Most of the Company’s leases in the U.S. and other countries have lease terms of three to five years, although 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 $19.3 million for 2014.
Numerous important factors could cause actual results and events to differ materially from those expressed or implied by forward-looking statements including, without limitation, (1) adverse capital and credit market conditions and their impact on the Company’s liquidity, access to capital and cost of capital, (2) the impairment of other financial institutions and its effect on the Company’s business, (3) requirements to post collateral or make payments due to declines in market value of assets subject to the Company’s collateral arrangements, (4) the fact that the determination of allowances and impairments taken on the Company’s investments is highly subjective, (5) adverse changes in mortality, morbidity, lapsation or claims experience, (6) changes in the Company’s financial strength and credit ratings and the effect of such changes on the Company’s future results of operations and financial condition, (7) inadequate risk analysis and underwriting, (8) general economic conditions or a prolonged economic downturn affecting the demand for insurance and reinsurance in the Company’s current and planned markets, (9) the availability and cost of collateral necessary for regulatory reserves and capital, (10) market or economic conditions that adversely affect the value of the Company’s investment securities or result in the impairment of all or a portion of the value of certain of the Company’s investment securities, that in turn could affect regulatory capital, (11) market or economic conditions that adversely affect the Company’s ability to make timely sales of investment securities, (12) risks inherent in the Company’s risk management and investment strategy, including changes in investment portfolio yields due to interest rate or credit quality changes, (13) fluctuations in U.S. or foreign currency exchange rates, interest rates, or securities and real estate markets, (14) adverse litigation or arbitration results, (15) the adequacy of reserves, resources and accurate information relating to settlements, awards and terminated and discontinued lines of business, (16) the stability of and actions by governments and economies in the markets in which the Company operates, including ongoing uncertainties regarding the amount of United States sovereign debt and the credit ratings thereof, (17) competitive factors and competitors’ responses to the Company’s initiatives, (18) the success of the Company’s clients, (19) successful execution of the Company’s entry into new markets, (20) successful development and introduction of new products and distribution opportunities, (21) the Company’s ability to successfully integrate acquired blocks of business and entities, (22) action by regulators who have authority over the Company’s reinsurance operations in the jurisdictions in which it operates, (23) the Company’s dependence on third parties, including those insurance companies and reinsurers to which the Company cedes some reinsurance, third-party investment managers and others, (24) the threat of natural disasters, catastrophes, terrorist attacks, epidemics or pandemics anywhere in the world where the Company or its clients do business, (25) interruption or failure of the Company's telecommunication, information technology or other operational systems, or the Company's failure to maintain adequate security to protect the confidentiality or privacy of personal or sensitive data stored on such systems, (26)changes in laws, regulations, and accounting standards applicable to the Company, its subsidiaries, or its business, (27) the effect of the Company’s status as an insurance holding company and regulatory restrictions on its ability to pay principal of and interest on its debt obligations, and (28) other risks and uncertainties described in this document and in the Company’s other filings with the Securities and Exchange Commission (“SEC”).
The Company provides traditional and non-traditional reinsurance to its clients. Traditional reinsurance includes individual and group life and health, disability, and critical illness reinsurance. Non-traditional reinsurance includes longevity reinsurance, asset-intensive reinsurance, and financial reinsurance.
The Company is one of the leading life reinsurers in North America based on premiums and the amount of life reinsurance in force. Based on an industry survey of 2013 information prepared by Munich American at the request of the Society of Actuaries Reinsurance Section (“SOA survey”), the Company has the third largest market share in North America as measured by individual life insurance in force. The Company’s approach to the North American market has been to:
Facultative Reinsurance. Based on discussions with the Company’s clients, an industry survey and informal knowledge about the industry, the Company believes it is a leader in facultative underwriting in North America. The Company intends to maintain that status by emphasizing its underwriting standards, prompt response on quotes, competitive pricing, capacity, value added services and flexibility in meeting customer needs. The Company believes its facultative business has allowed it to develop close, long-standing client relationships and generate additional business opportunities with its facultative clients. The Company has processed over 300,000 facultative submissions annually since 2011.
2) Continue Expansion Into Selected Markets and Products. The Company’s strategy includes building upon the expertise and relationships developed in its North American business platform to continue its expansion into selected markets and products, including:
International Markets. Management believes that international markets offer opportunities for long-term growth, and the Company intends to capitalize on these opportunities by establishing a presence in selected markets. Since 1994, the Company has entered new markets internationally, including, in the mid-to-late 1990’s, 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 a provisional branch license in 2013, 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. Before entering new markets, the Company evaluates several factors including:
Asset-intensive and Longevity Reinsurance and Other Products. The Company intends to continue leveraging its existing client relationships and reinsurance expertise to create customized reinsurance products and solutions. Industry trends, particularly the increased pace of consolidation and reorganization among life insurance companies and changes in products and product distribution, are expected to enhance existing opportunities for asset-intensive and longevity reinsurance and other products. The Company began reinsuring annuities with guaranteed minimum benefits on a limited basis in 2007. To date, most of the Company’s asset-intensive reinsurance business has been written in the U.S.; however, the Company believes opportunities outside of the U.S. may further develop in the near future, particularly in Asian markets with emerging economies and growing insurance demands. The Company also provides longevity reinsurance in Europe and Canada, and in 2008 entered the U.S. healthcare reinsurance market with a primary focus on long-term care and Medicare supplement insurance. In 2010, the Company expanded into the group reinsurance market in North America with the acquisition of Reliastar Life Insurance Company’s U.S. and Canada operations.
Consolidated net income increased $265.2 million, or 63.3%, and decreased $213.1 million, or 33.7%, in 2014 and 2013, respectively. Diluted earnings per share on net income were $9.78 in 2014 compared to $5.78 in 2013 and $8.52 in 2012. The increase in net income in 2014 is mainly attributable to the Asia Pacific segment's transition from a loss before income taxes of $226.7 million in 2013, to income before income taxes of $102.3 million in 2014. The loss in the Asia Pacific segment during 2013 reflects an increase in Australian group claims liabilities primarily related to total and permanent disability coverage and disability income benefits as well as poor claims experience in the Australian operation’s individual lump sum and individual disability businesses, primarily in the second quarter of 2013.
In addition, the increase in net income in 2014 reflects higher premiums and increases in both investment related gains and other revenues. The increase in other revenues in 2014 is primarily due to fee income on financial reinsurance transactions in addition to recapture fees and reinstatement fees recognized in the Asia Pacific segment, offset somewhat by the recognition in other revenues of gains on the repurchase of collateral finance securities of $46.5 million in 2013.
Net income in 2014 benefited from the release of liabilities established for uncertain tax positions due to the closure with the U.S. Internal Revenue Service of tax returns for a recent five-year period. As a result of that release and other adjustments, the provision for income taxes in 2014 was reduced and accrued interest expense of approximately $43.9 million was reversed. The effect of recognizing the closure of these tax years and other adjustments increased net income by $33.0 million. Additionally, the U.S. Congress retroactively extended the active financing exception legislation during 2014, which further reduced the provision for income taxes by $5.5 million. The Company's effective tax rate was 32.2% in 2014 compared to 34.1% in 2013.
The change in the Company’s liability for variable annuities associated with guaranteed minimum living benefits affects the amount of unrealized gains and losses the Company recognizes. The unrealized gains and losses associated with guaranteed minimum living benefits, after adjustment for deferred acquisition costs, decreased net income by $42.5 million in 2014 and increased it by $63.8 million in 2013, respectively, as compared to the prior years.
Consolidated net premiums increased $415.8 million, or 5.0%, and $347.4 million, or 4.4%, in 2014 and 2013, respectively, due to growth in life reinsurance in force, before the effect of foreign currency fluctuations. Foreign currency fluctuations relative to the prior year affected net premiums unfavorably by approximately $111.2 million and $142.0 million in 2014 and 2013, respectively. Consolidated assumed life insurance in force was $2,943.5 billion, $2,889.9 billion and $2,927.6 billion as of December 31, 2014, 2013 and 2012, respectively. Foreign currency fluctuations affected the increases in assumed life insurance in force unfavorably by $121.4 billion and $86.7 billion in 2014 and 2013, respectively. The Company added new business production, measured by face amount of insurance in force, of $482.0 billion, $370.4 billion and $426.6 billion during 2014, 2013 and 2012, respectively. Premiums on U.S. and Latin America health and group reinsurance contributed $120.0 million and $101.4 million to the increase in net premiums in 2014 and 2013, respectively.
The consolidated provision for income taxes represents 32.2%, 34.1% and 31.3%, of pre-tax income for 2014, 2013 and 2012, respectively. The effective tax rate for 2014 was affected by earnings of non-U.S. subsidiaries in which the Company is permanently reinvested, the statutory tax rates of which are less than the U.S. statutory tax rate of 35.0%; the tax expense for uncertain tax positions in 2014; the tax benefit for the release of tax liabilities as a result of the expiration of the statute of limitations for prior years; and the differences in tax bases in foreign jurisdictions. The effective tax rates for 2013 and 2012 were affected by the earnings of non-U.S. subsidiaries in which the Company is permanently reinvested, the statutory tax rates of which are less than the U.S. statutory rate of 35.0%; Subpart F income; tax expense related to uncertain tax positions; and differences in tax bases in foreign jurisdictions. Both Canada and Australia statutory rates of approximately 27% and 30% (blended federal and provincial in Canada), respectively, are less than the U.S. statutory rate resulting in the legal entities in these jurisdictions giving rise to the majority of the foreign rate differential in 2014, 2013 and 2012. In 2014 the income earned in the UK also contributed to the reduction to the rate.
Differences in experience compared with the assumptions and estimates utilized in establishing premiums receivable, the justification of the recoverability of DAC, in establishing reserves for future policy benefits and claim liabilities, or in the determination of other-than-temporary impairments to investment securities can have a material effect on the Company’s results of operations and financial condition.
Premiums are accrued when due and in accordance with information received from the ceding company. When the Company enters into a new reinsurance agreement, it records accruals based on the terms of the reinsurance treaty. Similarly, when a ceding company fails to report information on a timely basis, the Company records accruals based on the terms of the reinsurance treaty as well as historical experience. Other management estimates include adjustments for increased in force on existing treaties, lapsed premiums given historical experience, the financial health of specific ceding companies, collateral value and the legal right
The decrease in income before income taxes in 2013 can be largely attributed to the Asset-Intensive line of business. The decrease is primarily the result of a decrease in investment related gains (losses), net due to the significant amount of investment related gains recognized in 2012 associated with the portfolio restructure of a new fixed annuity transaction. In addition, rising interest rates during the year reduced the fair value of embedded derivatives associated with treaties written on a modco or funds withheld basis. These decreases were slightly offset by strong performance of the aforementioned fixed annuity transaction that was entered into during 2012 and the strong equity market performance in 2013. In addition, continued growth in Financial Reinsurance business also offset some of the negative variance in 2013, with an increase in income of approximately $12.6 million, or 38.4%.
Net premiums increased $162.0 million, or 3.6%, and $220.7 million, or 5.1% in 2014 and 2013, respectively. These increases in net premiums were driven primarily by the growth in individual life business in force and health and group reinsurance. Offsetting the growth somewhat in 2014 was a large retrocession transaction completed during the fourth quarter which reduced U.S. Traditional premiums by approximately $130.0 million. The segment added new life business production, measured by face amount of insurance in force, of $176.9 billion, $95.6 billion and $156.3 billion during 2014, 2013 and 2012, respectively. Contributing to the increase in 2014 was a large in force block transaction of $101.9 billion. Similarly 2012 includes a large in force transaction of $42.4 billion. Total face amount of life business in force was $1,483.9 billion, $1,397.0 billion and $1,401.8 billion as of December 31, 2014, 2013 and 2012, respectively. Premiums on health and group reinsurance contributed $120.0 million and $101.4 million to the increase in net premiums in 2014 and 2013, respectively.
Interest credited expense decreased $2.1 million, or 3.9%, and $2.4 million, or 4.3%, in 2014 and 2013, respectively. The variances in interest credited expense are largely offset by variances in investment income. The decreases in both 2014 and 2013 can be attributed to one treaty in which the most prevalent credited loan rate decreased, partially offset by a slight increase in its asset base. 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 13.6%, 13.7% and 13.8% in 2014, 2013 and 2012, respectively. Overall, while these ratios are expected to remain in a predictable range, they may fluctuate from period to period due to varying allowance levels within coinsurance-type arrangements. In addition, the amortization pattern of previously capitalized amounts, which are subject to the form of the reinsurance agreement and the underlying insurance policies, may vary. Also, the mix of first year coinsurance business versus yearly renewable term business can cause the percentage to fluctuate from period to period. In recent years, the mix of business has been premiums weighted toward yearly renewable term which has contributed to relatively stable rates.
Embedded Derivatives - Modco/Funds Withheld Treaties - Represents the change in the fair value of embedded derivatives on funds withheld at interest associated with treaties written on a modco or funds withheld basis. The fair value changes of embedded derivatives on funds withheld at interest associated with treaties written on a modco or funds withheld basis are reflected in revenues, while the related impact on deferred acquisition expenses is reflected in benefits and expenses. Changes in fair values of these embedded derivatives are net of a decrease in revenues of $1.6 million, $1.6 million and $62.7 million for the years ended December 31, 2014, 2013 and 2012, respectively, associated with a CVA. A 10% increase in the CVA would have decreased revenues in 2014 by approximately $0.1 million. Conversely, a 10% decrease in the CVA would have increased revenues in 2014 by approximately $0.1million.
Guaranteed Minimum Benefit Riders - Represents the impact related to guaranteed minimum benefits associated with the Company’s reinsurance of variable annuities. The fair value changes of the guaranteed minimum benefits along with the changes in fair value of the free standing derivatives (interest rate swaps, financial futures and equity options), purchased by the Company to substantially hedge the liability are reflected in revenues, while the related impact on deferred acquisition expenses is reflected in benefits and expenses. Changes in fair values of these embedded derivatives are net of an increase (decrease) in revenues of $1.6 million, $(12.5) million and $16.5 million in 2014, 2013 and 2012, respectively, associated with a CVA. A 10% increase in the CVA would have increased revenues by approximately $0.6 million in 2014. Conversely, a 10% decrease in the CVA would have decreased revenues by approximately $(0.6) million in 2014.
The change in fair value of the guaranteed minimum benefits, after allowing for changes in the associated free standing derivatives, decreased income before income taxes by $14.1 million and $32.8 million in 2014 and 2013, respectively, as compared to the prior years. The decrease in income in 2014 was due to less favorable equity markets, declining interest rates, increases in implied equity volatility, and the effect of updated fair value assumptions, partially offset by a reduced effect from the CVA. The decrease in income in 2013 was due to rising interest rates partially offset by the CVA and volatility.
Revenue before certain derivatives decreased by $88.7 million and increased by $186.3 million in 2014 and 2013, respectively. The decrease in 2014 was primarily due to a market value decrease in equity options held in the segment’s funds withheld at interest investment associated with the reinsurance of certain EIAs. Conversely, the increase in 2013 was primarily due to a market value increase related to the segment’s funds withheld at interest investment associated with the reinsurance of certain EIAs. The effect on investment income related to equity options is substantially offset by a corresponding change in interest credited expense.
Benefits and expenses before certain derivatives decreased by $140.2 million and increased by $210.1 million in 2014 and 2013, respectively. The decrease in 2014 was primarily due to a market value decrease related to the segment’s funds withheld at interest investment associated with the reinsurance of certain EIAs. Conversely, the increase in 2013 was primarily due to a market value increase in equity options held in the segment’s funds withheld at interest investment associated with the reinsurance of certain EIAs. The effect on interest credited related to equity options is substantially offset by a corresponding change in investment income. Additionally, 2014 reflects a decrease in deferred acquisition expenses related to investment related gains and losses associated with funds withheld and coinsurance portfolios.
Income before income taxes increased by $7.0 million, or 15.4%, and $12.6 million, or 38.4%, in 2014 and 2013, respectively. The increases in 2014 and 2013 were primarily related to the addition of new contracts and related additional fees from financial reinsurance.
The Company conducts reinsurance business in Canada primarily through RGA Canada, a wholly-owned subsidiary. RGA Canada assists clients with capital management activity and mortality and morbidity risk management, and is primarily engaged in traditional individual life reinsurance, as well as creditor, group life and health, critical illness, and longevity reinsurance. Creditor insurance covers the outstanding balance on personal, mortgage or commercial loans in the event of death, disability or critical illness and is generally shorter in duration than traditional life insurance.
Income before income taxes decreased by $62.6 million, or 38.1%, and $22.7 million, or 12.1%, in 2014 and 2013, respectively. The decrease in income in 2014 was primarily due to unfavorable traditional individual life mortality experience compared to the prior year and a decline of $12.5 million in net investment related gains. The decrease in 2013 is due to better traditional individual life mortality experience in the prior year and a decrease of $10.6 million in net investment related gains. In addition, 2012 income before income taxes reflected the impact of a decrease in reserves of $16.2 million for a block of group creditor business as a result of a refinement of estimates and $6.3 million of income from the recapture of a previously assumed block of individual life business. Foreign currency exchange fluctuation in the Canadian dollar resulted in a decrease in income before income taxes of approximately $8.0 million and $6.1 million in 2014 and 2013, respectively.
Net premiums increased $12.3 million, or 1.3%, and $46.5 million, or 5.1%, in 2014 and 2013, respectively. Foreign currency exchange fluctuation in the Canadian dollar resulted in a decrease in net premiums of approximately $70.3 million and $29.4 million in 2014 and 2013, respectively. Ignoring foreign currency exchange, premiums increased 8.6% and 8.4% in 2014 and 2013, respectively, primarily due to new business from both new and existing treaties. In addition, creditor premiums increased by $34.6 million and $10.1 million in 2014 and 2013, respectively. The segment added new business production, measured by face amount of insurance in force, of $48.3 billion, $46.0 billion and $49.0 billion during 2014, 2013 and 2012, respectively. The face amount of total reinsurance in force totaled approximately $402.8 billion, $386.3 billion, and $389.7 billion at December 31, 2014, 2013 and 2012, respectively. Excluding the impact of foreign exchange, reinsurance in force increased 6.6% in 2014. Premium 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.
Loss ratios for this segment were 82.6%, 78.8% and 77.2% in 2014, 2013 and 2012, respectively. The increase in the loss ratio for 2014 compared to 2013 is due to unfavorable traditional individual life mortality, primarily due to an increase in the number of large claims. The increase in the loss ratio for 2013 compared to 2012 is due to better traditional individual life mortality experience in 2012. Loss ratios for the traditional individual life mortality business were 99.6%, 93.7% and 91.8% in 2014, 2013 and 2012, respectively. Historically, the loss ratio increased 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. Excluding creditor business, claims and other policy benefits, as a percentage of net premiums and investment income were 78.0%, 72.6% and 71.8% in 2014, 2013 and 2012, respectively.
Income before income taxes increased by $87.1 million, or 116.8%, and $13.5 million, or 22.0%, in 2014 and 2013, respectively. The increase in income before income taxes in 2014 was primarily due to increased business volumes, most notably in payout annuity and fee income treaties. In addition, investment related gains increased $29.7 million in 2014 largely due to asset repositioning related to a payout annuity reinsurance transaction executed during the year. The increase in income before income taxes in 2013 was primarily due to increased business volumes, most notably in fee income treaties, partially offset by unfavorable claims experience. Foreign currency exchange fluctuations contributed to an increase in income before income taxes of approximately $5.1 million and a decrease of approximately $1.8 million in 2014 and 2013, respectively.
A portion of the net premiums for the segment, in each period presented, relates to reinsurance of critical illness coverage, primarily in the UK. This coverage provides a benefit in the event of the diagnosis of a pre-defined critical illness. Net premiums earned from this coverage totaled $257.7 million, $254.4 million and $247.5 million in 2014, 2013 and 2012, respectively.
Net investment income increased $55.1 million, or 105.9%, and $9.5 million, or 22.3%, in 2014 and 2013, respectively. The increase in 2014 can be primarily attributed to growth in the average invested asset base, primarily due to two large in force payout annuity treaties executed during 2014, partially offset by a decrease in investment yield. The increase in 2013 can be primarily attributed to growth in the average invested asset base and to a lesser extent, an increase in the investment yield. The average asset base was $3,615.9 million, $1,528.6 million and $1,312.3 million in 2014, 2013 and 2012, respectively. Investment income and investment related gains and losses are allocated to the various operating segments based on average assets and related capital levels deemed appropriate to support segment operations. Investment performance varies with the composition of investments and the relative allocation of capital to the operating segments.
Other revenues increased by $14.8 million, or 63.5% and $17.0 million, or 272.1%, in 2014 and 2013, respectively. The increases in other revenues in 2014 and 2013 relates to an increased number of fee income treaties. At December 31, 2014 and 2013, the amount of reinsurance assumed from client companies, as measured by pre-tax statutory surplus, risk based capital and other financial reinsurance structures was $0.9 billion and $1.0 billion, 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.
Loss ratios for this segment were 87.5%, 87.4% and 86.8% in 2014, 2013 and 2012, respectively. The increases in the loss ratios in 2014 and 2013 were due to changes in business mix over time and variability in claims experience, primarily from UK critical illness and mortality reinsurance. Although reasonably predictable over a period of years, claims experience is typically volatile over shorter periods. Management views recent experience as normal volatility that is inherent in the business.
Policy acquisition costs and other insurance expenses as a percentage of net premiums were 4.0%, 4.3% and 4.3% for 2014, 2013 and 2012, respectively. These percentages fluctuate due to timing of client company reporting, variations in the mixture of business and the relative maturity of the business. In addition, as the segment grows, renewal premiums, which have lower allowances than first-year premiums, represent a greater percentage of the total net premiums.
Income before income taxes increased by $329.0 million, or 145.1%, and decreased by $278.6 million, or 536.1%, in 2014 and 2013, respectively. The increase in income before income taxes in 2014 is mainly attributable to Australia's transition from a loss before income taxes of $291.6 million in 2013, to income before income taxes of $10.0 million in 2014, in addition to positive results throughout the remainder of the segment. The decrease in income before income taxes in 2013 is primarily due to a $274.1 million increase in Australian group claims liabilities related to total and permanent disability coverage and disability income benefits occurring in the second quarter of 2013, as well as poor claims experience in the Australian operation's individual disability business. Other operations in this segment reported results for 2013 in line with management's expectations. In total, the Australia operation reported a loss before income taxes of $291.6 million in 2013, while the other operations in this segment reported income before income taxes of $64.9 million for the same period. Foreign currency exchange fluctuations contributed to a decrease in income before income taxes of approximately $8.4 million in 2014 and an increase of approximately $6.9 million in 2013.
Net premiums increased by $89.7 million, or 6.0%, and $75.6 million, or 5.4%, in 2014 and 2013, respectively. The increase in premiums for 2014 was driven by both new and existing business written throughout the segment. Premiums in 2013 increased mainly in Hong Kong and South East Asia, and Australia with new treaties and growth in existing treaties, partially offset by a decrease in premiums in South Korea. The segment added new business production, measured by face amount of insurance in force, of $81.6 billion, $122.6 billion and $126.9 billion during 2014, 2013 and 2012, respectively. The face amount of reinsurance in force totaled approximately $494.3 billion, $547.7 billion, and $600.4 billion at December 31, 2014, 2013 and 2012, respectively. Foreign currency fluctuations unfavorably affected the face amount of reinsurance in force by $38.6 billion and $66.9 billion in 2014 and 2013, respectively. Foreign currency exchange fluctuations contributed to a decrease in net premiums of approximately $69.3 million and $88.5 million in 2014 and 2013, respectively. Premium levels can be significantly influenced by currency fluctuations, large transactions and reporting practices of ceding companies and, therefore, can fluctuate from period to period.
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 and Hong Kong. Net premiums from this coverage totaled $275.7 million, $247.6 million, and $225.3 million in 2014, 2013 and 2012, respectively.
Net investment income increased $8.1 million, or 8.6%, and $8.8 million, or 10.2%, in 2014 and 2013, respectively. The increase in 2014 can be primarily attributed to growth in the invested asset base. The increase in 2013 can be primarily attributed to growth in the average invested asset base and an increase in the investment yield. The average asset base was $2,485.3 million, $2,228.9 million and $2,141.3 million in 2014, 2013 and 2012, respectively. Investment income and investment related gains and losses are allocated to the various operating segments based on average assets and related capital levels deemed appropriate to support segment operations. Investment performance varies with the composition of investments and the relative allocation of capital to the operating segments.
Other revenues increased by $44.3 million, or 121.1%, and decreased by $16.3 million, or 30.8%, in 2014 and 2013, respectively. The increase in other revenues in 2014 is primarily due to a recapture fee associated with an individual lump sum treaty in Australia along with fees associated with the reinstatement and conversion of an existing treaty in Japan. The decrease in other revenues in 2013 relates to a reduction in the amount of financial reinsurance assumed and a transaction with a client in Australia which resulted in a one-time fee of $12.2 million recognized in 2012. The transaction did not have a significant impact on income before taxes because the amount was offset by additional amortization of deferred acquisition costs, net of the release of reserves. At December 31, 2014 and 2013, the amount of reinsurance assumed from client companies, as measured by pre-tax statutory surplus, risk based capital and other financial reinsurance structures was $1.2 billion and $1.5 billion, respectively. The decrease was primarily due to several financial reinsurance agreements, which are performing as expected, where the amount of reinsurance assumed from the client decreases over time. 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.
The largest portion of the Australian liability increase in 2013 relates to group total and permanent disability coverage, and to a lesser extent, group disability income benefits. The Company completed a comprehensive claims analysis in the second quarter of 2013 that indicated an increase in claim incidences as well as an increase in claim lags throughout the claim reporting process. Even though these group contracts are typically only three years in duration, the increase in developing loss ratios, compared to pricing, created the need for a significant increase in claims liabilities. The additional liabilities recorded reflect potential additional deterioration in the projection of future claims development. The Company believes a number of factors in the current Australian market have led to a significant rise in claim levels and reporting lags, and the Company continues working with the ceding companies to better manage this business. In 2013, the Company suspended new quoting activity in the Australian group total and permanent disability market indefinitely, however the Company is required to provide renewal quotes in some instances.
Other operating expenses increased $16.5 million, or 13.1%, and $5.4 million, or 4.5%, in 2014 and 2013, respectively. The 2014 increase in other operating expenses is primarily due to increased information and technology expense and compensation related costs. Foreign currency exchange fluctuations resulted in a decrease in operating expenses of approximately $2.8 million and $4.6 million in 2014 and 2013, respectively. Other operating expenses as a percentage of net premiums totaled 9.0%, 8.5% and 8.5% in 2014, 2013 and 2012, 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.
Total benefits and expenses decreased by $17.1 million or 12.3%, and increased by $5.5 million or 4.1%, in 2014 and 2013, respectively. The decrease in total benefits and expenses in 2014 was largely due to a decrease in interest expense of $27.6 million primarily from the reversal of accrued interest related to uncertain tax positions, slightly offset by an increase in other operating expenses of $18.7 million primarily related to compensation, consulting expense and various corporate initiatives. The increase in total benefits and expenses in 2013 was primarily due to an increase in interest expense of $19.0 million, as a result of a higher level of outstanding debt, and an increase in other operating expenses of $9.6 million primarily relating to employee compensation. These expense increases were largely offset by a $22.1 million decrease in policy acquisition costs and other insurance income primarily related to the offset to capital charges allocated to the operating segments.
The Company periodically reviews the EGP valuation model and assumptions so that the assumptions reflect best estimates of future experience. Two assumptions are considered to be most significant: (1) estimated interest spread, and (2) estimated future policy lapses. The following table reflects the possible change that would occur in a given year if assumptions, as a percentage of current deferred policy acquisition costs related to asset-intensive products ($690.7 million as of December 31, 2014), are changed as illustrated:
As of December 31, 2014, 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 current interest rate environment in select markets, primarily the U.S., continues to negatively affect the Company’s earnings. The Company’s average investment yield, excluding spread related business, continues to be below 5.00%, with only slight movement since 2012. In addition, the Company’s insurance liabilities, in particular its annuity products, are sensitive to changing market factors. However, results of operations in 2014 and 2013 reflect favorable changes in the value of embedded derivatives as credit spreads in the U.S. markets continue to tighten. Gross unrealized gains on fixed maturity and equity securities available-for-sale increased substantially in 2014, while gross unrealized losses decreased, reflecting the low interest rate environment and tightening credit spreads. Gross unrealized gains on fixed maturity and equity securities available-for-sale were $2,516.6 million and $1,524.3 million at December 31, 2014 and 2013, respectively. Gross unrealized losses totaled $134.9 million and $324.6 million at December 31, 2014 and 2013, respectively.
The Company continues to be in a position to hold any investment security showing an unrealized loss until recovery, provided it remains comfortable with the credit of the issuer. As indicated above, gross unrealized gains on investment securities of $2,516.6 million remain well in excess of gross unrealized losses of $134.9 million as of December 31, 2014. Historically low interest rates continued to put pressure on the Company’s investment yield. The Company does not rely on short-term funding or commercial paper and to date it has experienced no liquidity pressure, nor does it anticipate such pressure in the foreseeable future.
RGA is an insurance holding company whose primary uses of liquidity include, but are not limited to, the immediate capital needs of its operating companies, dividends paid to its shareholders, repurchase of common stock and interest payments on its indebtedness. RGA recognized interest expense of $131.9 million, $162.2 million and $143.3 million in 2014, 2013 and 2012, respectively. RGA made capital contributions to subsidiaries of $222.8 million, $144.5 million and $70.4 million in 2014, 2013 and 2012, respectively. Dividends to shareholders were $87.3 million, $77.6 million and $61.9 million in 2014, 2013 and 2012, respectively. RGA paid $201.5 million, $269.2 million and $6.9 million for the repurchase of common stock in 2014, 2013 and 2012, respectively. The primary sources of RGA’s liquidity include proceeds from its capital raising efforts, interest income on undeployed corporate investments, interest income received on surplus notes with RGA Reinsurance, RCM and Rockwood Re and dividends from operating subsidiaries. RGA recognized interest and dividend income of $521.6 million, $275.2 million and $86.4 million in 2014, 2013 and 2012, respectively. Net proceeds from unaffiliated long-term debt issuance were $395.1 million and $393.7 million in 2013 and 2012, respectively. As the Company continues its expansion efforts, RGA will continue to be dependent upon these sources of liquidity. As of December 31, 2014 and 2013, RGA held $623.4 million and $788.4 million, respectively, of cash and cash equivalents, short-term and other investments and fixed maturity investments. See “Part IV - Item 15(a)(2) Financial Statement Schedules - Schedule II - Condensed Financial Information of Registrant” for more information regarding RGA’s financial information.
RGA established an intercompany revolving credit facility where certain subsidiaries can lend to or borrow from each other and from RGA in order to manage capital and liquidity more efficiently. The intercompany revolving credit facility, which is a series of demand loans among RGA and its affiliates, is permitted under applicable insurance laws. This facility reduces overall borrowing costs by allowing RGA and its operating companies to access internal cash resources instead of incurring third-party transaction costs. The statutory borrowing and lending limit for RGA’s Missouri-domiciled insurance subsidiaries is currently 3% of the insurance company’s admitted assets as of its most recent year-end. There was $35.0 million and $50.0 million outstanding under the intercompany revolving credit facility as of December 31, 2014 and 2013, respectively. In addition to loans associated with the intercompany revolving credit facility, RGA and its subsidiary, RGA Capital LLC, provided loans to RGA Australian
The Company believes that it has sufficient liquidity for the next 12 months to fund its cash needs under various scenarios that include the potential risk of early recapture of reinsurance treaties and higher than expected death claims. Historically, the Company has generated positive net cash flows from operations. However, in the event of significant unanticipated cash requirements beyond normal liquidity, the Company has multiple liquidity alternatives available based on market conditions and the amount and timing of the liquidity need. These options include borrowings under committed credit facilities, secured borrowings, the ability to issue long-term debt, preferred securities or common equity and, if necessary, the sale of invested assets, subject to market conditions.
RGA declared dividends totaling $1.26 per share in 2014. 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.
In February 2014, RGA’s board of directors authorized a share repurchase program, with no expiration date, to repurchase up to $300.0 million of RGA’s outstanding common stock. In connection with this authorization, the board of directors terminated the stock repurchase authority granted in 2013. During 2014, RGA repurchased 2,530,608 shares of common stock under this program for $197.7 million. The common shares repurchased have been placed into treasury to be used for general corporate purposes.
RCM, RGA Reinsurance and Chesterfield Re are subject to Missouri statutory provisions that restrict the payment of dividends. They may not pay dividends in any 12-month period in excess of the greater of the prior year’s statutory net gain from operations or 10% of statutory capital and surplus at the preceding year-end, without regulatory approval. The applicable statutory provisions only permit an insurer to pay a shareholder dividend from unassigned surplus. As of January 1, 2015, RGA Reinsurance could pay maximum dividends, without prior approval, of approximately $152.8 million. Any dividends paid by RGA Reinsurance would be paid to RCM, its parent company, which in turn has restrictions related to its ability to pay dividends to RGA. Chesterfield Re would pay dividends to its immediate parent Chesterfield Financial, which would in turn pay dividends to RCM, subject to the terms of the indenture for the embedded value securitization transaction, in which Chesterfield Financial cannot declare or pay any dividends so long as any private placement notes are outstanding. The MDI allows RCM to pay a dividend to RGA to the extent RCM received the dividend from RGA Reinsurance, without limitation related to the level of unassigned surplus. Dividend payments from other subsidiaries are subject to regulations in the jurisdiction of domicile, which are generally based on their earnings and/or capital level. In addition, the earnings of substantially all of the Company’s foreign subsidiaries have been indefinitely reinvested in foreign operations.
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. The Company is required to maintain a minimum consolidated net worth, as defined in the debt agreements, of $2.8 billion, calculated as of the last day of each fiscal quarter. Also, consolidated indebtedness, calculated as of the last day of each fiscal quarter, cannot exceed 35% of the sum of the Company’s consolidated indebtedness
plus adjusted consolidated stockholders' equity. 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 $100.0 million, bankruptcy proceedings, or any other event which results in the acceleration of the maturity of indebtedness.
As of December 31, 2014 and 2013, the Company had $2,314.3 million and $2,214.4 million, respectively, in outstanding borrowings under its debt agreements and was in compliance with all covenants under those agreements. As of December 31, 2014, the average interest rate on long-term debt outstanding was 5.69% compared to 5.76% at the end of 2013. 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. Scheduled repayments of debt over the next five years and thereafter total $2.2 million in 2015, $2.5 million in 2016, $302.6 million in 2017, $2.7 million in 2018, $402.8 million in 2019 and $1,606.3 million thereafter.
The Company may borrow up to $850.0 million in cash and obtain letters of credit in multiple currencies on its revolving credit facility that expires in December 2019. As of December 31, 2014, the Company had no cash borrowings outstanding and $204.8 million in issued, but undrawn, letters of credit under this facility.
On August 21, 2012, RGA issued 6.20% Fixed-To-Floating Rate Subordinated Debentures due September 15, 2042 with a face amount of $400.0 million. These subordinated debentures have been registered with the Securities and Exchange Commission. The net proceeds from the offering were approximately $393.7 million, to be used for general corporate purposes. Capitalized issue costs were approximately $6.3 million.
In June 2006, RGA’s subsidiary, 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 the U.S. Valuation of Life Policies Model Regulation (commonly referred to as 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 the Company, 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, 2014 and 2013, respectively, the Company held assets in trust and in custody of $922.8 million and $913.5 million, of which $15.7 million and $20.5 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 $4.0 million, $5.1 million and $6.9 million in 2014, 2013 and 2012, respectively. The payment of interest and principal on the notes is insured through a financial guaranty insurance policy by a monoline insurance company, the parent company of which emerged from Chapter 11 bankruptcy in 2013. The notes represent senior, secured indebtedness of Timberlake Financial without legal recourse to RGA or its other subsidiaries.
Timberlake Financial relies primarily upon the receipt of interest and principal payments on a surplus note and dividend payments from its wholly-owned subsidiary, Timberlake Re, a South Carolina captive insurance company, to make payments of interest and principal on the notes. The ability of Timberlake Re to make interest and principal payments on the surplus note and dividend payments to Timberlake Financial is contingent upon the South Carolina Department of Insurance’s regulatory approval. Approval to pay interest on the surplus note was granted through March 30, 2015.
Based on the growth of the Company’s business and the pattern of reserve levels under Regulation XXX associated with term life business and other statutory reserve requirements, the amount of ceded reserve credits is expected to grow. This growth will require the Company to obtain additional letters of credit, put additional assets in trust, or utilize other funding mechanisms to support reserve credits. If the Company is unable to support the reserve credits, the regulatory capital levels of several of its subsidiaries may be significantly reduced, while the regulatory capital requirements for these subsidiaries would not change. The reduction in regulatory capital would not directly affect the Company’s consolidated shareholders’ equity under GAAP; however, it could affect the Company’s ability to write new business and retain existing business.
Company’s ability to reinsure certain products, maintain risk based capital ratios and deploy excess capital. As a result, the Company may need to alter the type and volume of business it reinsures, increase prices on those products, raise additional capital to support higher regulatory reserves or implement higher cost strategies, all of which could adversely affect the Company’s competitive position and its results of operations.
In the United States, the introduction of the certified reinsurer has provided an alternative way to manage collateral requirements. In 2014, RGA Americas was designated as a certified reinsurer by the Missouri Department of Insurance, Financial Institutions and Professional Registration. This designation allows the Company to retrocede business to RGA Americas in lieu of using captives for collateral requirements.
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, 2014, these treaties had approximately $1,558.3 million 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 $1,633.6 million were held in trust for the benefit of certain RGA subsidiaries to satisfy collateral requirements for reinsurance business at December 31, 2014. Additionally, securities with an amortized cost of $10,197.5 million as of December 31, 2014 were held in trust to satisfy collateral requirements under certain third-party reinsurance treaties. Under certain conditions, the Company may be obligated to move reinsurance from one subsidiary of RGA to another subsidiary or make payments under a given 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. If the Company was ever required to perform under these obligations, the risk to the Company on a consolidated basis under the reinsurance treaties would not change; however, additional capital may be required due to the change in jurisdiction of the subsidiary reinsuring the business, which could lead to a strain on liquidity.
Proceeds from the notes issued by Timberlake Financial and the Company’s direct investment in Timberlake Financial were deposited into a series of trust accounts as collateral and are not available to satisfy the general obligations of the Company. As of December 31, 2014 the Company held deposits in trust and in custody of $922.8 million for this purpose, which is not included above. See “Collateral Finance and Securitization Notes and Statutory Reserve Funding” above for additional information on the Timberlake notes.
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, 2014, there were approximately $176.5 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, 2014, $1,035.0 million in letters of credit from various banks were outstanding, but undrawn, backing reinsurance between the various subsidiaries of the Company. See Note 12-“Commitments, Contingencies and Guarantees” in the Notes to Consolidated Financial Statements for information regarding the Company’s letter of credit facilities.
Cash Flows from Operations - The principal cash inflows from the Company’s reinsurance activities come from premiums, investment and fee income, annuity considerations and deposit funds. The principal cash outflows relate to the liabilities associated with various life and health insurance, annuity and disability products, operating expenses, income tax and interest on outstanding debt obligations. The primary liquidity concern with respect to these cash flows is the risk of shortfalls in premiums and investment income.
Financing Cash Flows - The principal cash inflows from the Company’s financing activities come from issuances of RGA debt and equity securities, and deposit funds associated with universal life and other investment type policies and contracts. The principal cash outflows come from repayments of debt, payments of dividends to stockholders, purchases of treasury stock, and withdrawals associated with universal life and other investment type policies and contracts. A primary liquidity concern with respect to these cash flows is the risk of early contractholder and policyholder withdrawal.
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 $17,864.4 million exceeds the liability amount of $12,591.5 million included on the consolidated balance sheet principally due to the lack of discounting and accounting for separate account contracts.
The Company’s liquidity position (cash and cash equivalents and short-term investments) was $1,743.4 million and $1,063.0 million at December 31, 2014 and 2013, respectively. The increase in cash and cash equivalents in 2014 is primarily related to the timing and execution of an in force transaction and the embedded value securitization as well as the Company’s investment strategies. Cash and cash equivalents includes cash collateral received from derivative counterparties of $178.1 million and $51.0 million as of December 31, 2014 and 2013, respectively. This unrestricted cash collateral is included in cash and cash equivalents and the obligation to return it is included in other liabilities in the Company’s consolidated balance sheets. 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 participates in a securities borrowing program whereby securities, which are not reflected on the Company’s consolidated balance sheets, are borrowed from a third party. The Company is required to maintain a minimum of 100% of the market value of the borrowed securities as collateral, which consists of rights to reinsurance treaty cash flows.
See “Securities Borrowing and Other” in Note 4 - “Investments” in the Notes to Consolidated Financial Statements for information related to the Company’s securities borrowing, repurchase and repurchase/reverse repurchase programs. In addition to its security agreements with third parties, certain RGA’s subsidiaries have entered into intercompany securities lending agreements to more efficiently source securities for lending to third parties and to provide for more efficient regulatory capital management.
Investment yield increased in 2014 primarily due to additional income from prepayments received during the year and increased income from limited partnership and real estate joint venture investments. Investment yield decreased in 2013 due to lower yields upon reinvestment.
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 fixed maturity and equity securities, and the other-than-temporary impairments in AOCI by sector as of December 31, 2014 and 2013.
As of December 31, 2014, the Company’s investments in Canadian and Canadian provincial government securities represented 15.2% of the fair value of total fixed maturity securities compared to 15.7% of the fair value of total fixed maturity securities at December 31, 2013. 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, 2014 and 2013.
The quality of the Company’s available-for-sale fixed maturity securities portfolio, as measured at fair value and by the percentage of fixed maturity securities invested in various ratings categories, relative to the entire available-for-sale fixed maturity security portfolio, at December 31, 2014 and 2013 was as follows (dollars in thousands):
Asset-backed securities include credit card and automobile receivables, student loans, home equity loans and collateralized debt obligations (primarily collateralized loan obligations). The Company owns floating rate securities that represent approximately 13.5% and 14.0% of the total fixed maturity securities at December 31, 2014 and 2013, respectively. These investments have a higher degree of income variability than the other fixed income holdings in the portfolio due to the floating rate nature of the interest payments. The Company holds these investments to match specific floating rate liabilities primarily reflected in the consolidated balance sheets as collateral finance notes, as well as to enhance asset management strategies. In addition to the risks associated with floating rate securities, principal risks in holding asset-backed securities are structural, credit and capital market risks. Structural risks include the securities’ cash flow priority in the capital structure and the inherent prepayment sensitivity of the underlying collateral. Credit risks include the adequacy and ability to realize proceeds from the collateral. Credit risks are mitigated by credit enhancements which include excess spread, over-collateralization and subordination. Capital market risks include general level of interest rates and the liquidity for these securities in the marketplace.
The Company monitors its fixed maturity and equity 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 - “Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements for additional information. The Company recorded $13.1 million, $19.8 million and $43.2 million in other-than-temporary investment impairments in 2014, 2013 and 2012, respectively. The fixed maturity impairments in 2014 were largely related to high-yield energy and emerging market corporate securities. The fixed maturity impairments in 2013 and 2012 were largely related to other-than-temporary impairments in Subprime/Alt-A/Other structured securities, primarily related to commercial mortgage-backed securities. In addition, other impairments in 2014, 2013 and 2012 are due to mortgage loan provisions and impairments on limited partnerships. There were no impairment losses on equity securities in 2014 or 2013. The impairment losses on equity securities of $3.0 million in 2012 are primarily due to the decline in fair value of securities issued by European financial institutions. The impaired equity securities are hybrid securities that contain both debt and equity-like features. The table below summarizes other-than-temporary impairments for 2014, 2013 and 2012 (dollars in thousands):
At December 31, 2014 and 2013, the Company had $134.9 million and $324.6 million, respectively, of gross unrealized losses related to its fixed maturity and equity securities. The distribution of the gross unrealized losses related to these securities is shown below:
The Company’s determination of whether a decline in value is other-than-temporary includes analysis of the underlying credit and the extent and duration of a decline in value. The Company’s credit analysis of an investment includes determining whether the issuer is current on its contractual payments, evaluating whether it is probable that the Company will be able to collect all amounts due according to the contractual terms of the security and analyzing the overall ability of the Company to recover the amortized cost of the investment. In the Company’s impairment review process, the duration and severity of an unrealized loss position for equity securities are given greater weight and consideration given the lack of contractual cash flows and the deferability features of these securities. As of December 31, 2014 and 2013, there were immaterial gross unrealized losses on equity securities greater than 20 percent of the amortized cost for more than 12 months.
See “Securities Borrowing and Other” in Note 4 - “Investments” in the Notes to Consolidated Financial Statements for information related to the Company’s securities borrowing, repurchase and repurchase/reverse repurchase programs.
As of December 31, 2014 and 2013, the Company’s mortgage loans, gross of valuation allowances, were distributed throughout the United States as follows (dollars in thousands):
Valuation allowances on mortgage loans are established based upon inherent losses expected by management to be realized in connection with future dispositions or settlement of mortgage loans, including foreclosures. The valuation allowances
Policy loans comprised approximately 3.3% and 3.7% of the Company’s cash and invested assets as of December 31, 2014 and 2013, respectively, substantially all of which are associated with one client. These policy loans present no credit risk because the amount of the loan cannot exceed the obligation due the ceding company upon the death of the insured or surrender of the underlying policy. The provisions of the treaties in force and the underlying policies determine the policy loan interest rates. Because policy loans represent premature distributions of policy liabilities, they have the effect of reducing future disintermediation risk. In addition, the Company earns a spread between the interest rate earned on policy loans and the interest rate credited to corresponding liabilities.
Funds withheld at interest comprised approximately 15.4% and 17.3% of the Company’s cash and invested assets as of December 31, 2014 and 2013, respectively. For reinsurance agreements written on a modified coinsurance basis and certain agreements written on a coinsurance 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 with amounts owed by the ceding company. Ceding companies with funds withheld at interest had an average rating of “A” at December 31, 2014 and 2013. Certain ceding companies maintain segregated portfolios for the benefit of the Company.
Other invested assets include equity securities, limited partnership interests, joint ventures (other than operating joint ventures), structured loans, derivative contracts, contractholder-directed unit-linked investments, FHLB common stock, real estate held-for-investment and equity release mortgages. Other invested assets represented approximately 3.1% and 4.0% of the Company’s cash and invested assets as of December 31, 2014 and 2013, 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, 2014 and 2013.
The Company recorded $6.3 million, $4.8 million and $10.3 million in other-than-temporary impairments on other invested assets in 2014, 2013 and 2012, respectively.
The Company has utilized derivative financial instruments to protect the Company against possible changes in the fair value of its investment portfolio as a result of interest rate changes, to hedge against risk of changes in the purchase price of securities, to hedge liabilities associated with the reinsurance of variable annuities with guaranteed living benefits and to manage the portfolio’s effective yield, maturity and duration. In addition, the Company has used derivative financial instruments to reduce the risk associated with fluctuations in foreign currency exchange rates. The Company uses both exchange-traded and customized over-the-counter derivative financial instruments.
See Note 5 - “Derivative Instruments” in the Notes to Consolidated Financial Statements for a table that presents the notional amounts and fair value of investment related derivative instruments held at December 31, 2014 and 2013.
The Company may be exposed to credit-related losses in the event of non-performance by counterparties to derivative financial instruments. Generally, the credit exposure of the Company’s derivative contracts is limited to the fair value at the reporting date plus or minus any collateral posted or held by the Company. The Company had credit exposure related to its derivative contracts, excluding futures, longevity and mortality swaps, of $7.7 million and $9.7 million at December 31, 2014 and 2013, respectively.
In addition to leading the ERM function, the CRO also chairs the Company’s Risk Management Steering Committee (“RMSC”), which is made up of senior management executives, including the Chief Executive Officer, the Chief Financial Officer ("CFO"), and the COO, among others. The RMSC approves targets and limits for each material risk at the consolidated level and reviews these limits at least annually. Exposure to these risks is calculated and presented to the RMSC at least quarterly. Any waiver or exception to established risk limits needs to be approved by the RMSC. The Company also has risk-focused committees such as the Business Continuity and Information Governance Steering Committee, Consolidated Investment Committee, Derivatives Risk Oversight Committee, Asset Liability Management Committee, Actuarial Standards Group, Collateral and Liquidity Committee, and the Currency Risk Management Committee. These committees are comprised of various risk experts
and have overlapping membership, enabling consistent and holistic management of risks. These committees report directly or indirectly to the RMSC. In addition to the risk committees at a consolidated level, some of RGA’s operating entities have risk management committees that oversee relevant risks relative to segment-level risk targets and limits.
Structural Controls: Structural controls provide additional safeguards against undesired risk exposures and are embedded in business processes. Examples of structural controls include maximum retention limits, pricing and underwriting reviews, per issuer limits, concentration limits, and standard treaty language.
Misestimation of any key risk can threaten the long term viability of the enterprise. Further, the pricing process is a key operational risk and significant effort is applied to ensuring the appropriateness of pricing assumptions. Some of the safeguards
the Company uses to ensure proper pricing are: experience studies, strict underwriting, sensitivity and scenario testing, pricing guidelines and controls, authority limits and internal and external pricing reviews. In addition, the ERM function provides additional pricing oversight which includes periodic pricing audits.
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 locale, and jumbo limits, which prevent excessive coverage on a given individual.
Interest rate risk is the potential for loss, on a net asset and liability basis, due to changes in interest rates, including both normal rate changes and credit spread changes. 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 practices to reduce the risk of unfavorable consequences in this type of environment.
The Company manages interest rate risk to maximize the return on the Company’s capital and to preserve the value created by its business operations within certain constraints. As such, certain management monitoring processes are designed to minimize the effect of sudden and/or sustained changes in interest rates on fair value, cash flows, and net interest income. The Company manages its exposure to interest rates principally by managing the relative matching of the cash flows of its liabilities and assets
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, 2014 and 2013 (dollars in thousands):
Interest rate spreads are managed for near term income through a combination of crediting rate actions and portfolio management. Certain annuity products contain crediting rates that reset annually, of which $3,171.7 million and $2,813.5 million of account balances are not subject to surrender charges, with 99.7% and 99.3% of these already at their minimum guaranteed rates as of December 31, 2014 and 2013, respectively. As such, certain management monitoring processes are designed to minimize the effect of sudden and/or sustained changes in interest rates on fair value, cash flows, and net interest income.
Interest rate sensitivity analysis is used to measure the Company’s interest rate price risk by computing estimated changes in fair value of fixed rate assets and liabilities in the event of a hypothetical 10% change (increase or decrease) in market interest rates. The Company does not have fixed rate instruments classified as trading securities. The Company’s projected loss in fair value of financial instruments in the event of a 10% unfavorable change in market interest rates at its fiscal years ended December 31, 2014 and 2013 was $466.8 million and $485.3 million, respectively.
Interest rate sensitivity analysis is also used to measure the Company’s interest rate cash flow risk by computing estimated changes in the cash flows expected in the near term attributable to floating rate assets and liabilities in the event of a range of assumed changes in market interest rates. This analysis assesses the risk of loss in cash flows in the near term in market risk sensitive floating rate instruments in the event of a hypothetical 10% change (increase or decrease) in market interest rates. The Company does not have variable rate instruments classified as trading securities. The Company’s projected decrease in cash flows in the near term associated with floating rate instruments in the event of a 10% unfavorable change in market interest rates at its fiscal years ended December 31, 2014 and 2013 was $6.8 and $8.1 million, respectively.
In order to reduce the exposure to changes in fair values from interest rate fluctuations, the Company has developed strategies to manage the interest rate sensitivity of its assets and liabilities. In addition, from time to time, the Company has utilized the swap market to manage the sensitivity of fair values to interest rate fluctuations.
The maximum amount of assets held in a specific currency (with the exception of the U.S. dollar) is measured relative to risk targets and is monitored regularly.
Credits for fixed indexed annuities are affected by changes in equity markets. Thus the fair value of the benefit is a function of primarily index returns and volatility. The Company hedges most of the underlying equity exposure.
The Company reinsures variable annuities including those with guaranteed minimum death benefits (“GMDB”), guaranteed minimum income benefits (“GMIB”), guaranteed minimum accumulation benefits (“GMAB”) and guaranteed minimum withdrawal benefits (“GMWB”). Strong equity markets, increases in interest rates and decreases in volatility will generally decrease the fair value of the liabilities underlying the benefits. Conversely, a decrease in the equity markets along with a decrease in interest rates and an increase in volatility will generally result in an increase in the fair value of the liabilities underlying the benefits, which has the effect of increasing reserves and lowering earnings. The Company maintains a customized dynamic hedging program that is designed to substantially mitigate the risks associated with income volatility around the change in reserves on guaranteed benefits, ignoring the Company’s own credit risk assessment. However, the hedge positions may not fully offset the changes in the carrying value of the guarantees due to, among other things, time lags, high levels of volatility in the equity and derivative markets, extreme swings in interest rates, unexpected contract holder behavior, and divergence between the performance of the underlying funds and hedging indices. These factors, individually or collectively, may have a material adverse effect on the Company’s net income, financial condition or liquidity. The table below provides a summary of variable annuity account values and the fair value of the guaranteed benefits as of December 31, 2014 and 2013.
The risk that a client’s in force block incurs substantial surrenders and/or lapses due to credit impairment, reputation damage or other market changes affecting the counterparty. Severely higher than expected surrenders and/or lapses could result in inadequate in force business to recover cash paid out for acquisition costs.
Generally, RGA’s insurance subsidiaries retrocede amounts in excess of their retention to RGA Reinsurance, Parkway Re, RGA Barbados, RGA Americas, Rockwood Re, Manor Re, RGA Worldwide or RGA Atlantic. External retrocessions are arranged through the Company’s retrocession pools for amounts in excess of its retention. As of December 31, 2014, all retrocession pool members in this excess retention pool rated by the A.M. Best Company were rated “A-” or better. A rating of “A-” is the fourth highest rating out of fifteen possible ratings. For a majority of the retrocessionaires that were not rated, letters of credit or trust assets have been given as additional security. In addition, the Company performs annual financial and in force reviews of its retrocessionaires to evaluate financial stability and performance.
Financial risks take into account known factors related to collateral, expenses, financing, liquidity, tax, and valuation. There are many aspects to this set of risks that are important to the operations of the Company and its ability to meet obligations with its clients, shareholders, and regulators.
Reinsurance is an arrangement under which an insurance company, the reinsurer, agrees to indemnify another insurance company, the ceding company, for all or a portion of the insurance risks underwritten by the ceding company. Reinsurance is designed to (i) reduce the net liability on individual risks, thereby enabling the ceding company to increase the volume of business it can underwrite, as well as increase the maximum risk it can underwrite on a single life or risk; (ii) stabilize operating results by leveling fluctuations in the ceding company’s loss experience; (iii) assist the ceding company to meet applicable regulatory requirements; and (iv) enhance the ceding company’s financial strength and surplus position.
The accompanying consolidated financial statements include the accounts of RGA and its subsidiaries, all of which are wholly owned, and any variable interest entities where the Company is the primary beneficiary. Entities in which the Company has significant influence over the operating and financing decisions but are not required to be consolidated are reported under the equity method of accounting. The Company evaluates variable interest entities in accordance with the general accounting principles for Consolidation. Intercompany balances and transactions have been eliminated.
The Company has reclassified certain securities from the utility sector to the industrial sector in its 2013 presentation to conform to the 2014 classification of these securities within its corporate fixed maturities by industry type table.
Property, equipment and leasehold improvements, which are included in other assets, are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization 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 $222.7 million and $117.3 million at December 31, 2014 and 2013, respectively. Accumulated depreciation and amortization of property, equipment and leasehold improvements was $38.5 million and $42.3 million at December 31, 2014 and 2013, respectively. Related depreciation and amortization expense was $9.4 million, $8.4 million and $9.0 million for the years ended December 31, 2014, 2013 and 2012, 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 periodically for indicators of impairment in value. Unamortized computer software costs were $77.6 million and $49.6 million at December 31, 2014 and 2013, respectively. The increase in unamortized software costs in 2014 was primarily related to the development or acquisition of software for internal use in connection with the Company's information technology and infrastructure initiatives. Amortization expense was $5.9 million, $6.9 million, and $6.5 million for the years ended December 31, 2014, 2013 and 2012, respectively.
The Company establishes future policy benefits for guaranteed minimum death benefits (“GMDB”) relating to the reinsurance of certain variable annuity contracts by estimating the expected value of death benefits in excess of the projected account balance and recognizing the excess proportionally over the accumulation period based on total expected assessments. The Company regularly evaluates estimates used and adjusts the additional liability balance, with a related charge or credit to claims and other policy benefits, if actual experience or other evidence suggests that earlier assumptions should be revised. The assumptions used in estimating the GMDB liabilities are consistent with those used for amortizing DAC, and are thus subject to the same variability and risk. The Company’s GMDB liabilities at December 31, 2014 and 2013 were not material.
Guaranteed minimum income benefits (“GMIB”) provide the contract holder, after a specified period of time determined at the time of issuance of the variable annuity contract, with a minimum level of income (annuity) payments. Under the reinsurance treaty, the Company makes a payment to the ceding company equal to the GMIB net amount-at-risk at the time of annuitization
The fair values of the GMIB, GMWB and GMAB embedded derivative liabilities are reflected in interest-sensitive contract liabilities on the consolidated balance sheets and are calculated based on actuarial and capital market assumptions related to the projected cash flows, including benefits and related contract charges over the lives of the contracts. These projected cash flows incorporate expectations concerning policyholder behavior, such as lapses, withdrawals and benefit selections, and capital market assumptions such as interest rates and equity market volatilities. In measuring the fair value of GMIBs, GMWBs and GMABs, the Company attributes a portion of the fees collected from the policyholder equal to the present value of expected future guaranteed minimum income, withdrawal and accumulation benefits (at inception). The changes in fair value are reported in investment related gains (losses), net. Any additional fees represent “excess” fees and are reported in other revenues on the consolidated statements of income. These variable annuity guaranteed living benefits may be more costly than expected in volatile or declining markets, causing an increase in interest-sensitive contract liabilities, negatively affecting net income.
For certain reinsurance transactions involving in force blocks of business, the ceding company pays a premium equal to the initial required reserve (future policy benefit). In such transactions, for income statement presentation, the Company nets the expense associated with the establishment of the reserve on the consolidated balance sheets against the premiums from the transaction.
In July 2013, the FASB amended the general accounting principles for Income Taxes as it relates to the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This amendment clarifies that an unrecognized tax benefit should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. However, to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and
In June 2014, the FASB amended the general accounting principles for Transfers and Servicing as it relates to the accounting for repurchase-to-maturity transactions, repurchase financings, and disclosures. This amendment requires entities to account for repurchase-to-maturity transactions as secured borrowings, eliminates guidance on linked repurchase financing transactions, and expands disclosure requirements related to certain transfers of financial assets that are accounted for as sales and certain transfers accounted for as secured borrowings. These amendments are effective for annual years, and interim periods within those years, beginning after December 15, 2014.The adoption of this amendment is not expected to have an impact on the Company's consolidated financial statements other than the addition of the required disclosures.
During 2014, in connection with the distribution of benefits due under its employee benefit plans, RGA issued 584,915 shares of common stock from treasury and repurchased from recipients 49,564 of its common shares, at $78.22 per share, in settlement of income tax withholding requirements incurred by recipients. Additionally, in 2014, non-employee directors were granted a total of 13,800 shares of common stock.
The amortized cost and estimated fair value of fixed maturity securities available-for-sale at December 31, 2014 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, 2014 and 2013 (dollars in thousands):
As discussed in Note 2 - “Summary of Significant Accounting Policies,” 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 security prior to impairment. Any remaining difference between the fair value and amortized cost is recognized in AOCI. The following table sets forth the amount of pre-tax credit loss impairments on fixed maturity securities held by the Company as of the dates
indicated, for which a portion of the OTTI loss was recognized in AOCI, and the corresponding changes in such amounts (dollars in thousands):
The Company neither has an intention to sell nor does it expect to be required to sell the securities outlined in the table above, as of the dates indicated. However, unforeseen facts and circumstances may cause the Company to sell fixed maturity and equity securities in the ordinary course of managing its portfolio to meet certain diversification, credit quality and liquidity guidelines.
Unrealized losses decreased on investment-grade securities as a result of decreases in interest rates during 2014. Increases in unrealized losses during 2014 on non-investment grade securities are principally related to decreases in value on high-yield energy and emerging market corporate securities.
The volatility in derivatives and other is primarily due to changes in the fair value of embedded derivative liabilities associated with modified coinsurance and funds withheld treaties and guaranteed minimum benefit riders.
At December 31, 2014 and 2013 the Company held non-income producing securities with amortized costs of $42.7 million and $38.5 million, and estimated fair values of $52.8 million and $47.6 million, respectively. Generally, securities are non-income producing when principal or interest is not paid primarily as a result of bankruptcies or credit defaults, but also include securities where amortization has been discontinued. During 2014, 2013 and 2012 the Company sold fixed maturity and equity securities with fair values of $1,016.5 million, $1,104.0 million, and $828.0 million, which were below amortized cost, at gross realized losses of $31.3 million, $60.6 million and $27.5 million, respectively. The Company generally does not engage in short-term buying and selling of securities.
The Company participates in a securities borrowing program whereby securities, which are not reflected on the Company’s consolidated balance sheets, are borrowed from a third party. The borrowed securities are used to provide collateral under an affiliated reinsurance transaction. The Company is required to maintain a minimum of 100% of the fair value of the borrowed securities as collateral, which consists of rights to reinsurance treaty cash flows.
The following table includes the amount of borrowed securities, repurchased securities pledged and repurchased/reverse repurchased securities pledged and received as of December 31, 2014 and 2013 (dollars in thousands).
Mortgage loans represented approximately 7.4% and 7.7% of the Company’s invested assets as of December 31, 2014 and 2013, respectively. The Company makes mortgage loans on income producing properties that are geographically diversified throughout the U.S. with the largest concentration being in California, which represented 18.7% and 23.3% of mortgage loans on real estate
None of the payments due to the Company on its recorded investment in mortgage loans were delinquent as of December 31, 2014 and 2013.
The following table presents the recorded investment in mortgage loans, by method of measuring impairment, and the related valuation allowances, as of December 31, 2014 and 2013 (dollars in thousands):
Information regarding the Company’s loan valuation allowances for mortgage loans as of December 31, 2014, 2013 and 2012 are as follows (dollars in thousands):
The Company did not acquire any impaired mortgage loans during the years ended December 31, 2014 and 2013. The Company had no mortgage loans that were on a nonaccrual status at December 31, 2014 and 2013.
Policy loans comprised approximately 3.5% and 3.8% of the Company’s invested assets as of December 31, 2014 and 2013, respectively, substantially all of which are associated with one client. These policy loans present no credit risk because the amount of the loan cannot exceed the obligation due to the ceding company upon the death of the insured or surrender of the underlying policy. The provisions of the treaties in force and the underlying policies determine the policy loan interest rates. As policy loans represent premature distributions of policy liabilities, they have the effect of reducing future disintermediation risk. In addition, the Company earns a spread between the interest rate earned on policy loans and the interest rate credited to corresponding liabilities.
Other invested assets include equity securities, limited partnership interests, joint ventures (other than operating joint ventures), structured loans, derivative contracts, FVO contractholder-directed unit-linked investments, Federal Home Loan Bank of Des Moines ("FHLB") common stock (included in other), real estate held-for-investment (included in other) and equity release mortgages (included in other). The fair value option was elected for contractholder-directed investments supporting unit-linked variable annuity type liabilities which do not qualify for presentation and reporting as separate accounts. Other invested assets represented approximately 3.3% and 4.1% of the Company’s invested assets as of December 31, 2014 and 2013, respectively. Carrying values of these assets as of December 31, 2014 and 2013 are as follows (dollars in thousands):
The following table presents the components of AOCI, before income tax, and the consolidated income statement classification where the gain or loss is recognized related to cash flow hedges for the years ended December 31, 2014, 2013 and 2012 (dollars in thousands):
As of December 31, 2014, 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 $2.1 million. This expectation is based on the anticipated interest payments on hedged investments in fixed maturity securities that will occur over the next twelve months, at which time the
Company will recognize the deferred net gains (losses) as an adjustment to investment income over the term of the investment cash flows.
The Company uses foreign currency swaps 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, 2014, 2013 and 2012 (dollars in thousands):
The cumulative foreign currency translation gain recorded in AOCI related to these hedges was $75.8 million and $23.9 million at December 31, 2014 and 2013, respectively. If a foreign operation was sold or substantially liquidated, the amounts in AOCI would be reclassified to the consolidated statements of income. A pro rata portion would be reclassified upon partial sale of a foreign operation.
The Company uses various other derivative instruments for risk management purposes that either do not qualify or have not been qualified for hedge accounting treatment, including derivatives used to economically hedge changes in the fair value of liabilities associated with the reinsurance of variable annuities with guaranteed living benefits. The gain or loss related to the change in fair value for these derivative instruments is recognized in investment related gains (losses), in the consolidated statements of income, except where otherwise noted.
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, 2014, 2013 and 2012 is as follows (dollars in thousands):
Equity index options are used by the Company primarily to hedge minimum guarantees embedded in certain variable annuity products. To hedge against adverse changes in equity indices volatility, the Company buys put options. The contracts are net settled in cash based on differentials in the indices at the time of exercise and the strike price.
The Company sells protection under single name credit default swaps and credit default swap index tranches to diversify its credit risk exposure in certain portfolios and, in combination with purchasing securities, to replicate characteristics of similar investments based on the credit quality and term of the credit default swap. Credit default triggers for indexed reference entities and single name reference entities are defined in the contracts. The Company’s maximum exposure to credit loss equals the notional value for credit default swaps. In the event of default of a referencing entity, the Company is typically required to pay the protection holder the full notional value less a recovery amount determined at auction.
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 at December 31, 2014 and 2013 (dollars in thousands):
postings at established threshold levels. Certain of the Company's OTC derivatives are cleared derivatives, which are bilateral transactions between the Company and a counterparty where the transactions are cleared through a clearinghouse, such that each derivative counterparty is only exposed to the default of the clearinghouse. These cleared transactions require initial and daily variation margin collateral postings and include certain interest rate swaps and credit default swaps entered into on or after June 10, 2013, related to new guidelines implemented under the Dodd-Frank Wall Street Reform and Consumer Protection Act. Also, the Company enters into exchange-traded futures through regulated exchanges and these transactions are settled on a daily basis, thereby reducing credit risk exposure in the event of non-performance by counterparties to such financial instruments.
General accounting principles for Fair Value Measurements and Disclosures define fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. These principles also establish a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value and describes three levels of inputs that may be used to measure fair value:
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.
Assets and liabilities measured at fair value on a recurring basis as of December 31, 2014 and December 31, 2013 are summarized below (dollars in thousands):
The Company performs initial and ongoing analysis and review of the various techniques utilized in determining fair value to ensure that the valuation approaches utilized are appropriate and consistently applied, and that the various assumptions are reasonable. The Company also performs ongoing analysis and review of the information and prices received from third parties to ensure that the prices represent a reasonable estimate of the fair value and to monitor controls around pricing, which includes quantitative and qualitative analysis and is overseen by the Company’s investment and accounting personnel. Examples of procedures performed include, but are not limited to, review of pricing trends, comparison of a sample of executed prices of securities sold to the fair value estimates, comparison of fair value estimates to management’s knowledge of the current market, and ongoing confirmation that third party pricing services use, wherever possible, market-based parameters for valuation. In
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.
Equity Securities - Equity securities consist principally of exchange-traded funds 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. The fair values of preferred equity securities, for which quoted market prices are not readily available, are based on prices obtained from independent pricing services and these securities are generally classified within Level 2 in the fair value hierarchy. Non-binding broker quotes for equity securities are generally based on significant unobservable inputs and are reflected as Level 3 in the fair value hierarchy.
Derivative Assets and Derivative Liabilities - All of the derivative instruments utilized by the Company, except for longevity and mortality swaps, are classified within Level 2 on the fair value hierarchy. These derivatives are principally valued using an income approach. Valuations of interest rate contracts are based on present value techniques, which utilize significant inputs that may include the swap yield curve, LIBOR basis curves, and repurchase rates. Valuations of foreign currency contracts are based on present value techniques, which utilize significant inputs that may include the swap yield curve, LIBOR basis curves, currency spot rates, and cross currency basis curves. Valuations of credit contracts, are based on present value techniques, which utilize significant inputs that may include the swap yield curve, credit curves, and recovery rates. Valuations of equity market contracts, are based on present value techniques, which utilize significant inputs that may include the swap yield curve, spot equity index levels, and dividend yield curves. Valuations of equity market contracts, option-based, are based on option pricing models, which utilize significant inputs that may include the swap yield curve, spot equity index levels, dividend yield curves, and equity volatility. The Company does not currently have derivatives, except for longevity and mortality swaps, included in Level 3 measurement.
The following table presents quantitative information about significant unobservable inputs used in Level 3 fair value measurements that are developed by the Company, which does not include unobservable Level 3 asset and liability measurements provided by third parties, as of December 31, 2014 and 2013 (dollars in thousands):
The tables below provide a summary of the changes in fair value of Level 3 assets and liabilities for the year ended December 31, 2013, as well as the portion of gains or losses included in income for the year ended December 31, 2013 attributable to unrealized gains or losses related to those assets and liabilities still held at December 31, 2013 (dollars in thousands).
Carrying values presented herein differ from those presented in the consolidated balance sheets because certain items within the respective financial statement caption are embedded derivatives and are measured at fair value on a recurring basis.
Retrocessions are arranged through the Company’s retrocession pools for amounts in excess of the Company’s retention limit. As of December 31, 2014 and 2013, all rated retrocession pool participants followed by the A.M. Best Company were rated “A- (excellent)” or better. The Company verifies retrocession pool participants’ ratings on a quarterly basis. For a majority of the retrocessionaires that were not rated, security in the form of letters of credit or trust assets has been given as additional security. In addition, the Company performs annual financial reviews of its retrocessionaires to evaluate financial stability and performance. In addition to its third party retrocessionaires, various RGA reinsurance subsidiaries retrocede amounts in excess of their retention to affiliated subsidiaries.
The following table presents information for the Company's ceded reinsurance receivable assets, including the respective amount and A.M. Best rating for each reinsurer representing in excess of five percent of the total as of December 31, 2014 and 2013 (dollars in thousands):
Included in the total ceded reinsurance receivables balance were $143.0 million and $134.1 million of claims recoverable, of which $10.9 million and $4.2 million were in excess of 90 days past due, as of December 31, 2014 and 2013, respectively.
Reinsurance agreements, whether facultative or automatic, may provide for recapture rights on the part of the ceding company. Recapture rights permit the ceding company to reassume all or a portion of the risk formerly ceded to the reinsurer after an agreed-upon period of time, generally 10 years, or in some cases due to changes in the financial condition or ratings of the reinsurer. Recapture of business previously ceded does not affect premiums ceded prior to the recapture of such business, but would reduce premiums in subsequent periods. Additionally, some treaties give the ceding company the right to request the Company to place assets in trust for their benefit to support their 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, 2014 and 2013, these treaties had approximately$1,558.3 million and $1,552.3 million, respectively, 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 $1,633.6 million and $2,124.7 million were held in trust to satisfy collateral requirements for reinsurance business for the benefit of certain RGA subsidiaries at December 31, 2014 and 2013, respectively. In addition, the Company’s collateral financing operations have asset in trust requirements. See Note 14 - “Collateral Finance and Securitization Notes” for
additional information. Securities with an amortized cost of $10,197.5 million and $7,842.9 million, as of December 31, 2014 and 2013, respectively, were held in trust to satisfy collateral requirements under certain third-party reinsurance treaties. Under 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.
Pre-tax income for the years ended December 31, 2014, 2013 and 2012 consists of the following (dollars in thousands):
The provision for income tax expense for the years ended December 31, 2014, 2013 and 2012 consists of the following (dollars in thousands):
The 2014 results benefited from the release of liabilities established for uncertain tax positions due to the closure with the U.S. Internal Revenue Service of tax returns for a recent five-year period. As a result of that release and other adjustments, the tax provision for the period was reduced and the accrued interest liability was reversed.
As of December 31, 2014, the Company’s total amount of unrecognized tax benefits was $274.7 million and the total amount of unrecognized tax benefits that would affect the effective tax rate, if recognized, was $30.8 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, 2014, 2013 and 2012, is as follows (dollars in thousands):
The Company recognized interest expense (benefit) associated with uncertain tax positions in 2014, 2013 and 2012 of $(36.6) million, $7.6 million and $9.9 million, respectively. As of December 31, 2014 and 2013, the Company had $20.7 million and $57.3 million, respectively, of accrued interest related to unrecognized tax benefits.
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, 2014 and 2013 (dollars in thousands):
The Company expects to contribute to the plans $13.1 million in pension benefits and $4.3 million in other benefits during 2015.
The fair values of the Company’s pension plan assets as of December 31, 2014 and 2013 are summarized below (dollars in thousands):
As of December 31, 2014 and 2013, the Company classified all of its pension plan assets in the Level 1 category as quoted prices in active markets are available for these assets. See Note 6 - “Fair Value of Asset and Liabilities” for additional detail on the fair value hierarchy.
RCM, RGA Reinsurance and Chesterfield Re are subject to Missouri statutory provisions that restrict the payment of dividends. They may not pay dividends in any 12-month period in excess of the greater of the prior year’s statutory net gain from operations or 10% of statutory capital and surplus at the preceding year-end, without regulatory approval. The applicable statutory provisions only permit an insurer to pay a shareholder dividend from unassigned surplus. As of January 1, 2015, RGA Reinsurance could pay maximum dividends, without prior approval, of approximately $152.8 million. Any dividends paid by RGA Reinsurance would be paid to RCM, its parent company, which in turn has restrictions related to its ability to pay dividends to RGA. Chesterfield Re would pay dividends to its immediate parent Chesterfield Financial Holdings LLC, ("Chesterfield Financial"), which would in turn pay dividends to RCM, subject to the terms of the indenture for the embedded value securitization transaction, in which Chesterfield Financial cannot declare or pay any dividends so long as any private placement notes are outstanding. The Missouri Department of Insurance, Financial Institution and Professional Registration, allows RCM to pay a dividend to RGA to the extent RCM received the dividend from RGA Reinsurance, without limitation related to the level of unassigned surplus. Dividend payments from other subsidiaries are subject to regulations in the jurisdiction of domicile, which are generally based on their earnings and/or capital level. In addition, the earnings of substantially all of the Company’s foreign subsidiaries have been indefinitely reinvested in foreign operations.
The Company anticipates that the majority of its current commitments will be invested over the next five years; however, these commitments could become due any time at the request of the counterparties. Investments in limited partnerships and private placements are carried at cost or reported using the equity method and included in other invested assets in the consolidated balance sheets. Bank loans are carried at fair value and included in fixed maturities available-for-sale. Equity release mortgages are carried at unpaid principal balances, net of any amortized premium or discount and valuation allowance and included in other invested assets.
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. At December 31, 2014 and 2013, there were approximately $176.5 million and $210.3 million, respectively, of undrawn outstanding bank letters of credit in favor of third parties. Additionally, the Company utilizes letters of credit primarily to secure reserve credits
The Company maintains eight 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 $836.5 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 credit facilities as of December 31, 2014 and 2013 (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 $12.6 million, $9.8 million and $7.3 million for the years ended December 31, 2014, 2013 and 2012, respectively, and are included in policy acquisition costs and other insurance expenses.
Rent expenses amounted to approximately $19.3 million, $18.5 million and $19.5 million for the years ended December 31, 2014, 2013 and 2012, respectively.
Manor Reinsurance, Ltd. ("Manor Re") has obtained $300.0 million of collateral financing through 2020 from an international bank which enabled Manor Re to deposit assets in trust to support statutory reserve credit for an affiliated reinsurance transaction. The bank has recourse to RGA should Manor Re fail to make payments or otherwise not perform its obligations under this financing. At the election of the Company, this transaction will terminate in March 2015.
RGA, through wholly-owned subsidiaries, has committed to provide statutory reserve support to third-parties through 2035, 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, 2014, 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. The following table presents information about these commitments (dollars in millions):
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 $100.0 million, bankruptcy proceedings, or any other event which results in the acceleration of the maturity of indebtedness. As of December 31, 2014 and 2013, the Company had $2,314.3 million and $2,214.4 million, respectively, in outstanding borrowings under its debt agreements and was in compliance with all covenants under those agreements.
The ability of the Company to make debt principal and interest payments depends on the earnings and surplus of subsidiaries, investment earnings on undeployed capital proceeds, and the Company’s ability to raise additional funds. Future principal payments due on long-term debt as of December 31, 2014, were as follows (dollars in thousands):
The Company’s consolidated balance sheets include the assets of Timberlake Financial, a wholly-owned subsidiary, recorded as fixed maturity investments and other invested assets, which consists of restricted cash and cash equivalents, with the liability for the notes recorded as collateral finance and securitization notes. The Company’s consolidated statements of income include the investment return of Timberlake Financial as investment income and the cost of the facility is reflected in collateral finance and securitization expense.
No individual client generated 10% or more of the Company’s total gross premiums on a consolidated basis in 2014, 2013 and 2012. For the purpose of this disclosure, companies that are within the same insurance holding company structure are combined.
The Company adopted the RGA Flexible Stock Plan (the “Plan”) in February 1993, as amended, and the Flexible Stock Plan for Directors (the “Directors Plan”) in January 1997, as amended, (collectively, the “Stock Plans”). The Stock Plans provide for the award of benefits (collectively “Benefits”) of various types, including stock options, stock appreciation rights (“SARs”), restricted stock, performance shares, cash awards, and other stock-based awards, to key employees, officers, directors and others performing significant services for the benefit of the Company or its subsidiaries. As of December 31, 2014, shares authorized for the granting of Benefits under the Plan and the Directors Plan totaled 13,360,077 and 212,500 respectively. The Company uses treasury shares or shares made available from authorized but unissued shares to support the future exercise of options or settlement of awards granted under its stock plans.
As of December 31, 2014, the total compensation cost of non-vested awards not yet recognized in the financial statements was $25.4 million. It is estimated that these costs will vest over a weighted average period of 1.8 years.
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 not been satisfied as of the end of the reporting period. During 2014 and 2013, all outstanding options were included in the calculation of common equivalent shares. Approximately 1.8 million outstanding stock options were not included in the calculation of common equivalent shares during 2012. Approximately 0.5 million, 0.7 million and 0.7 million performance contingent shares were excluded from the calculation of common equivalent shares during 2014, 2013 and 2012, respectively.
Includes cash flow hedges. See Note 5 - “Derivative Instruments” for additional information on cash flow hedges.
The following table presents the amounts of AOCI reclassifications for the years ended December 31, 2014 and 2013 (dollars in thousands):
On October 21, 2014, the Company announced the execution of agreements under which the Company will acquire all of the stock of Aurora National Life Assurance Company (“Aurora”), a wholly owned life insurance subsidiary of Swiss Re. Aurora has approximately 82,000 policies in force and statutory policyholder liabilities of $2.7 billion. The underlying business is comprised of annuities, primarily payout annuities, and interest-sensitive life products. The transaction is expected to close in the first half of 2015 subject to customary regulatory approvals.