2017 (dollars in thousands):
The Company also held cash collateral for securities lending and the repurchase program/reverse repurchase programs of $28.6 million and $31.2 million as of December 31, 2018 and 2017, respectively. No cash or securities have been pledged by the Company for its securities borrowing program as of December 31, 2018 and 2017.
The following tables present information on the Company’s securities lending and repurchase transactions as of December 31, 2018 and 2017, respectively (dollars in thousands). Collateral associated with certain borrowed securities is not included within the tables as the collateral pledged to each counterparty is the right to reinsurance treaty cash flows.
The Company has elected to offset amounts recognized as receivables and payables resulting from the repurchase/reverse repurchase programs. After the effect of offsetting, the net amount presented on the consolidated balance sheets was a liability of $0.4 million and $1.1 million as of December 31, 2018 and 2017, respectively. As of December 31, 2018 and 2017, the Company recognized payables resulting from cash received as collateral associated with a repurchase agreement as discussed above. Amounts owed to and due from the counterparties may be settled in cash or offset, in accordance with the agreements.
The maturities of the mortgage loans as of December 31, 2018 and 2017 are as follows (dollars in thousands):
The following table presents the recorded investment in mortgage loans, by method of measuring impairment, and the related valuation allowances, as of December 31, 2018 and 2017 (dollars in thousands):
Information regarding the Company’s loan valuation allowances for mortgage loans as of December 31, 2018, 2017 and 2016 are as follows (dollars in thousands):
Information regarding the portion of the Company’s mortgage loans that were impaired as of December 31, 2018 and 2017 is as follows (dollars in thousands):
The Company’s average investment balance of impaired mortgage loans and the related interest income are reflected in the table below for the years ended December 31, 2018, 2017 and 2016 (dollars in thousands):
The Company did not acquire any impaired mortgage loans during the years ended December 31, 2018 and 2017. The Company had no mortgage loans that were on a nonaccrual status as of December 31, 2018 and 2017.
Funds withheld at interest comprised approximately 10.6% and 11.8% of the Company’s total investments as of December 31, 2018 and 2017, respectively. Of the $5.8 billion funds withheld at interest balance, net of embedded derivatives, as of December 31, 2018, $3.8 billion of the balance is associated with one client. For reinsurance agreements written on a modco 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 the Company’s consolidated balance sheets. In the event of a ceding company’s insolvency, the Company would need to assert a claim on the assets supporting its reserve liabilities. However, the risk of loss to the Company is mitigated by its ability to offset amounts it owes the ceding company for claims or allowances against amounts owed to the Company from the ceding company.
Other invested assets include limited partnership interests, joint ventures (other than operating joint ventures), equity release mortgages, derivative contracts and fair value option (“FVO”) contractholder-directed unit-linked investments. Other invested
The Company has certain embedded derivatives that are required to be separated from their host contracts and reported as derivatives. Host contracts include reinsurance treaties structured on a modco or funds withheld basis. Additionally, the Company reinsures equity-indexed annuity and variable annuity contracts with benefits that are considered embedded derivatives, including guaranteed minimum withdrawal benefits, guaranteed minimum accumulation benefits, and guaranteed minimum income benefits. The changes in fair values of embedded derivatives on equity-indexed annuities described below relate to changes in the fair value associated with capital market and other related assumptions. The Company’s utilization of a credit valuation adjustment did not have a material effect on the change in fair value of its embedded derivatives for the years ended December 31, 2018, 2017 and 2016.
The Company designates and reports certain foreign currency swaps to hedge the foreign currency fair value exposure of foreign currency denominated assets as fair value hedges when they meet the requirements of the general accounting principles for Derivatives and Hedging. The gain or loss on the hedged item attributable to a change in foreign currency and the offsetting gain or loss on the related foreign currency swaps as of December 31, 2018, 2017 and 2016 were (dollars in thousands):
As of December 31, 2018, the before-tax deferred net gains on derivative instruments recorded in AOCI that are expected to be reclassified to earnings during the next twelve months are approximately $0.1 million and $1.9 million in investment income and interest expense, respectively.
For the years ended December 31, 2018, 2017 and 2016, the ineffective portion of derivatives reported as cash flow hedges was not material to the Company’s results of operations. Also, there were no material amounts reclassified into earnings relating to instances in which the Company discontinued cash flow hedge accounting because the forecasted transaction did not occur by the
The Company uses foreign currency swaps and foreign currency forwards to hedge a portion of its net investment in certain foreign operations against adverse movements in exchange rates. The following table illustrates the Company’s net investments in foreign operations (“NIFO”) hedges for the years ended December 31, 2018, 2017 and 2016 (dollars in thousands):
A summary of the effect of non-hedging derivatives, including embedded derivatives, on the Company’s consolidated statements of income for the years ended December 31, 2018, 2017 and 2016 is as follows (dollars in thousands):
The following table presents the estimated fair value, maximum amount of future payments and weighted average years to maturity of credit default swaps sold by the Company as of December 31, 2018 and 2017 (dollars in thousands):
The following table provides information relating to the netting of the Company’s derivative instruments as of December 31, 2018 and December 31, 2017 (dollars in thousands):
Derivatives may be exchange-traded or they may be privately negotiated contracts, which are referred to as over-the-counter (“OTC”) derivatives. Certain of the Company’s OTC derivatives are cleared and settled through central clearing counterparties (“OTC cleared”) and others are bilateral contracts between two counterparties. The Company manages its credit risk related to OTC derivatives by entering into transactions with creditworthy counterparties, maintaining collateral arrangements and through
Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or market standard valuation techniques and assumptions that use significant inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Such observable inputs include benchmarking prices for similar assets in active, liquid markets, quoted prices in markets that are not active and observable yields and spreads in the market. The Company’s Level 2 assets and liabilities include investment securities with quoted prices that are traded less frequently than exchange-traded instruments and derivative contracts whose values are determined using market standard valuation techniques. Level 2 valuations are generally obtained from third party pricing services for identical or comparable assets or liabilities or through the use of valuation methodologies using observable market inputs. Prices from servicers are validated through analytical reviews and assessment of current market activity.
models to analyze the reasonableness of fair values utilizing credit spread and other market assumptions, where appropriate. As a result of the analysis, if the Company determines there is a more appropriate fair value based upon the available market data, the price received from the third party is adjusted accordingly. The Company also determines if the inputs used in estimated fair values received from pricing services are observable by assessing whether these inputs can be corroborated by observable market data.
Fixed Maturity Securities - The fair values of the Company’s publicly-traded fixed maturity securities are generally based on prices obtained from independent pricing services. Prices from pricing services are sourced from multiple vendors, and a vendor hierarchy is maintained by asset type based on historical pricing experience and vendor expertise. The Company generally receives prices from multiple pricing services for each security, but ultimately uses the price from the vendor that is highest in the hierarchy for the respective asset type. To validate reasonableness, prices are periodically reviewed as explained above. Consistent with the fair value hierarchy described above, securities with quotes from pricing services are generally reflected within Level 2, as they are primarily based on observable pricing for similar assets and/or other market observable inputs. If the pricing information received from third party pricing services is not reflective of market activity or other inputs observable in the market, the Company may challenge the price through a formal process with the pricing service.
Embedded Derivatives - The fair value of embedded derivative liabilities, including those calculated by third parties, are monitored through the use of attribution reports to quantify the effect of underlying sources of fair value change, including capital market inputs based on policyholder account values, interest rates and short-term and long-term implied volatilities, from period to period. Actuarial assumptions are based on experience studies performed internally in combination with available industry information and are reviewed on a periodic basis, at least annually.
The fair value of embedded derivatives associated with funds withheld reinsurance treaties is determined based upon a total return swap technique with reference to the fair value of the investments held by the ceding company that support the Company’s funds withheld at interest asset with an adjustment for a CVA. The fair value of the underlying assets is generally based on market observable inputs using industry standard valuation techniques. The valuation also requires certain significant inputs, which are generally not observable and accordingly, the valuation is considered Level 3 in the fair value hierarchy.
Equity Securities - Equity securities consist principally of exchange-traded funds and common and preferred stock of publicly and privately traded companies. The fair values of publicly traded equity securities are primarily based on quoted market prices in active markets and are classified within Level 1 in the fair value hierarchy. Non-binding broker quotes and internally developed evaluations for equity securities are generally based on significant unobservable inputs and are reflected as Level 3 in the fair value hierarchy.
Cash Equivalents and Short-Term Investments - Cash equivalents and short-term investments include money market instruments, commercial paper and other highly liquid debt instruments. Money market instruments are generally valued using unadjusted quoted prices in active markets that are accessible for identical assets and are primarily classified as Level 1. The fair value of certain other cash equivalents and short-term investments, such as bonds with original maturities twelve months or less, are based upon other market observable data and are typically classified as Level 2. However, certain short-term investments may incorporate significant unobservable inputs resulting in a Level 3 classification. Various time deposits, certificates of deposit and sweeps carried as cash equivalents or short-term investments are not measured at estimated fair value and therefore are excluded from the tables presented.
Transfers between Levels 1 and 2 are made to reflect changes in observability of inputs and market activity. The Company recognizes transfers of assets and liabilities into and out of levels within the fair value hierarchy at the beginning of the quarter in which the actual event or change in circumstances that caused the transfer occurs. There were no transfers between Level 1 and Level 2 for the year ended December 31, 2018. The following table presents the transfers between Level 1 and Level 2 during the year ended December 31, 2017 (dollars in thousands):
The following table presents quantitative information about significant unobservable inputs used in Level 3 fair value measurements that are developed internally by the Company as of December 31, 2018 and 2017 (dollars in thousands):
The significant unobservable inputs used in the fair value measurement of the Company’s corporate, sovereign, government-backed, other political subdivision and equity security investments include probability of default, liquidity premium and subordination premium. Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement. Generally, a change in the assumption used for the probability of default is accompanied by a directionally similar change in the assumptions used for the liquidity premium and subordination premium. For securities with a fair value derived using the market comparable pricing valuation technique, liquidity premium is the only significant unobservable input.
The actuarial assumptions used in the fair value of embedded derivatives, which include assumptions related to lapses, withdrawals, and mortality, are based on experience studies performed by the Company in combination with available industry information and are reviewed on a periodic basis, at least annually. The significant unobservable inputs used in the fair value measurement of embedded derivatives are assumptions associated with policyholder experience and selected capital market assumptions for equity-indexed and variable annuities. The selected capital market assumptions, which include long-term implied volatilities, are projections based on short-term historical information. Changes in interest rates, equity indices, equity volatility, CVA, and actuarial assumptions regarding policyholder experience may result in significant fluctuations in the value of embedded derivatives.
Assets and liabilities transferred into Level 3 are due to a lack of observable market transactions and price information. Assets and liabilities are transferred out of Level 3 when circumstances change such that significant inputs can be corroborated with market observable data. This may be due to a significant increase in market activity for the asset or liability, a specific event, or one or more significant input(s) becoming observable. Transfers out of Level 3 were primarily the result of the Company obtaining observable pricing information or a third party pricing quotation that appropriately reflects the fair value of those assets and liabilities. The Company also transferred equity securities with a fair value of approximately $38.9 million into Level 3 as a result of the adoption of the new accounting guidance for the recognition and measurement of equity securities.
The reconciliations for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) are as follows (dollars in thousands):
The amount reported within purchases, sales and settlements is the purchase price (for purchases) and the sales/settlement proceeds (for sales and settlements) based upon the actual date purchased or sold/settled. Items purchased and sold/settled in the same period are excluded from the rollforward. The Company had no issuances during the period.
The Company is required by general accounting principles for Fair Value Measurements and Disclosures to disclose the fair value of certain financial instruments including those that are not carried at fair value. The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments, which were not measured at fair value on a recurring basis, as of December 31, 2018 and 2017 (dollars in thousands). This table excludes any payables or receivables for collateral under repurchase agreements and other transactions. The estimated fair value of the excluded amount approximates carrying value as they equal the amount of cash collateral received/paid.
The effect of reinsurance on life insurance in force is shown in the following schedule (dollars in millions):
certain conditions, RGA may be obligated to move reinsurance from one RGA subsidiary company to another or make payments under the treaty. These conditions include change in control or ratings of the subsidiary, insolvency, nonperformance under a treaty, or loss of reinsurance license of such subsidiary.
The Tax Cuts and Jobs Act (“U.S. Tax Reform”) was signed into law on December 22, 2017. U.S. Tax Reform made broad changes to the U.S. tax code, including (1) reducing the U.S. federal corporate tax rate from 35 percent to 21 percent; (2) imposed a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries; (3) generally eliminated U.S. federal income taxes on dividends from foreign subsidiaries; (4) eliminated the corporate alternative minimum tax (“AMT”) and changed how existing AMT credits can be realized; (5) created the base erosion anti-abuse tax (“BEAT”); (6) established a new provision designed to tax global intangible low-taxed income (“GILTI”), which allows for the possibility of using foreign tax credits and a deduction of up to 50% to offset the income tax liability (subject to some limitations); and (7) modified the rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017.
In connection with the Company’s initial analysis of the impact of U.S. Tax Reform, it recorded a discrete provisional net tax benefit of $1,033.8 million in the period ending December 31, 2017. This estimated net benefit primarily consisted of the U.S. federal rate reduction from 35% to 21% applied to the net deferred tax liability. The Company provisionally estimated there would be no one-time transition tax on unrepatriated earnings of foreign subsidiaries. Further, as a result of U.S. Tax Reform, the Company established a valuation allowance of $58.9 million related to U.S. foreign tax credit carryforwards. The valuation allowance related to the Company’s interpretation of the changes in the ability to use existing foreign tax credit carryforwards against future foreign branch profits.
Under GAAP, the Company is allowed to make an accounting policy choice of either (1) treating taxes due on future U.S. inclusions in taxable income related to the GILTI as a current-period expense when incurred (“the period cost method”) or (2) factoring such amounts into a Company’s measurement of its deferred taxes (“the deferred method”). The Company made a policy election to account for GILTI as a period cost.
The Company’s effective tax rate differed from the U.S. federal income tax statutory rate of 21%, 35%, and 35% as a result of the following for the years ended December 31, 2018, 2017 and 2016 (dollars 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, 2018 and 2017, are presented in the following tables (dollars in thousands):
The earnings of substantially all of the Company’s foreign subsidiaries have been permanently reinvested in foreign operations. No provision has been made for U.S. tax or foreign withholding taxes that may be applicable upon any repatriation or sale. At December 31, 2018 and 2017, the financial reporting basis in excess of the tax basis for which no deferred taxes have been recognized was approximately $1,364.1 million and $1,442.9 million, respectively. As U.S. Tax Reform generally eliminates U.S. federal income taxes on dividends from foreign subsidiaries, the Company does not expect to incur material income taxes if these funds are repatriated.
As of December 31, 2018 the Company had foreign tax credit carryforwards of $27.8 million in Ireland and as of December 31, 2017, the Company had $152.0 million of foreign tax credit carryforwards in the U.S. and Ireland. The Ireland foreign tax credit carryforward has a full valuation allowance.
As of December 31, 2018, the Company’s total amount of unrecognized tax benefits was $324.6 million and the total amount of unrecognized tax benefits that would affect the effective tax rate, if recognized, was $12.8 million. Management believes there will be no material impact to the Company’s effective tax rate related to unrecognized tax benefits over the next 12 months.
A reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2018, 2017 and 2016, is as follows (dollars in thousands):
Certain subsidiaries of the Company are sponsors or administrators of both qualified and non-qualified defined benefit pension plans (“Pension Plans”). The largest of these plans is a non-contributory qualified defined benefit pension plan sponsored by RGA Reinsurance Company (“RGA Reinsurance”) that covers U.S. employees. The benefits under the Pension Plans are generally based on years of service and compensation levels.
The following table presents information for qualified and non-qualified pension plans with a projected benefit obligation in excess of plan assets as of December 31, 2018 and 2017 (dollars in thousands):
During 2019, the Company expects to contribute $16.3 million and $1.5 million to the pension plans and other benefit plans, respectively.
Target allocations of U.S. qualified pension plan assets are determined with the objective of maximizing returns and minimizing volatility of net assets through adequate asset diversification and partial liability immunization. Adjustments are made to target allocations based on the Company’s assessment of the effect of economic factors and market conditions. The target allocations for plan assets are 60% equity securities and 40% debt securities as of December 31, 2018 and 2017. The Company’s plan assets are primarily invested in mutual funds. The mutual funds include holdings of S&P 500 securities, large-cap securities, mid-cap securities, small-cap securities, international securities, corporate debt securities, U.S. and other government securities, mortgage-related securities and cash.
to reflect letters of credit issued for its benefit as an admitted asset and a direct credit to unassigned surplus. Under NAIC SAP, letters of credit issued on behalf of the reporting company are not reported on the balance sheet.
RGA has issued guarantees to third parties on behalf of its subsidiaries for the payment of amounts due under certain reinsurance treaties, securities borrowing and repurchase arrangements, financing arrangements and office lease obligations, whereby if a subsidiary fails to meet an obligation, RGA or one of its other subsidiaries will make a payment to fulfill the obligation. In limited circumstances, treaty guarantees are granted to ceding companies in order to provide them additional security, particularly in cases where RGA’s subsidiary is relatively new, unrated, or not of a significant size, relative to the ceding company. Liabilities supported by the treaty guarantees, before consideration for any legally offsetting amounts due from the guaranteed party are reflected on the Company’s consolidated balance sheets in a policy related liability. Potential guaranteed amounts of future payments will vary depending on production levels and underwriting results. Guarantees related to securities borrowing and repurchase arrangements provide additional security to third parties should a subsidiary fail to provide securities when due. RGA’s guarantees issued as of December 31, 2018 and 2017 are reflected in the following table (dollars in thousands):
The Company’s long-term debt consists of the following as of December 31, 2018 and 2017 (dollars in thousands):
RGA has entered into an interest rate swap on its Variable Rate Junior Subordinated Debentures that effectively fixes the interest rate on these securities at 4.82% until December 2037.
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, maximum ratios of debt to capitalization and change of control provisions. 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 an amount in excess of the amounts set forth in those agreements, bankruptcy proceedings, or any other event that results in the acceleration of the maturity of indebtedness. As of December 31, 2018 and 2017, the Company had $2,806.5 million and $2,808.8 million, respectively, in outstanding borrowings under its debt agreements and was in compliance with all covenants under those agreements. As of December 31, 2018 and 2017, the average interest rate on long-term debt outstanding was 5.24%.
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. Future principal payments due on long-term debt, excluding discounts, as of December 31, 2018, were as follows (dollars in thousands):
The Company maintains eight committed credit facilities, a syndicated revolving credit facility with a capacity of $850.0 million and seven letter of credit facilities with a combined capacity of $1,260.3 million. The Company may borrow cash and obtain letters of credit in multiple currencies under its syndicated revolving credit facility. The following table provides additional information on the Company’s existing committed credit facilities as of December 31, 2018 and 2017 (dollars in thousands):
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. Total fees expensed associated with the Company’s letters of credit were $9.7 million, $10.5 million and $7.9 million for the years ended December 31, 2018, 2017 and 2016, respectively, and are included in policy acquisition costs and other insurance expenses.
In 2006, RGA’s subsidiary, Timberlake Financial L.L.C. (“Timberlake Financial”), issued $850.0 million of Series A Floating Rate Insured Notes, due June 2036, in a private placement. The notes were issued to fund the collateral requirements for statutory reserves required by Regulation XXX on specified term life insurance policies reinsured by RGA Reinsurance and retroceded to Timberlake Re. Proceeds from the notes, along with a $112.8 million direct investment by RGA, were deposited into a series of accounts that collateralize the notes and are not available to satisfy the general obligations of the Company. As of December 31, 2018 and 2017, respectively, the Company held assets in trust and in custody of $767.9 million and $841.5 million, of which $57.1 million and $39.7 million were held in a Debt Service Coverage account to cover interest payments on the notes. Interest on the notes accrues at an annual rate of 1-month LIBOR plus a base rate margin, payable monthly, and totaled $9.4 million, $6.4 million and $4.2 million in 2018, 2017 and 2016, respectively.
In 2014, RGA’s subsidiary, Chesterfield Financial Holdings LLC, (“Chesterfield Financial”), issued $300.0 million of asset-backed notes due December 2024 in a private placement. The notes were issued as part of an embedded value securitization transaction covering a closed block of policies assumed by RGA Reinsurance and retroceded to Chesterfield Re. Proceeds from the notes, along with a direct investment by the Company, were applied by Chesterfield Financial to (i) pay certain transaction-related expenses, (ii) establish a reserve account owned by Chesterfield Financial and pledged to the indenture trustee for the benefit of the holders of the notes (primarily to cover interest payments on the notes), and (iii) to fund an initial stock purchase from and capital contribution to Chesterfield Re to capitalize Chesterfield Re and to finance the payment of a ceding commission by Chesterfield Re to RGA Reinsurance under the retrocession agreement. As of December 31, 2018 and 2017, the Company held deposits in trust of $13.5 million and $19.4 million, respectively, to cover interest payments on the notes, which are not available to satisfy the general obligations of the Company. Interest on the notes accrues at an annual rate of 4.50%, payable quarterly, and totaled $9.5 million, $11.3 million and $13.1 million in 2018, 2017 and 2016, respectively. The notes represent senior, secured indebtedness of Chesterfield Financial. Limited support is provided by RGA for temporary potential liquidity events at Chesterfield Financial and for temporary potential statutory capital and surplus events at Chesterfield Re. Otherwise, there is no legal recourse to RGA or its other subsidiaries. The notes are not insured or guaranteed by any other person or entity.
The Canada Traditional segment is primarily engaged in individual life reinsurance, and to a lesser extent creditor, group life and health, critical illness and disability reinsurance, through yearly renewable term and coinsurance agreements. The Canada Financial Solutions segment concentrates on assisting clients with longevity risk transfer structures within underlying annuities and pension benefit obligations, and on assisting clients in meeting applicable regulatory requirements while enhancing their financial strength and regulatory surplus position through financial reinsurance structures.
The Asia Pacific Traditional segment provides individual and group life and health reinsurance, critical illness coverage, disability and superannuation through yearly renewable term and coinsurance agreements. The Asia Pacific Financial Solutions segment provides financial reinsurance, asset-intensive and certain disability and life blocks.
The accounting policies of the segments are the same as those described in Note 2 - “Significant Accounting Policies and Pronouncements.” 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.
The Company uses several actuarial methods to compute incurred-but-not reported liabilities. These methods use historical claim reporting patterns to develop a triangle of reported claim amounts. The claim triangle is then used to develop the ultimate claims amount and the incurred-but-not reported liabilities. Expected claim methods use exposure data such as premiums to develop the ultimate claim amount. The final method blends the estimates from the development and the expected claim methods. There were no significant changes in methodologies during 2018.
The following is unaudited supplementary information about average historical claims duration as of December 31, 2018:
Reconciliation of the Disclosure of Incurred and Paid Claims Development to the Liability for Unpaid Claims and Claims Adjustment Expenses
The reconciliation of the net incurred and paid claims development tables to the liability for claims and claim adjustment expense in the consolidated balance sheet as of December 31, 2018 is as follows (dollars in thousands):
During 2017, RGA’s board of directors authorized and amended a share repurchase program, with no expiration date, to repurchase up to $400.0 million of RGA’s outstanding common stock. In connection with this authorization, the board of directors terminated all previously announced repurchase authorizations. The following table summarizes the Company’s current share repurchase program activity for the years ended 2018 and 2017 (dollar amounts in thousands, except per share amounts):
The following table presents the amounts of AOCI reclassifications for the years ended December 31, 2018 and 2017 (dollars in thousands):
Equity-based compensation expense of $30.1 million, $22.3 million, and $33.1 million related to grants or awards under the Stock Plans was recognized in 2018, 2017 and 2016, respectively. Equity-based compensation expense is principally related to the issuance of stock options, performance contingent restricted units, stock appreciation rights and restricted stock.
As of December 31, 2018, the total compensation cost of non-vested awards not yet recognized in the financial statements was $24.7 million. It is estimated that these costs will vest over a weighted average period of 1.4 years.
On January 24, 2019, RGA’s board of directors authorized a share repurchase program for up to $400.0 million of RGA’s outstanding common stock. The authorization was effective immediately and does not have an expiration date. Repurchases would be made in accordance with applicable securities laws and would be made through market transactions, block trades, privately negotiated transactions or other means or a combination of these methods, with the timing and number of shares repurchased dependent on a variety of factors, including share price, corporate and regulatory requirements and market and business conditions. Repurchases may be commenced or suspended from time to time without prior notice. In connection with this new authorization, the board of directors terminated the stock repurchase authority granted in 2017.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2018, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2019 expressed an unqualified opinion on the Company's internal control over financial reporting.