The Company leases its headquarters facility in Chesterfield, Missouri, which consists of approximately 185,501 square feet. In addition, the Company leases approximately 262,446 square feet of office space in 26 locations throughout the U.S., Canada, Europe, South Africa, and the Asia Pacific region.
The Company’s long-term profitability primarily depends on the volume and amount of death claims incurred and the ability to adequately price the risks it assumes. While death claims are reasonably predictable over a period of many years, claims become less predictable over shorter periods and are subject to significant fluctuation from quarter to quarter and year to year. Effective January 1, 2008, the Company increased the maximum amount of coverage that it retains per life in the U.S. from $6.0 million to $8.0 million. This increase does not affect business written prior to January 1, 2008. Claims in excess of this retention amount are retroceded to retrocessionaires; however, the Company remains fully liable to the ceding company for the entire amount of risk it assumes. The increase in the Company’s U.S. retention limit from $6.0 million to $8.0 million reduces the amount of premiums it pays to retrocessionaires, but increases the maximum effect a single death claim can have on its results and therefore may result in additional volatility to its results. For other countries, particularly those with higher risk factors or smaller books of business, the Company systematically reduces its retention. The Company has a number of retrocession arrangements whereby certain business in force is retroceded on an automatic or facultative basis.
The Company allocates capital to its segments based on an internally developed economic capital model, the purpose of which is to measure the risk in the business and to provide a basis upon which capital is deployed. The economic capital model considers the unique and specific nature of the risks inherent in RGA’s businesses. As a result of the economic capital allocation process, a portion of investment income and investment related gains and losses are credited to the segments based on the level of allocated capital. In addition, the segments are charged for excess capital utilized above the allocated economic capital basis. This charge is included in policy acquisition costs and other insurance expenses.
The Company believes it is one of the leading life reinsurers in North America based on premiums and the amount of life reinsurance in force. The Company believes, based on an industry survey of 2008 information prepared by Munich American at the request of the Society of Actuaries Reinsurance Section (“SOA survey”), that it has the second largest market share in North America as measured by life insurance in force. The Company’s approach to the North American market has been to:
In 1994, the Company began using its North American underwriting expertise and industry knowledge to expand into international markets and now has subsidiaries, branches or representative offices in Australia, Barbados, Bermuda, China, France, Germany, Hong Kong, India, Ireland, Italy, Japan, Mexico, the Netherlands, Poland, South Africa, South Korea, Spain, Taiwan and the United Kingdom. These operations are included in either the Company’s Asia Pacific segment or its Europe & South Africa segment. The Company generally starts new operations from the ground up in these markets as opposed to acquiring existing operations, and it often enters these markets to support its North American clients as they expand internationally. Based on information from a nationally recognized rating agency, the Company believes it is the third largest life reinsurer in the world based on 2008 net life reinsurance premiums. While the Company believes information provided by the rating agency is generally reliable, the Company has not independently verified the data. The rating agency does not guarantee the accuracy and completeness of the information. The Company conducts business with the majority of the largest U.S. and international life insurance companies. The Company has also developed its capacity and expertise in the reinsurance of asset-intensive products (primarily annuities and corporate-owned life insurance) and financial reinsurance.
Outsourcing of Mortality. The SOA survey indicates that U.S. life reinsurance in force has tripled from $2.7 trillion in 1998 to $8.1 trillion at year-end 2008. The Company believes this trend reflects the continued utilization by life insurance companies of reinsurance to manage capital and mortality risk and to develop competitive products. However, the survey results indicate a smaller percentage of new business was reinsured in 2008 than previous years, which has caused premium growth rates in the U.S. life reinsurance market to moderate from previous years. The Company believes the decline in new business being reinsured is likely a reaction by ceding companies to a broad-based increase in reinsurance rates in the market and stronger capital positions maintained by ceding companies in recent years. However, the Company believes reinsurers will continue to be an integral part of the life insurance market due to their ability to efficiently aggregate a significant volume of life insurance in force, creating economies of scale and greater diversification of risk. As a result of having larger amounts of data at their disposal compared to primary life insurance companies, reinsurers tend to have better insights into mortality trends, creating more efficient pricing for mortality risk.
Additionally, merger and acquisition transactions within the life insurance industry continue. The Company believes that reorganizations and consolidations of life insurers will continue. As reinsurance services are increasingly used to facilitate these transactions and manage risk, the Company expects demand for its products to continue.
markets such as Japan and South Korea are beginning to realize the benefits that reinsurers bring to the life insurance market. Additionally, the Company believes that in certain European markets, ceding companies may want to reduce counterparty exposure to their existing life reinsurers, creating opportunities for the Company.
Asset intensive 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 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 business and other products have 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 Japan. The Company also reinsures the longevity risk related to payout annuities in the UK, 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 Canadian operations. See Note 22 - “Subsequent Event” in the Notes to Consolidated Financial Statements for additional information on the acquisition.
Consolidated income from continuing operations increased $219.3 million, or 116.7%, and decreased $120.5 million, or 39.1%, in 2009 and 2008, respectively. Diluted earnings per share from continuing operations were $5.55 in 2009 compared to $2.88 in 2008 and $4.80 in 2007. The increase in income in 2009 was primarily due to a favorable change in the fair value of embedded derivatives within the U.S. segment due to the impact of tightening credit spreads in the U.S. debt markets. Also contributing to the favorable results were increased net premiums and investment income and the recognition in other revenues of a gain on the repurchase of long-term debt of $38.9 million. The decrease in income in 2008 compared to 2007 reflects an increase in investment related losses due to the recognition of investment impairments and an increase in the unrealized loss due to an unfavorable change in the fair value of embedded derivatives within the U.S. Asset-Intensive sub-segment due primarily to the impact of widening credit spreads in the U.S. debt markets. Also contributing to the decrease in income in 2008 was unfavorable mortality experience in the U.S. Traditional sub-segment. Offsetting these negative income items in 2008 were increases in premium levels in all segments and favorable mortality experience in the Canada, Europe & South Africa and Asia Pacific segments. Foreign currency exchange fluctuations resulted in a decrease to income from continuing operations of approximately $8.7 million in 2009 and an increase of approximately $4.2 million in 2008.
Consolidated net premiums increased $375.9 million, or 7.0%, and $440.3 million, or 9.0%, in 2009 and 2008, respectively, due to growth in life reinsurance in force and scheduled premium increases on treaties written on a yearly-renewable-term basis. Consolidated assumed insurance in force was $2.3 trillion, $2.1 trillion and $2.1 trillion as of December 31, 2009, 2008 and 2007, respectively. The Company added new business production, measured by face amount of insurance in force, of $321.0 billion, $305.0 billion and $302.4 billion during 2009, 2008 and 2007, respectively. Management believes industry consolidation, reduced capital levels in the life insurance industry and the established practice of reinsuring mortality risks should continue to provide opportunities for growth at levels comparable to 2009 and 2008. Foreign currency fluctuations relative to the prior year unfavorably affected net premiums by approximately $207.6 million and approximately $50.3 million in 2009 and 2008, respectively.
Consolidated investment income, net of related expenses, increased $251.2 million, or 28.8%, and decreased $36.6 million, or 4.0%, in 2009 and 2008, respectively, primarily due to market value changes related to the Company’s funds withheld at interest investment related to the reinsurance of certain equity-indexed annuity products, which are substantially offset by a corresponding change in interest credited to policyholder account balances. The increase in investment income in 2009 also reflects a larger average invested asset base offset by a lower effective investment portfolio yield. Largely offsetting the decrease in investment income in 2008 was a larger average invested asset base and a higher effective investment portfolio yield. Average invested assets at amortized cost, excluding funds withheld, totaled $13.0 billion, $11.7 billion and $10.6 billion in 2009, 2008 and 2007, respectively. The average yield earned on investments, excluding funds withheld, was 5.75%, 6.02% and 5.96% in 2009, 2008 and 2007, respectively. The Company expects the average yield to vary from year to year depending on a number of variables, including the prevailing interest rate and credit spread environment, changes in the mix of the underlying investments, and the timing of dividends and distributions on certain investments.
Total investment related gains (losses), net improved by $681.4 million and declined by $468.5 million in 2009 and 2008, respectively. The improvement in 2009 is due to favorable changes in the value of embedded derivatives associated with reinsurance treaties written on a modified coinsurance or funds withheld basis of $506.2 million and guaranteed minimum living benefits of $520.2 million partially offset by an increase in net hedging losses related to the liabilities associated with guaranteed minimum living benefits of $392.3 million. The decline in 2008 is due to an increase of $122.6 million in investment impairments and unfavorable changes in the value of embedded derivatives associated with reinsurance treaties written on a modified coinsurance or funds withheld basis of $285.9 million and guaranteed minimum living benefits of $258.5 million partially offset by an increase in net hedging gains related to the liabilities associated with guaranteed minimum living benefits of $178.8 million. See the discussion of “Investments” in the “Liquidity and Capital Resources” section of Management’s Discussion and Analysis for additional information on impairment losses. Investment income and investment related gains and losses are allocated to the operating segments based upon average assets and related capital levels deemed appropriate to support the segment business volumes.
The consolidated provision for income taxes from continuing operations represents approximately 31.3%, 33.0%, and 35.1% of pre-tax income for 2009, 2008 and 2007, respectively. The 2009 effective tax rate was affected by the recognition of a previously uncertain tax position in addition to the recognition of a deferred tax asset for which a valuation allowance previously existed and by earnings of non-U.S. subsidiaries in which the Company is permanently reinvested whose statutory tax rates are less than the U.S. statutory tax rate. In 2008, the consolidated effective tax rate was lower than expected due to a decrease in the tax liability related to the Company’s uncertain tax position. The Company calculated tax benefits related to its discontinued operations of $5.9 million and $7.8 million for 2008 and 2007, respectively. The effective tax rate on discontinued operations is approximately 35% for both 2008 and 2007.
Additionally, for each of the Company’s reinsurance contracts, it must determine if the contract provides indemnification against loss or liability relating to insurance risk, in accordance with applicable accounting standards. The Company must review all contractual features, particularly those that may limit the amount of insurance risk to which the Company is subject or features that delay the timely reimbursement of claims. If the Company determines that the possibility of a significant loss from insurance risk will occur only under remote circumstances, it records the contract under a deposit method of accounting with the net amount receivable or payable reflected in premiums receivable and other reinsurance balances or other reinsurance liabilities on the consolidated balance sheets. Fees earned on the contracts are reflected as other revenues, as opposed to net premiums, on the consolidated statements of income.
Other policy claims and benefits include claims payable for incurred but not reported losses, which are determined using case-basis estimates and lag studies of past experience. These estimates are periodically reviewed and any adjustments
When available, fair values are based on quoted prices in active markets that are regularly and readily obtainable. Generally, these are very liquid investments and the valuation does not require management judgment. When quoted prices in active markets are not available, fair value is based on market standard valuation techniques, primarily a combination of a market approach, including matrix pricing and an income approach. The assumptions and inputs used by management in applying these techniques include, but are not limited to: interest rates, credit standing of the issuer or counterparty, industry sector of the issuer, coupon rate, call provisions, sinking fund requirements, maturity, estimated duration and assumptions regarding liquidity and future cash flows.
The Company reinsures certain annuity products that contain terms that are deemed to be embedded derivatives, primarily equity-indexed annuities and variable annuities with guaranteed minimum benefits. The Company assesses each identified embedded derivative to determine whether it is required to be bifurcated under the general accounting principles for Derivatives and Hedging. If the instrument would not be accounted for in its entirety at fair value and it is determined that the terms of the embedded derivative are not clearly and closely related to the economic characteristics of the host contract, and that a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative is bifurcated from the host contract and reported separately. Such embedded derivatives are carried on the consolidated balance sheets at fair value with the host contract.
The valuation of the various embedded derivatives requires complex calculations based on actuarial and capital market inputs assumptions related to estimates of future cash flows. Such assumptions include, but are not limited to, assumptions regarding equity market performance, equity market volatility, interest rates, credit spreads, benefits and related contract charges, mortality, lapses, withdrawals, benefit selections and non-performance risk. These assumptions have a significant impact on the value of the embedded derivatives. For example, independent future decreases in equity market returns, future decreases in interest rates and future increases in equity market volatilities would increase the value of the embedded liability derivative associated with guaranteed minimum withdrawal benefits on variable annuities at December 31, 2009, resulting in an increase in investment related losses. See “Market Risk” disclosures in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional information.
Additionally, reinsurance treaties written on a modified coinsurance or funds withheld basis are subject to the general accounting principles for Derivatives and Hedging related to embedded derivatives. The majority of the Company’s funds withheld at interest balances are associated with its reinsurance of annuity contracts, the majority of which are subject to the general accounting principles for Derivatives and Hedging related to embedded derivatives. Management believes the embedded derivative feature in each of these reinsurance treaties is similar to a total return swap on the assets held by the ceding companies. The valuation of these embedded derivatives is sensitive to the credit spread environment. Decreases or increases in credit spreads result in an increase or decrease in value of the embedded derivative and therefore an increase in investment related gains or losses, respectively. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for the U.S. Asset-Intensive Segment for additional information.
The Company may be required to change its provision for income taxes in certain circumstances. Examples of such circumstances include when the ultimate deductibility of certain items is challenged by taxing authorities, when it becomes clear that certain items will not be challenged, or when estimates used in determining valuation allowances on deferred tax assets significantly change or when receipt of new information indicates the need for adjustment in valuation allowances. Additionally, future events such as changes in tax legislation could have an impact on the provision for income tax and the effective tax rate. Any such changes could significantly affect the amounts reported in the consolidated financial statements in the year these changes occur.
The Company at times is a party to various litigation and arbitrations. The Company cannot predict or determine the ultimate outcome of any pending litigation or arbitrations or even provide useful ranges of potential losses. A legal reserve is established when the Company is notified of an arbitration demand or litigation or is notified that an arbitration demand or litigation is imminent, it is probable that the Company will incur a loss as a result and the amount of the probable loss is reasonably capable of being estimated. However, it is possible that an adverse outcome on any particular arbitration or litigation situation could have a material adverse effect on the Company’s consolidated financial position and/or net income in a particular reporting period.
Income before income taxes for the U.S. Traditional sub-segment increased by $24.7 million, or 10.7%, and decreased by $106.6 million, or 31.6% in 2009 and 2008, respectively. The increase in 2009 was primarily driven by an increase in business and slightly better mortality experience as compared to 2008. This was partially offset by increased investment related losses in 2009. The decrease in 2008 was due to an increase in investment related losses of $58.1 million and adverse mortality experience compared to 2007. The increase in investment related losses in 2008 was due to the aforementioned realized investment losses, recognized primarily in the third quarter of 2008.
Net premiums for the U.S. Traditional sub-segment grew $220.8 million, or 7.1%, and $224.7 million, or 7.8% in 2009 and 2008, respectively. These increases in net premiums were driven primarily by the growth of total U.S. Traditional business in force and increasing premium sales associated with treaties written on a yearly renewable term basis. Total face amount was $1,285.5 million, $1,269.0 million and $1,226.8 million as of December 31, 2009 and 2008, and 2007, respectively.
Interest credited expense increased $2.7 million, or 4.5%, and $1.9 million, or 3.2%, in 2009 and 2008, respectively. The 2009 and 2008 increases are the result of one treaty that had a slight increase in its asset base with a credited loan rate remaining constant at 5.6% since 2007. Interest credited in this case relates to amounts credited on cash value products which also have a significant mortality component. The amount of interest credited fluctuates in step with changes in deposit levels, cash surrender values and investment performance. Income before income taxes is affected by the spread between the investment income and the interest credited on the underlying products.
Other operating expenses increased $6.7 million, or 14.0%, and decreased $1.8 million, or 3.6% in 2009 and 2008, respectively. Other operating expenses, as a percentage of net premiums, were 1.6%, 1.6% and 1.7% in 2009, 2008 and 2007, respectively. The expense ratio tends to fluctuate only slightly from period to period due to maturity and scale of this operation.
The U.S. Asset-Intensive sub-segment assumes primarily investment risk within underlying annuities and corporate-owned life insurance policies. Most of these agreements are coinsurance, coinsurance with funds withheld or modified coinsurance whereby the Company recognizes profits or losses primarily from the spread between the investment income earned and the interest credited on the underlying deposit liabilities.
Income for the asset-intensive business tends to be volatile due to changes in the fair value of certain derivatives, including embedded derivatives associated with reinsurance treaties structured on a modified coinsurance (“Modco”) basis or funds withheld basis, as well as embedded derivatives associated with the Company’s reinsurance of equity-indexed annuities
In 2009, the change in fair value of the embedded derivative increased revenues by $78.4 million, partially offset by the related deferred acquisition expenses of $45.3 million, for a positive pre-tax income impact of $33.1 million, primarily due to a decrease in investment credit spreads. During 2008, credit spreads widened sharply, particularly in the second half of the year. As a result, the change in fair value of the embedded derivative decreased revenues by $427.8 million, partially offset by the related deferred acquisition expenses of $246.7 million, for a negative pre-tax income impact of $181.1 million.
Equity-Indexed Annuities- Represents the impact of changes in the risk-free rate on the calculation of the fair value of embedded derivative liabilities associated with equity-indexed annuities, after adjustments for related deferred acquisition expenses and retrocession. In 2009 and 2008, expenses decreased $2.7 million and increased $15.2 million respectively.
The increase in income before taxes and certain derivatives in 2009 of $24.9 million is primarily due to improvement in the broader U.S. financial markets and related favorable impacts on the underlying annuity account values. In addition, investment related gains in funds withheld portfolios, included in investment income, increased $20.5 million before deferred acquisition costs. These increases were partially offset by an $7.7 million increase in policy acquisition costs as a result of deferred acquisition costs recoverability testing of deferred acquisition costs for new business issues. The decrease in income before income taxes and derivatives in 2008 of $10.1 million was primarily due to a combination of investment related losses in funds withheld portfolios, included in investment income, of $15.3 million before deferred acquisition costs and an increase in realized investment related losses of approximately $7.1 million, net of deferred acquisition costs. Higher mortality and fee income earned on the variable annuity transactions also contributed to income in both 2009 and 2008.
The average invested asset base supporting this sub-segment was $5.1 billion, $5.1 billion and $4.8 billion for 2009, 2008 and 2007, respectively. The asset base in 2009 was relatively flat compared to 2008 due to annuity contract surrenders which led to a decline in the account value and related invested asset base, offset by new business written on an existing equity-indexed treaty. The growth in the asset base in 2008 was driven by new business on an existing equity-indexed treaty, a new fixed-annuity transaction and a new guaranteed investment contract, together adding approximately $700.0 million to the asset base of this sub-segment. Invested assets outstanding were $5.2 billion as of December 31, 2009 compared to $5.1 billion in 2008. As of December 31, 2009, $3.6 billion of the invested assets were funds withheld at interest, of which 94.9% of the balance was associated with equity-indexed annuity treaties with one client. As of December 31, 2008, $3.4 billion of the invested assets were funds withheld at interest, of which 91.1% of the balance was associated with equity-indexed annuity treaties with one client.
The 2009 increase of $198.7 million and the 2008 decrease of $68.1 million in benefits and expenses before certain derivatives were primarily due to changes in the interest credited expense related to equity option income on funds withheld equity-indexed annuity treaties. These changes were mostly offset by a corresponding increase or decrease in investment income.
The U.S. Financial Reinsurance sub-segment income before income taxes consists primarily of net fees earned on financial reinsurance transactions. Financial reinsurance risks are assumed by the U.S. segment and a portion are retroceded to other insurance companies or brokered business in which the Company does not participate in the assumption of risk. The fees earned from financial reinsurance contracts and brokered business are reflected in other revenues, and the fees paid to retrocessionaires are reflected in policy acquisition costs and other insurance expenses.
Income before income taxes increased by $4.1 million, or 34.4%, and decreased by $0.8 million, or 6.3%, in 2009 and 2008, respectively. The increase in 2009 was primarily related to new treaties written in the fourth quarter. The decrease in 2008 was primarily due to one treaty, which was recaptured late in 2007.
Reinsurance in force for the Canada operation totaled approximately $276.8 billion, $209.5 billion, and $217.7 billion at December 31, 2009, 2008, and 2007, respectively. On a Canadian dollar basis, reinsurance in force for the Canada operation reflected continued growth and totaled approximately C$290.2 billion, C$255.4 billion, and C$217.4 billion at December 31, 2009, 2008, and 2007, respectively.
respectively. 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.
Net investment income decreased $2.7 million, or 1.9%, and increased $15.8 million, or 12.7%, in 2009 and 2008, respectively. The effect of changes in the Canadian dollar exchange rates resulted in a decrease in net investment income of approximately $9.3 million and an increase of approximately $0.9 million in 2009 and 2008, respectively. Investment income and investment related gains and losses are allocated to the segments based upon average assets and related capital levels deemed appropriate to support segment business volumes. Investment performance varies with the composition of investments and the relative allocation of capital to the operating segments. The increase in investment income in 2008 was mainly the result of an increase in the allocated asset base due to growth in the underlying business volume.
Other revenues decreased by $17.2 million in 2009 but increased by $18.2 million in 2008 compared to 2007. The decrease in 2009 was primarily due to the absence of recapture fees while the increase in 2008 was due to an increase of $16.2 million in recapture fees.
Other operating expenses decreased $0.3 million, or 1.3%, and increased $2.7 million, or 13.1%, in 2009 and 2008, respectively. The effect of changes in the Canadian dollar exchange rates resulted in a decrease in operating expenses of approximately $1.2 million and an increase of approximately $1.1 million in 2009 and 2008, respectively. Other operating expenses as a percentage of net premiums were 3.7%, 4.3% and 4.2% in 2009, 2008 and 2007, respectively.
The Europe & South Africa segment includes operations in France, Germany, India, Italy, Mexico, the Netherlands, Poland, South Africa, Spain and the UK. The segment provides life reinsurance for a variety of products through yearly renewable term and coinsurance agreements, reinsurance of critical illness coverage and to a lesser extent, the reinsurance of longevity risk related to payout annuities. Reinsurance agreements may be facultative or automatic agreements covering primarily individual risks and in some markets, group risks.
A significant 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 $212.1 million, $236.4 million and $235.2 million in 2009, 2008 and 2007, 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.
Loss ratios for this segment were 84.0%, 75.2% and 76.0% in 2009, 2008 and 2007, respectively. During 2009, a retrocession block of business was recaptured which had the effect of increasing the loss ratio. Excluding this recapture, the loss ratio for 2009 was 82.2%. During 2008, a block of business was recaptured which had the effect of lowering the loss ratio. Excluding this recapture, the loss ratio for 2008 was 77.0%. The increases in the loss ratios for 2009 and 2008 were primarily due to unfavorable claims experience in the UK and South Africa. Although reasonably predictable over a period
The Asia Pacific segment includes operations in Australia, Hong Kong, Japan, Malaysia, Singapore, New Zealand, South Korea, Taiwan and mainland China. The principal types of reinsurance include life, critical illness, disability income, superannuation, and financial reinsurance. Superannuation is the Australian government mandated compulsory retirement savings program. Superannuation funds accumulate retirement funds for employees, and, in addition, offer life and disability insurance coverage. Reinsurance agreements may be facultative or automatic agreements covering primarily individual risks and in some markets, group risks.
Income before income taxes decreased by $2.0 million, or 2.3%, and increased by $25.4 million, or 42.3%, in 2009 and 2008, respectively. The decrease in income before income taxes in 2009 was primarily related to increased claims and other policy benefits throughout the segment. The increase in income before income taxes in 2008 was primarily due to increased net premiums and favorable mortality experience throughout the segment. Foreign currency exchange fluctuations resulted in a negligible increase to income before income taxes in 2009 and an increase of approximately $3.6 million in 2008.
Net premiums decreased by $1.9 million, or 0.2%, and increased by $136.3 million, or 15.8%, in 2009 and 2008, respectively. The decrease in premiums in 2009 was due to a decrease of $61.3 million, collectively, in Korea, Taiwan and New Zealand largely offset by an increase of $54.3 million, collectively, in Australia, Hong Kong and Japan compared to 2008. The premium growth in 2008 was primarily the result of increases in Australia, Korea, Taiwan and Japan, collectively adding approximately $121.4 million to net premiums compared to 2007. The segment added new business production, measured by face amount of insurance in force, of $21.0 billion, $31.9 billion and $30.1 billion during 2009, 2008 and 2007,
Throughout most of 2009, there were unfavorable foreign currency fluctuations, particularly in the Australian dollar, Korean won, New Zealand dollar and Taiwanese dollar, against the U.S. dollar. The overall effect of changes in Asia Pacific segment currencies was a decrease in 2009 net premiums of approximately $58.0 million compared to 2008. The unfavorable foreign currency exchange fluctuation in 2009 was partially offset by an increase in net premiums that was primarily the result of new business from both new and existing treaties. During 2008, there was an unfavorable foreign currency fluctuation, particularly in the Korean won, offset by a favorable fluctuation in the Japanese yen, against the U.S. dollar. The overall effect of changes in local Asia Pacific segment currencies was a decrease in 2008 net premiums of approximately $5.0 million compared to 2007.
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 $181.2 million, $213.8 million, and $189.8 million in 2009, 2008 and 2007, respectively.
Net investment income increased $13.9 million, or 29.4%, and $11.0 million, or 30.3%, in 2009 and 2008, respectively. These increases can be primarily attributed to growth in the invested asset base. 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 the segment business volumes. Investment performance varies with the composition of investments and the relative allocation of capital to the operating segments.
Other revenues increased by $12.7 million, or 103.2%, and $3.1 million, or 34.0%, in 2009 and 2008, respectively. The primary source of other revenues is fees from financial reinsurance treaties in Japan. At December 31, 2009 and 2008, the amount of reinsurance assumed from client companies, as measured by pre-tax statutory surplus, was $0.5 billion and $0.6 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.
Policy acquisition costs and other insurance expenses as a percentage of net premiums were 10.7%, 10.7% and 11.5% for 2009, 2008 and 2007, respectively. The ratio of policy acquisition costs and other insurance expenses as a percentage of net premiums should generally decline as the business matures; however, the percentage does fluctuate periodically due to timing of client company reporting and variations in the mixture of business.
Other operating expenses increased $12.2 million, or 18.5%, and $9.5 million, or 16.9%, in 2009 and 2008, respectively. Other operating expenses as a percentage of net premiums totaled 7.8%, 6.6% and 6.5% in 2009, 2008 and 2007, respectively. The timing of premium flows and the level of costs associated with the entrance into and development of new markets in the growing Asia Pacific segment may cause other operating expenses as a percentage of net premiums to fluctuate over periods of time.
The Company periodically reviews the EGP valuation model and assumptions so that the assumptions reflect a reasonable view 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 ($1,177.6 million as of December 31, 2009), are changed as illustrated:
Estimated future policy lapse rates decreasing (increasing) 20% on a permanent basis (including surrender charges)
Results of operations in 2009 reflect a favorable change in the value of embedded derivatives as credit spreads tightened significantly since the first quarter of 2009. Gross unrealized losses in the Company’s fixed maturity and equity securities available-for-sale have improved from $1,552.8 million at March 31, 2009 and $1,416.4 million at December 31, 2008 to $584.9 million at December 31, 2009. Likewise, gross unrealized gains have also improved. The recent market conditions have adversely affected the Company’s results of operations and financial position. From the third quarter of 2008 through the end of 2009, the Company incurred significant investment related losses as a result of impairments. Results of operations in 2008 also reflected a significant unfavorable change in the value of embedded derivatives, which is a direct result of widening credit spreads and changes in the risk-free rates in the U.S. debt markets.
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 the early recapture of a reinsurance treaty by the ceding company and significantly
higher than expected death claims. Historically, the Company has generated positive net cash flows from operations. However, in the event of significant unanticipated cash requirements beyond normal liquidity, the Company has multiple liquidity alternatives available based on market conditions and the amount and timing of the liquidity need. These options include borrowings under committed credit facilities, secured borrowings, the ability to issue long-term debt, preferred securities or common equity and, if necessary, the sale of invested assets subject to market conditions.
RCM and RGA Reinsurance 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. 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. RCM’s primary asset is its investment in RGA Reinsurance. As of January 1, 2010, RCM and RGA Reinsurance could pay maximum dividends, without prior approval, of approximately $141.3 million and $146.6 million, respectively. 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.
The dividend limitations for RCM and RGA Reinsurance are based on statutory financial results. Statutory accounting practices differ in certain respects from accounting principles used in financial statements prepared in conformity with GAAP. Significant differences include deferred acquisition costs, deferred income taxes, required investment reserves, reserve calculation assumptions and surplus notes.
Certain of the Company’s debt agreements contain financial covenant restrictions related to, among other things, liens, the issuance and disposition of stock of restricted subsidiaries, minimum requirements of net worth, maximum ratios of debt to capitalization and change in control provisions. A material ongoing covenant default could require immediate
The Company maintains three revolving credit facilities, including a syndicated credit facility with an overall capacity of $750.0 million that expires in September 2012. The Company may borrow cash and may obtain letters of credit in multiple currencies under this facility. As of December 31, 2009, the Company had no cash borrowings outstanding and $373.9 million in issued, but undrawn, letters of credit under this facility. The Company’s other credit facilities consist of a £15.0 million credit facility that expires in May 2011, and an A$50.0 million Australian credit facility that expires in March 2011, with no outstanding balances as of December 31, 2009.
As of December 31, 2009, the average interest rate on long-term and short-term debt outstanding, excluding the Company-obligated mandatorily redeemable preferred securities of subsidiary trust holding solely junior subordinated debentures of the Company (“Trust Preferred Securities”), was 6.38% compared to 6.39% at the end of 2008. Interest is expensed on the face amount, or $225.0 million, of the Trust Preferred Securities at a rate of 5.75%.
Reinsurance agreements, whether facultative or automatic, generally provide recapture provisions. Most U.S.-based reinsurance treaties include a recapture right for ceding companies, generally after 10 years. Outside of the U.S., treaties primarily include a mutually agreed upon recapture provision. Recapture rights permit the ceding company to reassume all or a portion of the risk formerly ceded to the reinsurer. In some situations, the Company has the right to place assets in trust for the benefit of the ceding party in lieu of recapture. Additionally, certain treaties may grant recapture rights to ceding companies in the event of a significant decrease in RGA Reinsurance’s NAIC risk based capital ratio or financial strength rating. The RBC ratio trigger varies by treaty at amounts between 125% and 225% of the NAIC’s company action level. Financial strength rating triggers vary by treaty with the majority of the triggers reached if RGA Reinsurance’s financial strength rating falls five notches from its current rating of “AA-“ to the “BBB” level on the S&P scale. Recapture of business previously ceded does not affect premiums ceded prior to the recapture of such business, but would reduce premiums in subsequent periods. Upon recapture, the Company would reflect a net gain or loss on the settlement of the assets and liabilities associated with the treaty. In some cases, the ceding company is required to pay the Company a recapture fee. The Company estimates approximately $294.5 billion of its gross assumed in force business, as of December 31, 2009, was subject to treaties where the ceding company could recapture in the event minimum levels of financial condition or ratings were not maintained.
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, 2009, these treaties had approximately $1,059.3 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 $1,022.4 million were held in trust for the benefit of certain subsidiaries of the Company to satisfy collateral requirements for reinsurance business at December 31, 2009. Additionally, securities with an amortized cost of $1,755.6 million as of December 31, 2009 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 RGA subsidiary 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. If RGA was ever required to perform under these obligations, the risk to the consolidated company 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.
Additional sources of liquidity to meet unexpected cash outflows in excess of operating cash inflows and current cash and equivalents on hand include selling short-term investments or fixed maturity securities and drawing funds under existing credit facilities, under which the Company had availability of $445.3 million as of December 31, 2009. The Company also has $685.6 million of funds available through collateralized borrowings from the Federal Home Loan Bank of Des Moines (“FHLB”).
of its business operations will be sufficiently met by the positive cash flows generated. Additionally, the Company believes it maintains a high-quality fixed maturity portfolio with positive liquidity characteristics. These securities are available-for-sale and could be sold if necessary to meet the Company’s short- and long-term obligations, subject to market conditions.
Net cash used in investing activities was $1,939.1 million, $1,073.2 million and $976.9 million in 2009, 2008 and 2007, respectively. Changes in cash used in investing activities primarily relate to the management of the Company’s investment portfolios and the investment of excess cash generated by operating and financing activities. The increase in net cash used in investing activities in 2009 was due in part to the investment of proceeds from the issuance of common stock in the fourth quarter of 2008 and senior notes issued in the fourth quarter of 2009. The increase in net cash used in investing activities in 2008 was primarily due to the investment of proceeds from investment type contracts.
Net cash provided by financing activities was $195.0 million, $841.2 million and $116.6 million in 2009, 2008 and 2007, respectively. The decrease in cash provided by financing activities in 2009 was largely due to reduced deposits under investment type contracts, a $335.5 million decrease in the cash collateral received under derivative contracts due to a change in the value of the underlying derivatives and $62.5 million related to the repurchase and repayment of long-term debt. The increase in cash provided by financing activities in 2008 was largely due to deposits under investment type contracts and a $159.8 million increase in the cash collateral received under derivative contracts due to a change in the value of the underlying derivatives. Issuances of Company securities resulted in increases in cash provided by financing activities of $64.5 million and $36.6 million in 2009 and 2008, respectively.
Future policyholder benefits include liabilities related primarily to the Company’s reinsurance of life and health insurance products. Amounts presented in the table above represent the estimated obligations as they become due to ceding companies for benefits under such contracts, and also include future premiums, allowances and other amounts due to or from the ceding companies as the result of the Company’s assumptions of mortality, morbidity, policy lapse and surrender risk as appropriate to the respective product. Total payments may vary materially from prior years due to the assumption of new treaties or as a result of changes in projections of future experience. All estimated cash payments presented in the table above are undiscounted as to interest, net of estimated future premiums on policies currently in force and gross of any reinsurance recoverable. The sum of the undiscounted estimated cash flows shown for all years in the table is a negative obligation of $(1,293.3) million compared to the discounted liability amount of $7,748.5 million included on the consolidated balance sheet, substantially all due to the effects of discounting the estimated cash flows. The time value of money is not factored into the calculations in the table above. In addition, differences will arise due to changes in the projection of future benefit payments compared with those developed when the reserve was established. Expected premiums exceed expected policy benefit payments and allowances due to the nature of the reinsurance treaties, which generally have increasing premium rates that exceed the increasing benefit payments.
Interest-sensitive contract liabilities include amounts related to the Company’s reinsurance of asset-intensive products, primarily deferred annuities and corporate-owned life insurance. Amounts presented in the table above represent the estimated obligations as they become due both to and from ceding companies relating to activity of the underlying policyholders. Amounts presented in the table above represent the estimated obligations under such contracts undiscounted as to interest, including assumptions related to surrenders, withdrawals, premium persistency, partial withdrawals, surrender charges, annuitizations, mortality, future interest credited rates and policy loan utilization. The sum of the obligations shown for all years in the table of $13,070.5 million exceeds the liability amount of $7,666.0 million included on the consolidated balance sheet principally due to the lack of discounting and accounting for separate account contracts.
In 2006, the Company entered into a reinsurance agreement that requires it to post collateral for a portion of the business being reinsured. As part of the collateral requirements, a third party financial institution has issued a letter of credit
for the benefit of the ceding company (the “beneficiary”), which may draw on the letter of credit to be reimbursed for valid claim payments not made by RGA pursuant to the reinsurance treaty. RGA is not a direct obligor under the letter of credit. To the extent the letter of credit is drawn by the beneficiary, reimbursement to the third party financial institution will be through reduction in amounts owed to RGA by the third party financial institution under a secured structured loan. RGA’s liability under the reinsurance agreement will be reduced by any amount drawn by the ceding company under the letter of credit. As of December 31, 2009, the structured loan totaled $150.7 million and the amount of the letter of credit totaled $150.7 million. The structured loan is recorded in “other invested assets” on RGA’s consolidated balance sheets.
The Company periodically sells investment securities under agreements to repurchase the same securities. These arrangements are used for purposes of short-term financing. There were no securities subject to these agreements outstanding at December 31, 2009 or 2008. The book value of securities subject to these agreements, if any, are included in fixed maturity securities while the repurchase obligations would be reported in other liabilities in the consolidated statement of financial position. The Company also occasionally enters into arrangements to purchase securities under agreements to resell the same securities. Amounts outstanding, if any, are reported in cash and cash equivalents. These agreements are primarily used as yield enhancement alternatives to other cash equivalent investments. There were no agreements outstanding at December 31, 2009 or 2008.
RGA Reinsurance is a member of the FHLB and holds $27.8 million of common stock in the FHLB, which is included in other invested assets on the Company’s consolidated balance sheets. RGA Reinsurance occasionally enters into traditional funding agreements with the FHLB but had no outstanding traditional funding agreements with the FHLB at December 31, 2009 or 2008.
effect on profitability. Certain of these asset-intensive agreements, primarily in the U.S. operating segment, are generally funded by fixed maturity securities that are withheld by the ceding company.
The Company had total cash and invested assets of $19.7 billion and $16.5 billion at December 31, 2009 and 2008, respectively, as illustrated below (dollars in thousands):
Investment yield decreased in 2009 as the decline of certain key indices such as LIBOR resulted in lower investment returns on the Company’s floating rate investments. In addition, recent economic conditions, have resulted in the decision to maintain a higher level of liquidity. Thus, the Company invested some of its cash flows in highly liquid assets with shorter maturities than what was previously held in the portfolio, which has also contributed to the decrease in the average yield of the portfolio. Investment yield increased in 2008 as the economic environment allowed the Company to invest in securities with higher spreads than those already held in the portfolio. Also in 2008, new liability structures with longer duration targets allowed the Company to invest in securities with longer maturities than what was held in the portfolio, which, in a positively-sloped yield curve environment, has also contributed to the increase in the average yields of the portfolio.
The following tables provide information relating to investments in fixed maturity securities and equity securities by sector as of December 31, 2009 and 2008 (dollars in thousands):
Important factors in the selection of investments include diversification, quality, yield, total rate of return potential and call protection. The relative importance of these factors is determined by market conditions and the underlying product or portfolio characteristics. Cash equivalents are primarily invested in high-grade money market instruments. The largest asset class in which fixed maturities were invested was in corporate securities, which represented approximately 45.9% of total fixed maturities at December 31, 2009, compared to 46.7% at December 31, 2008. The tables below show the major industry types and weighted average credit ratings, which comprise the U.S. and foreign corporate fixed maturity holdings at December 31, 2009 and 2008 (dollars in thousands):
Includes U.S. dollar-denominated debt obligations of foreign obligors and other foreign investments.
The residential mortgage-backed securities include agency-issued pass-through securities, collateralized mortgage obligations, a majority of which are guaranteed or otherwise supported by the Federal Home Loan Mortgage Corporation, Federal National Mortgage Association, or the Government National Mortgage Association. The weighted average credit rating of the residential mortgage-backed securities was “AA+” at December 31, 2009 and 2008. The principal risks inherent in holding mortgage-backed securities are prepayment and extension risks, which will affect the timing of when cash will be received and are dependent on the level of mortgage interest rates. Prepayment risk is the unexpected increase in principal payments, primarily as a result of owner refinancing. Extension risk relates to the unexpected slowdown in principal payments. In addition, mortgage-backed securities face default risk should the borrower be unable to pay the contractual interest or principal on their obligation. The Company monitors its mortgage-backed securities to mitigate exposure to the cash flow uncertainties associated with these risks.
As of December 31, 2009 and 2008, the Company had exposure to commercial mortgage-backed securities with amortized costs totaling $1,655.0 million and $1,573.4 million, and estimated fair values of $1,439.1 and $1,143.3 million. Those amounts include exposure to commercial mortgage-backed securities held directly in the Company’s investment portfolios within fixed maturity securities, as well as securities held by ceding companies that support the Company’s funds withheld at interest investment. The securities are highly rated with weighted average S&P credit ratings of approximately “AA” and “AA+” at December 31, 2009 and 2008, respectively. Approximately 65.1% and 83.7%, based on estimated fair value, were classified in the “AAA” category at December 31, 2009 and 2008, respectively. The Company recorded other-than-temporary impairments of $7.8 million, net of non-credit adjustments, in its direct investments in commercial mortgage-backed securities for the year ended December 31, 2009. The Company did not record any other-than-temporary impairments in its direct investments in commercial mortgage-backed securities in 2008. The following tables summarize the securities by rating and underwriting year at December 31, 2009 and 2008 (dollars in thousands):
Asset-backed securities include credit card and automobile receivables, sub-prime mortgage-backed securities, home equity loans, manufactured housing bonds and collateralized debt obligations. The Company’s asset-backed securities are diversified by issuer and contain both floating and fixed rate securities and had a weighted average credit rating of “AA” at December 31, 2009 and 2008. The Company owns floating rate securities that represent approximately 19.0% and 20.0% of the total fixed maturity securities at December 31, 2009 and 2008, 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 facility. 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’ priority in the issuer’s capital structure, the adequacy of and ability to realize proceeds from collateral, and the potential for prepayments. Credit risks include consumer or corporate credits such as credit card holders, equipment lessees, and corporate obligors. Capital market risks include general level of interest rates and the liquidity for these securities in the marketplace.
At December 31, 2009 and 2008, the Company’s fixed maturity and funds withheld portfolios included approximately $601.8 million and $538.2 million, respectively, in estimated fair value, of securities that are insured by various financial guarantors, or less than five percent of consolidated investments. The securities are diversified between municipal bonds and asset-backed securities with well diversified collateral pools. The Company invested in insured collateralized debt obligation (“CDO”) structures backing sub-prime investments of approximately $0.2 million and $0.1 million at December 31, 2009 and 2008, respectively. The insured securities are primarily investment grade, at issuance, without the benefit of the insurance provided by the financial guarantor and therefore the Company does not expect to incur significant realized losses as a result of the financial difficulties encountered by several of the financial guarantors. In addition to the insured securities, the Company held investment-grade securities issued by financial guarantors totaling $8.3 million and $13.4 million in amortized cost at December 31, 2009 and 2008, respectively.
impairments in 2008 and 2009 are due primarily to the continued turmoil in the U.S. and global financial markets which has resulted in bankruptcies, credit defaults, consolidations and government interventions. The table below summarizes other-than-temporary impairments for 2009, net of non-credit adjustments, 2008 and 2007 (dollars in thousands).
The following tables present the estimated fair values and gross unrealized losses, including other-than-temporary impairment losses reported in AOCI, for the 1,316 and 1,716 fixed maturity securities and equity securities that have estimated fair values below amortized cost at December 31, 2009 and 2008, respectively. These investments are presented by class and grade of security, as well as the length of time the estimated fair value has remained below amortized cost.
As of December 31, 2009, the Company does not intend to sell these fixed maturity securities and does not believe it is more likely than not that it will be required to sell these fixed maturity securities before the recovery of the fair value up to the current amortized cost of the investment, which may be maturity. However, as facts and circumstances change, the Company may sell fixed maturity securities in the ordinary course of managing its portfolio to meet diversification, credit quality, asset-liability management and liquidity profile. As of December 31, 2009, the Company has the ability and intent to hold the equity securities until the recovery of the fair value up to the current cost of the investment. However, from time to time if facts and circumstances change, the Company may sell equity securities in the ordinary course of managing its portfolio to meet diversification, credit quality and liquidity profile.
As of December 31, 2009 and 2008, respectively, the Company classified approximately 15.3% and 17.1% of its fixed maturity securities in the Level 3 category (refer to Note 6 - “Fair Value of Financial Instruments” in the Notes to Consolidated Financial Statements for additional information). These securities primarily consist of private placement corporate securities with an inactive trading market and asset-backed securities with subprime exposure in the Level 3 category due to the current market uncertainty associated with these securities and the Company’s utilization of information from third parties.
Valuation allowances on mortgage loans are established based upon losses expected by management to be realized in connection with future dispositions or settlement of mortgage loans, including foreclosures. The valuation allowances are established after management considers, among other things, the value of underlying collateral and payment capabilities of debtors. Any subsequent adjustments to the valuation allowances will be treated as investment gains or losses. Information
regarding the Company’s loan valuation allowances for mortgage loans as of December 31, 2009 and 2008 are as follows (dollars in thousands):
Funds withheld at interest comprised approximately 24.8% and 27.4% of the Company’s cash and invested assets as of December 31, 2009 and 2008, respectively. Of the $4.9 billion funds withheld at interest balance as of December 31, 2009, $3.4 billion of the balance is associated with one client. 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. Interest accrues to these assets at rates defined by the treaty terms and the Company estimated the yields were approximately 7.69%, 3.54% and 6.42% for the years ended December 31, 2009, 2008 and 2007, respectively. Changes in these estimated yields are affected by equity options held in the funds withheld portfolio associated with equity-indexed annuity treaties. The Company is subject to the investment performance on the withheld assets, although it does not directly control them. These assets are primarily fixed maturity investment securities and pose risks similar to the fixed maturity securities the Company owns. To mitigate this risk, the Company helps set the investment guidelines followed by the ceding company and monitors
compliance. Ceding companies with funds withheld at interest had an average rating of “A” and “A+” at December 31, 2009 and 2008, respectively. Certain ceding companies maintain segregated portfolios for the benefit of the Company.
The Company has utilized derivative financial instruments, primarily to protect the Company against possible changes in the fair value of its investment portfolio as a result of interest rate changes, 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. The Company’s use of derivative financial instruments historically has not been significant to its financial position.
Generally, RGA’s insurance subsidiaries retrocede amounts in excess of their retention to RGA Reinsurance, Parkway Re, RGA Barbados, RGA Americas, 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, 2009, all retrocession pool members in this excess retention pool reviewed by the A.M. Best Company were rated “A-”, the fourth highest rating out of fifteen possible ratings, or better. For a majority of the retrocessionaires that were not rated, letters of credit or trust assets have been given as additional security in favor of RGA Reinsurance. In addition, the Company performs annual financial and in force reviews of its retrocessionaires to evaluate financial stability and performance.
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, 2009 and 2008 was $355.5 million and $169.6 million, respectively.
At December 31, 2009, the Company’s estimated changes in fair value were within the targets outlined in the Company’s investment policy.
The cash flows from interest payments move in the same direction as interest rates for the Company’s floating rate instruments. The volatility in mortgage prepayments partially offsets the cash flows from interest. At December 31, 2009, the Company’s estimated changes in cash flows were within the targets outlined in the Company’s investment policy.
The Company is subject to foreign currency translation, transaction, and net income exposure. The Company manages its exposure to currency principally by matching invested assets with the underlying reinsurance liabilities to the extent possible. The Company has in place net investment hedges for a portion of its investments in its Canada and Australia operations. Translation differences resulting from translating foreign subsidiary balances to U.S. dollars are reflected in stockholders’ equity on the consolidated balance sheets. The Company generally does not hedge the foreign currency exposure of its subsidiaries transacting business in currencies other than their functional currency (transaction exposure). The majority of the Company’s foreign currency transactions are denominated in Canadian dollars, British pounds, Australian dollars, Japanese yen, Korean won, euros, and the South African rand.
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 mitigate the risks associated with income volatility around the change in reserves on guaranteed benefits. 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, 2009 and 2008.
The primary, direct effect on the Company of inflation is the increase in operating expenses. A large portion of the Company’s operating expenses consists of salaries, which are subject to wage increases at least partly affected by the rate of inflation. The rate of inflation also has an indirect effect on the Company. To the extent that a government’s policies to control the level of inflation result in changes in interest rates, the Company’s investment income is affected.
In April 2009, the FASB amended the general accounting principles for Investments as it relates to the recognition and presentation of other-than-temporary impairments. This amendment updates the other-than-temporary impairment guidance for debt securities to make it more operational and to improve the presentation and disclosure of other-than-temporary impairments (“OTTI”) on debt and equity securities in the financial statements. The recognition provisions apply only to debt securities classified as available-for-sale and held-to-maturity, while the presentation and disclosure
In June 2009, the FASB amended the general accounting principles for Transfers and Servicing as it relates to the transfers of financial assets. This amendment also requires additional disclosures to address concerns regarding the transparency of transfers of financial assets. The amendment is effective for fiscal years and interim periods beginning after November 15, 2009. The Company is currently evaluating the impact of this amendment on its consolidated financial statements.
In February 2008, the FASB amended the general accounting principles for Transfers and Servicing as it relates to the accounting for transfers of financial assets and repurchase financing transactions. This amendment provides guidance for evaluating whether to account for a transfer of a financial asset and repurchase financing as a single transaction or as two separate transactions. The amendment is effective prospectively for financial statements issued for fiscal years beginning after November 15, 2008. The adoption of this amendment did not have a material impact on the Company’s consolidated financial statements.
In March 2008, the FASB amended the general accounting principles for Derivatives and Hedging as it relates to the disclosures about derivative instruments and hedging activities. This amendment requires enhanced qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. The amendment is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company adopted this amendment in the first quarter of 2009. The required disclosures are provided in Note 5 - “Derivative Instruments” in the Notes to Consolidated Financial Statements.
In December 2008, the FASB amended the general accounting principles for Compensation as it relates to employers disclosures about postretirement benefit plan assets. This amendment provides guidance for disclosure of the types of assets and associated risks in retirement plans. The new disclosures are designed to provide additional insight into the major categories of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period, significant concentrations of risk within plan assets and how investment decisions are made, including factors necessary to understanding investment policies and strategies. The disclosures about plan assets required by this amendment is effective for financial statements with fiscal years ending after December 15, 2009. The Company has adopted this amendment. The required disclosures are provided in Note 10 - “Employee Benefit Plans” in the Notes to Consolidated Financial Statements.
The Company has determined that there were no subsequent events, other than as disclosed in Note 22 - “Subsequent Event”, that would require disclosure or adjustments to the accompanying consolidated financial statements through February 26, 2010, the date the financial statements were issued.
less any recorded credit loss, the recognition of the other-than-temporary impairment is bifurcated. The Company recognizes the credit loss portion in investment related gains (losses), net and the non-credit loss portion in AOCI.
The cost of other invested assets is adjusted for impairments in value deemed to be other-than-temporary in the period in which the determination is made. These impairments are included within investment related gains (losses), net and the cost basis of the investment securities is reduced accordingly. The Company does not change the revised cost basis for subsequent recoveries in value. However, the Company will adjust the cost basis for any necessary accretion or amortization.
(i) a fair value hedge; (ii) a cash flow hedge; (iii) a foreign currency hedge; or (iv) a hedge of a net investment in a foreign operation. In this documentation, the Company sets forth how the hedging instrument is expected to hedge the designated risks related to the hedged item and sets forth the method that will be used to retrospectively and prospectively assess the hedging instrument’s effectiveness and the method which will be used to measure ineffectiveness. A derivative designated as a hedging instrument must be assessed as being highly effective in offsetting the designated risk of the hedged item. Hedge effectiveness is formally assessed at inception and periodically throughout the life of the designated hedging relationship. Assessments and measurement of hedge effectiveness are also subject to interpretation and estimation and different interpretations or estimates may have a material effect on the amount reported in net income.
Quoted prices in markets that are not active or inputs that are observable either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities other than quoted prices in Level 1; quoted prices in markets that are not active; or other inputs that are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.
Costs of acquiring new business, which vary with and are primarily related to the production of new business, have been deferred to the extent that such costs are deemed recoverable from future premiums or gross profits. Such costs include commissions and allowances as well as certain costs of policy issuance and underwriting. The Company performs periodic tests to establish that Deferred Policy Acquisition Costs (“DAC”) remain recoverable at all times, including at issue, and if financial performance significantly deteriorates to the point where a premium deficiency exists, a cumulative charge to current operations will be recorded. As a result of recoverability testing for new business issues, a charge of approximately $7.7 million to current operations was recorded in the Asset Intensive sub-segment in 2009 with projected revenue deemed insufficient to cover future benefits and expenses.
The Company assumes and retrocedes financial reinsurance contracts that represent low mortality risk reinsurance treaties. These contracts are reported as deposits and are included in other reinsurance assets/liabilities. The amount of revenue reported in other revenues on these contracts represents fees and the cost of insurance under the terms of the reinsurance agreement. Balances resulting from the assumption and/or subsequent transfer of benefits and obligations resulting from cash flows related to variable annuities have also been classified as other reinsurance balance assets and/or liabilities.
Liabilities for future benefits on life policies are established in an amount adequate to meet the estimated future obligations on policies in force. Liabilities for future policy benefits under long-term life insurance policies have been computed based upon expected investment yields, mortality and withdrawal (lapse) rates, and other assumptions. These assumptions include a margin for adverse deviation and vary with the characteristics of the plan of insurance, year of issue, age of insured, and other appropriate factors. Interest rates range from 4.0% to 6.3%. The mortality and withdrawal assumptions are based on the Company’s experience as well as industry experience and standards. Liabilities for future benefits on interest-sensitive life and investment-type contract liabilities are carried at the accumulated contract holder values without reduction for potential surrender or withdrawal charges.
The Company periodically reviews actual and anticipated experience compared to the assumptions used to establish policy benefits. The Company establishes premium deficiency reserves if actual and anticipated experience indicates that existing policy liabilities together with the present value of future gross premiums will not be sufficient to cover the present value of future benefits, settlement and maintenance costs and to recover unamortized acquisition costs. The premium deficiency
RGA and its eligible subsidiaries file a consolidated federal income tax return. The U.S. consolidated tax return includes the operations of RGA, RGA Americas, RGA Reinsurance, RGA Barbados, RGA Technology Partners, Inc., RCM, RGA Sigma Reinsurance SPC, Timberlake Financial L.L.C. (“Timberlake Financial”), Timberlake Reinsurance Company II (“Timberlake Re”), Reinsurance Partners, Inc., RGA Worldwide Reinsurance Company, Ltd. (“RGA Worldwide”), formerly Triad Re, Ltd., and Parkway Reinsurance Company (“Parkway Re”). The Company’s Argentine, Australian, certain Barbadian, Bermudian, Canadian, South African, Indian, Irish, Singaporean and United Kingdom subsidiaries are taxed under applicable local statutes.
Income taxes represent the net amount of income taxes that the Company expects to pay to or receive from various taxing jurisdictions in connection with its operations. The Company provides for federal, state and foreign income taxes currently payable, as well as those deferred due to temporary differences between the financial reporting and tax bases of assets and liabilities. The Company’s accounting for income taxes represents management’s best estimate of various events and transactions.
The realization of deferred tax assets depends upon the existence of sufficient taxable income within the carryback or carryforward periods under the tax law in the applicable tax jurisdiction. The Company has significant deferred tax assets related to net operating and capital losses. Most of the Company’s exposure related to its deferred tax assets are within legal entities that file a consolidated U.S. federal income tax return. The Company has projected its ability to utilize its net operating losses and has determined that all of these losses are expected to be utilized prior to their expiration. The Company
Collateral finance facility represents notes issued to fund collateral requirements for statutory reserves on specified term life insurance policies reinsured by RGA Reinsurance. The cost of the facility is reflected in collateral finance facility expense. See Note 16 - “Collateral Finance Facility” for additional information.
The fair value of the detachable warrants on the date the PIERS units were issued is recorded in stockholders’ equity on the consolidated balance sheets under the caption “Warrants”. In the aggregate as of December 31, 2009, 4.5 million warrants to purchase approximately 5.6 million shares of Company common stock at a price per share of $39.98 were outstanding. If on any date after December 18, 2004, the closing price of RGA common stock exceeds and has exceeded a price per share equal to $47.97 for at least 20 trading days within the immediately preceding 30 consecutive trading days, the Company may redeem the warrants in whole for cash, RGA common stock, or a combination of cash and RGA common stock.
In the normal course of business, the Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to other insurance enterprises or reinsurers under excess coverage and coinsurance contracts. Effective January 1, 2008, the Company increased the maximum amount of coverage that it retains per life in the U.S. from $6.0 million to $8.0 million. This increase does not affect business written prior to January 1, 2008, unless the Company elects to recapture eligible business previously ceded at a lower retention level. Claims in excess of this retention amount are retroceded to retrocessionaires; however, the Company remains fully liable to the ceding company for the entire amount of risk it assumes. The increase in the Company’s U.S. retention limit from $6.0 million to $8.0 million reduces the amount of premiums it pays to retrocessionaires, but increases the maximum effect a single death claim can have on its results and therefore may result in additional volatility to its results. In certain limited situations, due to the acquisition of in force blocks of business, the Company has retained more than $8.0 million per individual policy. In total, there are 17 such cases of over-retained policies, for amounts averaging $1.6 million over the Company’s normal retention limit. The largest amount in excess of the Company’s retention on any one life is $6.3 million. The Company enters into agreements with other reinsurers to mitigate the risk related to the over-retained policies. Additionally, due to some lower face amount reinsurance coverages provided by the Company in addition to individual life, such as group life, disability and health, under certain circumstances, the Company could potentially incur claims totaling more than $8.0 million per individual life in the U.S. For other countries, particularly those with higher risk factors or smaller books of business, the Company systematically reduces its retention. The Company has a number of retrocession arrangements whereby certain business in force is retroceded on an automatic or facultative basis.
The following table presents the weighted average interest-crediting rates and minimum guaranteed rate ranges for contracts containing guaranteed rates by major class of interest-sensitive product as of December 31, 2009.
The Company manages interest rate spreads 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 $843.4 million of account balances are not subject to surrender charges, with 69.6% of these already at their minimum guaranteed rates as of December 31, 2009. 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 matching floating rate liabilities with corresponding floating rate assets and by matching fixed rate liabilities with corresponding fixed rate assets. On a limited basis, the Company may use equity options or other derivatives to minimize its exposure to movements in equity markets that have a direct correlation with certain of its reinsurance products.
Investment income is recognized as it accrues or is legally due. Realized gains and losses on sales of investments are included in investment related gains (losses), net, as are credit impairments that are other-than-temporary in nature. The cost of investments sold is determined based upon the specific identification method.
In January 2010, the FASB amended the general accounting principles for Consolidation as it relates to decreases in ownership of a subsidiary. This amendment clarifies the scope of the decrease in ownership provisions. This amendment also requires additional disclosures about the deconsolidation of a subsidiary or derecognition of a group of assets. The amendment is effective for fiscal years and interim periods beginning after December 15, 2009. The adoption of this amendment is not expected to have an impact on the consolidated financial statements.
In June 2009, the FASB amended the general accounting principles for Consolidation as it relates to the assessment of a variable interest entity. This amendment also requires additional disclosures to provide transparent information regarding the involvement in a variable interest entity. The amendment is effective for fiscal years and interim periods beginning after November 15, 2009. The Company is currently evaluating the impact of this amendment on its consolidated financial statements.
In December 2007, the FASB amended the general accounting principles for Business Combinations. This amendment establishes principles and requirements for how an acquirer recognizes and measures certain items in a business combination, as well as disclosures about the nature and financial effects of a business combination. The FASB also amended the general accounting principles for Consolidation as it relates to noncontrolling interests in consolidated financial statements. This amendment establishes accounting and reporting standards surrounding noncontrolling interest, or minority interests, which are the portions of equity in a subsidiary not attributable, directly or indirectly, to a parent. The amendments are effective for fiscal years beginning on or after December 15, 2008 and apply prospectively to business combinations. Presentation and disclosure requirements related to noncontrolling interests must be retrospectively applied. The adoption of these amendments did not have a material impact on the Company’s consolidated financial statements.
In April 2009, the FASB amended the general accounting principles for Investments as it relates to the recognition and presentation of other-than-temporary impairments. This amendment updates the other-than-temporary impairment guidance for debt securities to make it more operational and to improve the presentation and disclosure of other-than-temporary impairments (“OTTI”) on debt and equity securities in the financial statements. The recognition provisions apply only to debt securities classified as available-for-sale and held-to-maturity, while the presentation and disclosure requirements apply to both debt and equity securities. An impaired debt security will be considered other-than-temporarily impaired if the Company has the intent to sell or it more likely than not will be required to sell prior to recovery of the amortized cost. If the holder of a debt security does not expect recovery of the entire cost basis, even if there is no intention to sell the security, an OTTI has occurred. This amendment also changes how an entity recognizes an OTTI for a debt security by separating the loss between the amount representing the credit loss and the amount relating to other factors, if the Company does not have the intent to sell or it more likely than not will not be required to sell prior to recovery of the amortized cost less any current period credit loss. Credit losses will be recognized in net income and losses relating to other factors will be recognized in AOCI. If the Company has the intent to sell or it more likely than not will be required to sell before its recovery of amortized cost less any current period credit loss, the entire OTTI will be recognized in net income. This amendment is effective for interim and annual reporting periods ending after June 15, 2009. The adoption of this amendment resulted in a net after-tax increase to retained earnings and a decrease to accumulated other comprehensive income of $4.4 million, as of April 1, 2009. The required disclosures are provided in Note 4 - “Investments”.
amendment is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company adopted this amendment in the first quarter of 2009. The required disclosures are provided in Note 5 - “Derivative Instruments”.
In January 2010, the FASB amended the general accounting principles for Fair Value Measurements and Disclosures as it relates to the disclosures about fair value measurements. This amendment requires new disclosures about the transfers in and out of Level 1 and 2 measurements and also enhances disclosures about the activity within the Level 3 measurements. It also clarifies the required level of disaggregation and the disclosures regarding valuation techniques and inputs to fair value measurements. The amendment is effective for interim and annual reporting periods beginning after December 15, 2009, except for the enhanced Level 3 disclosures. Those disclosures are effective for interim and annual reporting periods beginning after December 15, 2010. The Company is currently evaluating the impact of this amendment on its consolidated financial statements.
derivative liabilities associated with equity-indexed annuity products primarily from the incorporation of nonperformance risk, also referred to as the Company’s own credit risk, into the fair value calculation.
In December 2008, the FASB amended the general accounting principles for Compensation as it relates to employers disclosures about postretirement benefit plan assets. This amendment provides guidance for disclosure of the types of assets and associated risks in retirement plans. The new disclosures are designed to provide additional insight into the major categories of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period, significant concentrations of risk within plan assets and how investment decisions are made, including factors necessary to understanding investment policies and strategies. The disclosures about plan assets required by this amendment is effective for financial statements with fiscal years ending after December 15, 2009. The Company has adopted this amendment. The required disclosures are provided in Note 10 - “Employee Benefit Plans.”
In October 2009, the FASB amended the general accounting principles for Debt as it relates to the accounting for own-share lending arrangements entered into in contemplation of a convertible debt issuance or other financing. This amendment provides accounting and disclosure guidance for own-share lending arrangements issued in contemplation of convertible debt issuance. The amendment is effective for fiscal years and interim periods beginning after December 15, 2009. The adoption of this amendment is not expected to have an impact on the consolidated financial statements.
On November 4, 2008, RGA completed a public offering of 10,235,000 shares of RGA class A common stock, $0.01 par value per share. The price per share was $33.89, and the aggregate value of the transaction was approximately $346.9 million. The Company expects to use the net proceeds from the offering to pursue reinsurance opportunities and for general corporate purposes.
On January 23, 2002, the board of directors approved a stock repurchase program authorizing the Company to purchase up to $50 million of its shares of stock, as conditions warrant. The board’s action allows management, at its discretion, to purchase shares on the open market. The Company has approximately $43.4 million remaining under the approved program with no shares purchased since 2002. Purchased shares are held as treasury stock. The Company generally uses treasury shares to support the future exercise of options or settlement of awards granted under its stock plans.
Major categories of investment income, net of related expenses consist of the following (dollars in thousands):
The other-than-temporary impairments in 2008 and 2009 are due to the continued turmoil in the U.S. and global financial markets which has resulted in bankruptcies, credit defaults, consolidations and government interventions. 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.
The Company reviews all securities to determine whether an other-than-temporary decline in value exists and whether losses should be recognized. The Company considers relevant facts and circumstances in evaluating whether a credit or interest rate-related impairment of a security is other-than-temporary. Relevant facts and circumstances considered include: (1) the extent and length of time the fair value has been below cost; (2) the reasons for the decline in fair value; (3) the financial position and access to capital of the issuer, including the current and future impact of any specific events; and (4) for fixed maturity securities, the Company’s intent to sell a security or whether it is more likely than not it will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity and for equity securities, its ability and intent to hold the security for a period of time that allows for the recovery in value. To the extent the Company determines that a security is deemed to be other-than-temporarily impaired, an impairment loss is recognized.
As of December 31, 2009, the Company held securities with a fair value of $448.3 million issued by the Federal National Mortgage Corporation, $482.6 million that were issued by the United States Treasury, $895.7 million that were issued by the Canadian province of Ontario and $679.9 million in one entity that were guaranteed by the Canadian province of Quebec, all of which exceeded 10% of consolidated stockholders’ equity. As of December 31, 2008, the Company held securities with a fair value of $383.0 million issued by the Federal Home Loan Mortgage Corporation, $396.2 million issued by the Federal National Mortgage Corporation, $661.2 million that were issued by the Canadian province of Ontario, $521.5 million in one entity that were guaranteed by the Canadian province of Quebec, and $275.1 million issued by the Canadian province of Quebec, all of which exceeded 10% of consolidated stockholders’ equity.
At December 31, 2009, the contractual maturities of investments in fixed maturity securities were as follows (dollars in thousands):
Mortgage loans represented approximately 4.0% and 4.7% of the Company’s cash and invested assets as of December 31, 2009 and 2008, respectively. The Company makes mortgage loans on income producing properties, such as apartments, retail and office buildings, light warehouses and light industrial facilities. Loan to value ratios at the time of loan approval are 75% or less for domestic mortgages. The distribution of mortgage loans by property type is as follows as of December 31, 2009 and 2008 (dollars in thousands):
Funds withheld at interest comprised approximately 24.8% and 27.4% of the Company’s cash and invested assets as of December 31, 2009 and 2008, respectively. Of the $4.9 billion funds withheld at interest balance as of December 31, 2009, $3.4 billion of the balance is associated with one client. For reinsurance agreements written on a modified coinsurance basis and certain agreements written on a coinsurance funds withheld basis, assets equal to the net statutory reserves are withheld and legally owned and managed by the ceding company and are reflected as funds withheld at interest on 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 to the Company from the ceding company. Interest accrues to these assets at rates defined by the treaty terms and the Company estimates the yield was approximately 7.69%, 3.54% and 6.42% for the years ended December 31, 2009, 2008 and 2007, respectively. Changes in these estimated yields are affected by equity options held in the funds withheld portfolio associated with equity-indexed annuity treaties. The Company is subject to the investment performance on the withheld assets, although it does not directly control them. These assets are primarily fixed maturity investment securities and pose risks similar to the fixed maturity securities the Company owns. To mitigate this risk, the Company helps set the investment guidelines followed by the ceding company and monitors compliance.
The following table presents the notional amounts and fair value of derivative instruments as of December 31, 2009 and 2008 (dollars in thousands):
The Company designates and accounts for certain interest rate swaps that convert fixed rate investments to floating rate investments as fair value hedges when they meet the requirements of the general accounting principles for Derivatives and Hedging. The gain or loss on the hedged item attributable to the hedged benchmark interest rate and the offsetting gain or loss on the related interest rate swaps for the year ended December 31, 2009 were (dollars in thousands):
The Company’s investment related gains (losses), net representing the ineffective portion of all fair value hedges, was $0.2 million and $0.3 million for the years ended December 31, 2009 and 2008, respectively.
The Company’s other comprehensive income for the years ended December 31, 2009 and 2008, included gains (losses) of $(8.1) million and $53.7 million, respectively, related to foreign currency swaps used to hedge its net investment in its foreign operations. The cumulative foreign currency translation gain recorded in accumulated other comprehensive income related to these hedges was $40.5 million and $48.6 million at December 31, 2009 and 2008, respectively. When net investments in foreign operations are sold or substantially liquidated, the amounts in accumulated other comprehensive income are reclassified to the consolidated statements of income. A pro rata portion will be reclassified upon partial sale of the net investments in foreign operations.
The Company uses various other derivative instruments for risk management purposes that either do not qualify for hedge accounting treatment or have not currently been qualified by the Company 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. For the years ended December 31, 2009 and 2008, the Company recognized investment related gains (losses) of $(217.5) million and $165.5 million, respectively, related to derivatives that do not qualify or have not been qualified for hedge accounting.
Interest rate swaps are used by the Company primarily to reduce market risks from changes in interest rates and to alter interest rate exposure arising from mismatches between assets and liabilities (duration mismatches). With an interest rate swap, the Company agrees with another party to exchange, at specified intervals, the difference between fixed rate and floating rate interest amounts as calculated by reference to an agreed notional principal amount. These transactions are executed pursuant to master agreements that provide for a single net payment or individual gross payments to be made by the counterparty at each due date.
The Company has certain embedded derivatives which are required to be separated from their host contracts and reported as derivatives. Host contracts include reinsurance treaties structured on a modified coinsurance or funds withheld basis. Additionally, the Company reinsures equity-indexed annuity and variable annuity contracts with benefits that are considered embedded derivatives, including GMWB, GMAB, and GMIB. The related gains (losses) for the years ended December 31, 2009, 2008 and 2007 are reflected in the following table (dollars in thousands):
The Company may be exposed to credit-related losses in the event of nonperformance by counterparties to derivative financial instruments. Generally, the current credit exposure of the Company’s derivative contracts is limited to the fair value at the reporting date. The credit exposure of the Company’s derivative transactions is represented by the fair value of contracts after consideration of any collateral received with a net positive fair value at the reporting date.
December 31, 2009, the Company had pledged collateral of $16.0 million to counterparties on swaps. As of December 31, 2008, the Company held unrestricted cash collateral of $159.8 million. The receivable or payable related to cash collateral is included in other assets or other liabilities, net, in the consolidated balance sheets. From time to time, the Company has accepted collateral consisting of various securities; however, there were no securities held as collateral as of December 31, 2009 and 2008. In addition, the Company has exchange-traded futures, which require the maintenance of a margin account. As of December 31, 2009 and 2008, the Company pledged collateral of $17.1 million and $25.9 million, respectively, which is included in cash and cash equivalents.
The carrying and fair values of interest-sensitive contract liabilities reflected in the table above exclude contracts with significant mortality risk. The fair value of the Company’s interest-sensitive contract liabilities and related reinsurance ceded receivables is based on the cash surrender value of the liabilities, adjusted for recapture fees. The fair value of the Company’s long-term debt is estimated based on either quoted market prices or quoted market prices for the debt of corporations with similar credit quality. The fair values of the Company’s collateral finance facility and company-obligated mandatorily redeemable preferred securities are estimated using discounted cash flows.
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
Market Approach. Market approach valuation techniques use prices and other relevant information from market transactions involving identical or comparable assets or liabilities. Valuation techniques consistent with the market approach include comparables and matrix pricing. Comparables use market multiples, which might lie in ranges with a different multiple for each comparable. The selection of where within the range the appropriate multiple falls requires judgment, considering both quantitative and qualitative factors specific to the measurement. Matrix pricing is a mathematical technique used principally to value certain securities without relying exclusively on quoted prices for the specific securities but comparing the securities to benchmark or comparable securities.
For the years ended December 31, 2009 and 2008, the application of valuation techniques applied to similar assets and liabilities has been consistent.
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the related assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using market standard valuation techniques described above. When observable inputs are not available, the market standard techniques for determining the estimated fair value of certain securities that trade infrequently, and therefore have little transparency, rely on inputs that are significant to the estimated fair value and that are not observable in the market or cannot be derived principally from or corroborated by observable market data. These unobservable inputs can be based in large part on management judgment or estimation and cannot be supported by reference to market activity. Even though unobservable, management believes these inputs are based on assumptions deemed appropriate given the circumstances and consistent with what other market participants would use when pricing similar assets and liabilities. For the Company’s invested assets, this category generally includes U.S. and foreign corporate securities (primarily private placements), asset-backed securities (including those with exposure to sub-prime mortgages), and to a lesser extent, certain residential and commercial mortgage-backed securities, among others. Additionally, the Company’s embedded derivatives, all of which are associated with reinsurance treaties, are classified in Level 3 since their values include significant unobservable inputs associated with actuarial assumptions regarding policyholder behavior. Embedded derivatives are reported with the host instruments on the consolidated balance sheet.
The tables below summarize gains and losses due to changes in fair value, including both realized and unrealized gains and losses, recorded in earnings for Level 3 assets and liabilities for years ended December 31, 2009 and 2008 (dollars in thousands).
The tables below summarize changes in unrealized gains or losses recorded in earnings for the year ended December 31, 2009 and 2008 for Level 3 assets and liabilities that are still held at December 31, 2009 and 2008 (dollars in thousands).
Retrocession reinsurance treaties do not relieve the Company from its obligations to direct writing companies. Failure of retrocessionaires to honor their obligations could result in losses to the Company. Consequently, allowances would be established for amounts deemed uncollectible. At December 31, 2009 and 2008, no allowances were deemed necessary. The Company regularly evaluates the financial condition of its reinsurers and retrocessionaires.
The effect of reinsurance on claims and other policy benefits is as follows (dollars in thousands):
The effect of reinsurance on life insurance in force is shown in the following schedule (in millions):
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, 2009, these treaties had approximately $1,059.3 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 $1,022.4 million were held in trust to satisfy collateral requirements for reinsurance business for the benefit of certain subsidiaries of the Company at December 31, 2009. In addition, the Company’s collateral finance facility has asset in trust requirements. See Note 16 - “Collateral Finance Facility” for additional information. Securities with an amortized cost of $1,755.6 million, as of December 31, 2009, were held in trust to satisfy collateral requirements under certain third-party reinsurance treaties. Additionally, 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. See Note 16 - “Collateral Finance Facility” for additional information on assets in trust.
As of December 31, 2009 and 2008, a valuation allowance for deferred tax assets of approximately $3.4 million and $7.9 million, respectively, was provided on the foreign tax credits, net operating and capital losses of RGA South Africa Holdings, RGA Financial Products Limited, RGA UK Services Limited, and RGA Reinsurance. The Company utilizes valuation allowances when it believes, based on the weight of the available evidence, that it is more likely than not that the deferred income taxes will not be realized.
The earnings of substantially all of the Company’s foreign subsidiaries have been indefinitely reinvested in foreign operations. Therefore, no provision has been made for any U.S. taxes or foreign withholding taxes that may be applicable upon any actual or deemed repatriation, or sale. The determination of any unrecognized deferred tax liability for temporary differences related to investments in the Company’s foreign subsidiaries is not practicable. At December 31, 2009 and 2008, the financial reporting basis in excess of the tax basis for which no deferred taxes have been recognized was approximately $415.4 million and $159.9 million, respectively.
A reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2009, 2008 and 2007, is as follows (dollars in thousands):
A December 31 measurement date is used for all of the defined benefit and postretirement plans.
The Company expects to contribute to the plans $3.6 million in pension benefits and $0.2 million in other benefits during 2010.
The estimated net loss and prior service cost for the defined benefit pension plans and post-retirement plans that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year are $1.2 million and $0.3 million, respectively.
Target allocations of assets are determined with the objective of maximizing returns and minimizing volatility of net assets through adequate asset diversification and partial liability immunization. Adjustments are made to target allocations based on the Company’s assessment of the effect of economic factors and market conditions. The target allocations for plan assets are 60% equity securities and 40% debt securities as of December 31, 2009 and 2010. The Company’s plan assets are primarily invested in mutual funds. The mutual funds include holdings of S&P 500 securities, large-cap securities, mid-cap securities, small-cap securities, international securities, corporate debt securities, U.S. and other government securities, mortgage-related securities and cash.
The fair values of the Company’s pension plan assets are as follows (dollars in thousands):
Mutual funds are invested 38% in bond index funds, 31% in S&P 500 index funds, 16% in mid-cap stock funds, 10% in foreign large blend funds and 5% in small-cap stock funds.
As of December 31, 2009, 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. Therefore, a reconciliation for pension plan assets measured at fair value using significant unobservable inputs (Level 3) for the year ended December 31, 2009 is not required. See Note 6 - “Fair Value of Financial Instruments” for additional detail on the fair value hierarchy.
Certain subsidiaries of the Company also sponsor saving and investment plans under which a portion of employee contributions are matched. Subsidiary contributions to these plans, which are partially tied to RGA’s financial results, were $2.7 million, $3.4 million and $2.8 million in 2009, 2008 and 2007, respectively.
The Company leases office space and furniture and equipment under non-cancelable operating lease agreements, which expire at various dates. Future minimum office space annual rentals under non-cancelable operating leases at December 31, 2009 are as follows:
The amounts above are net of expected sublease income of approximately $0.4 million annually through 2010. Rent expenses amounted to approximately $13.9 million, $12.5 million and $11.8 million for the years ended December 31, 2009, 2008 and 2007, respectively.
The total capital and surplus positions of RCM, RGA Reinsurance and RGA Canada exceed the risk-based capital requirements of the applicable regulatory bodies. RCM and RGA Reinsurance are subject to 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 operating income or 10% of capital and surplus at the preceding year-end, without regulatory approval. The applicable statutory provisions only permit an insurer to pay a shareholder dividend from unassigned surplus. Any dividends paid by RGA Reinsurance would be paid to RCM, its parent company, which in turn has restrictions related to its ability to pay dividends to RGA. The assets of RCM consist primarily of its investment in RGA Reinsurance. As of January 1, 2010, RCM and RGA Reinsurance could pay maximum dividends, without prior approval, of approximately $141.3 million and $146.6 million, respectively. 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 by other subsidiaries are subject to regulations in the jurisdiction of domicile.
The Company had commitments to fund investments in limited partnerships, commercial mortgage loans and private placement investments in the amount of $86.6 million, $12.6 million and $7.0 million, respectively, at December 31, 2009. The Company anticipates that the majority of its current commitments will be invested over the next five years, however, contractually, these commitments could become due at the request of the counterparties. Investments in limited partnerships are carried at cost and included in other invested assets in the consolidated balance sheets.
The Company has obtained letters of credit, issued by banks, in favor of various affiliated and unaffiliated insurance companies from which the Company assumes business. These letters of credit represent guarantees of performance under the reinsurance agreements and allow ceding companies to take statutory reserve credits. Certain of these letters of credit contain financial covenant restrictions. At December 31, 2009 and 2008, there were approximately $21.4 million and $26.6 million, respectively, of outstanding bank letters of credit in favor of third parties. Additionally, the Company utilizes letters of credit to secure reserve credits when it retrocedes business to its subsidiaries, including Parkway Re, RGA Americas, RGA Barbados and RGA Atlantic. 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 United Kingdom. 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, 2009 and 2008, $617.5 million and $428.8 million, respectively, in letters of credit from various banks were outstanding, backing reinsurance between the various subsidiaries of the Company. The Company maintains a syndicated revolving credit facility with an overall capacity of $750.0 million, which is scheduled to mature in September 2012. The Company may borrow cash and may obtain letters of credit in multiple currencies under this facility. At December 31, 2009, the Company had $373.9 million in issued, but undrawn, letters of credit under this facility, which is included in the total above. Applicable letter of credit fees and fees payable for the credit facility depend upon the Company’s senior unsecured long-term debt rating. In September 2009, the Company entered into a ten-year, $200.0 million letter of credit facility agreement. This letter of credit is expected to be fully utilized though 2016 and then amortize to zero by 2019. As of December 31, 2009, the Company had $200.0 million in issued, but undrawn, letters of credit under this new facility, which is included in the total above. Letter of credit fees for this facility are fixed for the term of the facility. Fees associated with the Company’s other letters of credit are not fixed for periods in excess of one year and are based on the Company’s ratings and the general availability of these instruments in the marketplace.
In March 2007, RGA issued 5.625% Senior Notes due March 15, 2017 with a face amount of $300.0 million. These senior notes were registered with the Securities and Exchange Commission. The net proceeds from the offering were approximately $295.3 million, a portion of which were used to pay down $50.0 million of indebtedness under a U.S. bank credit facility. The remaining net proceeds were designated for general corporate purposes. Capitalized issue costs were approximately $2.4 million.
maturity of indebtedness. As of December 31, 2009, the Company had $1,216.1 million in outstanding borrowings under its debt agreements and was in compliance with all covenants under those agreements. The ability of the Company to make debt principal and interest payments depends on the earnings and surplus of subsidiaries, investment earnings on undeployed capital proceeds, and the Company’s ability to raise additional funds.
RGA guarantees the payment of amounts outstanding under the credit facility maintained by its subsidiary operation in Australia. At December 31, 2009 there was no debt outstanding under this credit facility.
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. 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, 2009 and 2008, respectively, the Company held assets in trust and in custody of $876.7 million and $885.4 million for this purpose. Interest on the notes will accrue at an annual rate of 1-month LIBOR plus a base rate margin, payable monthly and totaled $8.3 million and $28.7 million in 2009 and 2008, respectively. The payment of interest and principal on the notes is insured by a monoline insurance company through a financial guaranty insurance policy. The notes represent senior, secured indebtedness of Timberlake Financial without legal recourse to RGA or its other subsidiaries. Timberlake Financial will rely 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 South Carolina regulatory approval, the return on Timberlake Re’s investment assets and the performance of specified term life insurance policies with guaranteed level premiums retroceded by RGA’s subsidiary, RGA Reinsurance, to Timberlake Re.
The Company has five main geographic-based operational segments, each of which is a distinct reportable segment: U.S., Canada, Europe & South Africa, Asia Pacific and Corporate and Other. The U.S. operations market traditional life reinsurance, reinsurance of asset-intensive products and financial reinsurance, primarily to large U.S. market life insurance companies. Asset-intensive products primarily include reinsurance of corporate-owned life insurance and annuities. The Canada operations provide insurers with reinsurance of traditional individual life products as well as creditor reinsurance, group life and health reinsurance and non-guaranteed critical illness products. Europe & South Africa operations include traditional life reinsurance and critical illness business from Europe & South Africa, in addition to other markets being developed by the Company. Asia Pacific operations provide primarily traditional life reinsurance, critical illness and, to a lesser extent, financial reinsurance through RGA Australia and RGA Reinsurance. Corporate and Other includes results from, among others, RGA Technology Partners, Inc., a wholly-owned subsidiary that develops and markets technology solutions for the insurance industry and the investment income and expense associated with the Company’s collateral finance facility. Effective January 1, 2009, due to immateriality, the discontinued accident and health operations were included in the results of the Corporate and Other segment. The consolidated statements of income for 2008 and 2007 reflect this line of business as a discontinued operation. The Company measures segment performance based on income or loss before income taxes.
During 2009, three clients generated $334.5 million or 37.9% of gross premiums for the Canada operations. Five clients of the Company’s United Kingdom operations generated approximately $400.8 million, or 49.4% of the total gross premiums for the Europe & South Africa operations. Ten clients, six in Australia, two in Korea and two in Japan, generated approximately $582.4 million, or 56.7% of the total gross premiums for the Asia Pacific operations. The U.S. reinsurance operation’s largest client generated approximately $573.0 million or 16.3% of U.S. operations gross premiums.
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, 2009, shares authorized for the granting of Benefits under the Plan and the Directors Plan totaled 9,260,077 and 212,500 respectively. The Company generally uses treasury shares to support the future exercise of options or settlement of awards granted under its stock plans.
The Black-Scholes model was used to determine the fair value of stock options granted and recognized in the financial statements. The Company used daily historical volatility when calculating stock option values. The risk-free rate is based on observed interest rates for instruments with maturities similar to the expected term of the stock options. Dividend yield is determined based on historical dividend distributions compared to the price of the underlying common stock as of the valuation date and held constant over the life of the stock options. The Company estimated expected life using the historical average years to exercise or cancellation. The per share weighted-average fair value of stock options granted during 2009, 2008 and 2007 was $8.99, $14.02 and $18.72 on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: 2009-expected dividend yield of 1.12%, risk-free interest rate of 2.03%, expected life of 6.0 years, and an expected rate of volatility of the stock of 29.1% over the expected life of the options; 2008-expected dividend yield of 0.6%, risk-free interest rate of 3.23%, expected life of 6.0 years, and an expected rate of volatility of the stock of 20.0% over the expected life of the options; and 2007-expected dividend yield of 0.6%, risk-free interest rate of 4.67%, expected life of 6.0 years, and an expected rate of volatility of the stock of 23.4% over the expected life of the options.
In general, restrictions lapse on restricted stock awards at the end of a three- or ten-year vesting period. Restricted stock awarded under the plan generally has no strike price and is included in the Company’s shares outstanding. As of December 31, 2009, no shares of restricted stock were outstanding.
During 2009, 2008 and 2007 the Company also issued 309,063, 160,968 and 105,453 performance contingent units (“PCUs”) to key employees at a weighted average fair value per unit of $32.20, $56.03 and $59.63, respectively. As of December 31, 2009, 309,063, 153,107 and 94,046 PCUs were outstanding from the 2009, 2008 and 2007 grants, respectively. Each PCU represents the right to receive up to two shares of Company common stock, depending on the results of certain performance measures over a three-year period. The compensation expense related to the PCUs is recognized ratably over the requisite performance period. In February 2010, 2009 and 2008, the board approved a 0.68, 1.33 and 1.92 share payout for each PCU granted in 2007, 2006 and 2005, resulting in the issuance of 63,409, 164,630 and 218,240 shares of common stock from treasury, respectively.
As of December 31, 2009, there was $15.9 million of unrecognized compensation costs related to equity-based grants or awards. It is estimated that these costs will vest over a weighted average period of 2.3 years.
The calculation of equivalent shares from outstanding stock options does not include the effect of options having a strike 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. Approximately 1.2 million, 1.6 million and 0.3 million outstanding stock options were not included in the calculation of common equivalent shares during 2009, 2008 and 2007, respectively. Approximately 0.6 million, 0.4 million and 0.4 million performance contingent shares were excluded from the calculation of common equivalent shares during 2009, 2008 and 2007, respectively.
Effective January 1, 2009, due to immateriality, the discontinued accident and health operations were included in the results of the Corporate and Other segment. The consolidated statements of income for 2008 and 2007 reflect this line of business as a discontinued operation. The calculation of the claim reserve liability for the entire portfolio of accident and health business requires management to make estimates and assumptions that affect the reported claim reserve levels. Revenues associated with discontinued operations, which were not reported on a gross basis in the Company’s consolidated statements of income in 2008 and 2007, totaled $2.1 million and $2.0 million, respectively. As of December 31, 2009, there are no arbitrations or claims disputes associated with the Company’s discontinued accident and health operations, and the remaining runoff activity of this business is not expected to be significant.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Reinsurance Group of America, Incorporated and subsidiaries as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
Reinsurance Group of America, Incorporated common stock is traded on the New York Stock Exchange (NYSE) under the symbol “RGA”. There were 92,436 stockholders of record of RGA’s common stock on January 29, 2010. See “Shareholder Dividends” and “Debt and Trust Preferred Securities” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources”.