The Company’s headquarters is located at 16600 Swingley Ridge Road, Chesterfield, Missouri, which comprises approximately 400,000 square feet. In addition, the Company leases approximately 309,000 square feet of office space in 42 locations throughout the world.
Most of the Company’s leases have terms of three to five years; while some leases have longer terms, none exceed 15 years. As provided in Note 12 - “Commitments, Contingencies and Guarantees” in the Notes to Consolidated Financial Statements, the rental expense on operating leases for office space and equipment totaled $15.7 million for 2017.
The following selected financial data has been derived from the Company’s audited consolidated financial statements. The consolidated statement of income data for the years ended December 31, 2017, 2016 and 2015, and the consolidated balance sheet data at December 31, 2017 and 2016 have been derived from the Company’s audited consolidated financial statements included elsewhere herein. The consolidated statement of income data for the years ended December 31, 2014 and 2013, and the consolidated balance sheet data at December 31, 2015, 2014 and 2013 have been derived from the Company’s audited consolidated financial statements not included herein. The selected financial data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes included elsewhere herein.
2017 includes the effect of U.S. Tax Reform. See Note 9 - “Income Tax” in the Notes to Consolidated Financial Statements for additional information.
Numerous important factors could cause actual results and events to differ materially from those expressed or implied by forward-looking statements including, without limitation, (1) adverse capital and credit market conditions and their impact on the Company’s liquidity, access to capital and cost of capital, (2) the impairment of other financial institutions and its effect on the Company’s business, (3) requirements to post collateral or make payments due to declines in market value of assets subject to the Company’s collateral arrangements, (4) the fact that the determination of allowances and impairments taken on the Company’s investments is highly subjective, (5) adverse changes in mortality, morbidity, lapsation or claims experience, (6) changes in the Company’s financial strength and credit ratings and the effect of such changes on the Company’s future results of operations and financial condition, (7) inadequate risk analysis and underwriting, (8) general economic conditions or a prolonged economic downturn affecting the demand for insurance and reinsurance in the Company’s current and planned markets, (9) the availability and cost of collateral necessary for regulatory reserves and capital, (10) market or economic conditions that adversely affect the value of the Company’s investment securities or result in the impairment of all or a portion of the value of certain of the Company’s investment securities, that in turn could affect regulatory capital, (11) market or economic conditions that adversely affect the Company’s ability to make timely sales of investment securities, (12) risks inherent in the Company’s risk management and investment strategy, including changes in investment portfolio yields due to interest rate or credit quality changes, (13) fluctuations in U.S. or foreign currency exchange rates, interest rates, or securities and real estate markets, (14) adverse litigation or arbitration results, (15) the adequacy of reserves, resources and accurate information relating to settlements, awards and terminated and discontinued lines of business, (16) the stability of and actions by governments and economies in the markets in which the Company operates, including ongoing uncertainties regarding the amount of U.S. sovereign debt and the credit ratings thereof, (17) competitive factors and competitors’ responses to the Company’s initiatives, (18) the success of the Company’s clients, (19) successful execution of the Company’s entry into new markets, (20) successful development and introduction of new products and distribution opportunities, (21) the Company’s ability to successfully integrate acquired blocks of business and entities, (22) action by regulators who have authority over the Company’s reinsurance operations in the jurisdictions in which it operates, (23) the Company’s dependence on third parties, including those insurance companies and reinsurers to which the Company cedes some reinsurance, third-party investment managers and others, (24) the threat of natural disasters, catastrophes, terrorist attacks, epidemics or pandemics anywhere in the world where the Company or its clients do business, (25) interruption or failure of the Company’s telecommunication, information technology or other operational systems, or the Company’s failure to maintain adequate security to protect the confidentiality or privacy of personal or sensitive data stored on such systems, (26) changes in laws, regulations, and accounting standards applicable to the Company, its subsidiaries, or its business, (27) the benefits or burdens associated with the Tax Cuts and Jobs Act of 2017 may be different than expected, (28) the effect of the Company’s status as an insurance holding company and regulatory restrictions on its ability to pay principal of and interest on its debt obligations, and (29) other risks and uncertainties described in this document and in the Company’s other filings with the Securities and Exchange Commission (“SEC”).
Forward-looking statements should be evaluated together with the many risks and uncertainties that affect the Company’s business, including those mentioned in this document and described in the periodic reports the Company files with the SEC. These forward-looking statements speak only as of the date on which they are made. The Company does not undertake any obligations to update these forward-looking statements, even though the Company’s situation may change in the future. For a discussion of these risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements, you are advised to see Item 1A - “Risk Factors”.
The Company is among the leading global providers of life reinsurance and financial solutions, with $3.3 trillion of life reinsurance in force and assets of $60.5 billion as of December 31, 2017. The Company’s historical approach to the reinsurance market has been to focus on large, high-quality life insurers as clients, provide quality facultative underwriting and automatic reinsurance capacity while delivering responsive and flexible service to its clients.
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 consistent 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 is 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. Segment investment performance varies with the composition of investments and the relative allocation of capital to the operating segments.
Segment revenue levels can be significantly influenced by currency fluctuations, large transactions, mix of business and reporting practices of ceding companies, and therefore may fluctuate from period to period. Although reasonably predictable over a period of years, segment claims experience can be volatile over shorter periods. See “Results of Operations by Segment” below for further information about the Company’s segments.
Outsourcing of Mortality. The Company believes life insurance companies will continue to utilize reinsurance to manage capital and mortality risk and to develop competitive products. The Company believes there has been a decline in the percentage of new business being reinsured in recent years, which has caused premium growth rates in the U.S. life reinsurance market to moderate. The Company believes a decline in new business being reinsured is likely a reaction by ceding companies to a broad-based increase in reinsurance rates in the market, stronger capital positions maintained by ceding companies in recent years and a desire by ceding companies to adjust their risk profiles. However, the Company believes reinsurers will continue to be an integral part of the life insurance market due to their ability to efficiently aggregate a significant volume of life insurance in force, creating economies of scale and greater diversification of risk. As a result of having larger amounts of data at their disposal compared to primary life insurance companies, reinsurers tend to have better insights into mortality trends, creating more efficient pricing for mortality risk.
Facultative Reinsurance. Based on discussions with the Company’s clients, an industry survey and informal knowledge about the industry, the Company believes it is a leader in facultative underwriting in North America. The Company intends to maintain that status by emphasizing its underwriting standards, prompt response on quotes, competitive pricing, capacity, value added services and flexibility in meeting customer needs. The Company believes its facultative business has allowed it to develop close, long-standing client relationships and generate additional business opportunities with its facultative clients.
International Markets. Management believes that international markets continue to offer opportunities for long-term growth, and the Company intends to capitalize on these opportunities by growing its presence in selected markets. Since 1994, the Company has entered new markets internationally, including, in the mid-to-late 1990s, Australia,
Consolidated income before income taxes increased $98.9 million, or 9.5%, and $299.2 million, or 40.2% in 2017 and 2016, respectively. The increase in income before income taxes in 2017 was primarily due to higher investment income, increased other revenues and improved claims experience in Europe, Middle East and Africa (“EMEA”) partially offset by higher interest expense. The increase in investment income is discussed below, the increase in other revenues is largely due to recapture fees as discussed within the Asia Pacific section. The increase in interest expense is discussed within the Corporate and Other section. The increase in income before income taxes in 2016 was primarily due to an increase in investment related gains, higher investment income and improved mortality experience in the U.S. operations compared to the prior year.
The change in the value of embedded derivatives related to reinsurance treaties written on a modco or funds withheld basis are subject to the general accounting principles for Derivatives and Hedging related to embedded derivatives. The unrealized gains and losses associated with these embedded derivatives, after adjustment for deferred acquisition costs, increased income before income taxes by $60.3 million and $54.1 million in 2017 and 2016, respectively, as compared to the prior years.
Changes in risk-free rates used in the fair value estimates of embedded derivatives associated with EIAs affect the amount of unrealized gains and losses the Company recognizes. The unrealized gains and losses associated with EIAs, after adjustment for deferred acquisition costs and retrocession, increased income before income taxes by $3.4 million and $8.4 million in 2017 and 2016, respectively, as compared to the prior years.
The change in the Company’s liability for variable annuities associated with guaranteed minimum living benefits affects the amount of unrealized gains and losses the Company recognizes. The unrealized gains and losses associated with guaranteed minimum living benefits, after adjustment for deferred acquisition costs, increased income before income taxes by $145.9 million in 2017 and decreased income by $18.8 million in 2016, as compared to the prior years. After consideration of the change in fair value of freestanding derivatives used to hedge this liability, income before income taxes increased by $15.5 million in 2017 and decreased by $19.4 million in 2016, as compared to the prior years.
Consolidated net premiums increased $592.3 million, or 6.4%, and $678.1 million, or 7.9%, in 2017 and 2016, respectively. The increases in 2017 and 2016 are primarily due to growth in life reinsurance in force. In addition, the increase in 2016 reflects large in force block transactions entered into during the latter part of 2015, partially offset by adverse foreign currency fluctuations. Foreign currency fluctuations relative to the prior year affected net premiums favorably by approximately $25.9 million in 2017 and unfavorably by $172.2 million in 2016. Consolidated assumed life insurance in force was $3,297.3 billion, $3,062.5 billion and $2,995.1 billion as of December 31, 2017, 2016 and 2015, respectively. Foreign currency fluctuations affected the increases in assumed life insurance in force favorably by $121.1 billion in 2017 and unfavorably by $68.0 billion 2016. The Company added new business production, measured by face amount of insurance in force, of $395.4 billion, $404.8 billion and $491.0 billion during 2017, 2016 and 2015, respectively.
Consolidated investment income, net of related expenses, increased $242.8 million, or 12.7%, and $177.4 million, or 10.2%, in 2017 and 2016, respectively, primarily due to increases in the average invested asset base. Investment income reflects market value changes related to the Company’s funds withheld at interest investment associated with the reinsurance of certain EIAs, which contributed $117.0 million and $23.4 million to the increases in 2017 and 2016, respectively. The effect on investment income of the EIAs’ market value changes is substantially offset by a corresponding change in interest credited to policyholder account balances resulting in an insignificant effect on net income.
The average invested assets at amortized cost, excluding spread related business, totaled $25.2 billion, $23.2 billion and $20.8 billion in 2017, 2016 and 2015, respectively. The average yield earned on investments, excluding spread related business, was 4.55%, 4.57% and 4.82% in 2017, 2016 and 2015, respectively. The yield in 2015 benefited from the cumulative effect of income related to a funds withheld transaction executed in the fourth quarter of 2015 within the U.S. and Latin America Traditional segment, retroactive to the beginning of the year. The average yield will vary from year to year depending on a number of variables, including the prevailing interest rate and credit spread environment, prepayment fees and make-whole premiums, changes in the mix of the underlying investments and cash balances, and the timing of dividends and distributions on certain investments. Investment income in 2017 benefited from a higher level of bond make-whole premiums and distributions from joint ventures and limited partnerships. A continued low interest rate environment is expected to put downward pressure on this yield in future reporting periods.
Total investment related gains (losses), net, improved by $73.7 million, or 78.2%, and $258.9 million, or 157.2% in 2017 and 2016, respectively. These improvements are primarily due to a favorable changes in the value of embedded derivatives related to reinsurance treaties written on a modco or funds withheld basis of $90.6 million and $152.9 million in 2017 and 2016, respectively. Investment impairments on fixed maturity securities increased by $3.8 million in 2017 and decreased by $18.6 million in 2016, compared to the prior years. See Note 4 - “Investments” and Note 5 - “Derivative Instruments” in the Notes to Consolidated Financial Statements for additional information on investment related gains (losses), net, and derivatives. Investment income is allocated to the operating segments based upon average assets and related capital levels deemed appropriate to support segment operations.
The effective tax rate on a consolidated basis was (59.4%), 32.8%, and 32.6% for 2017, 2016, and 2015, respectively. The 2017 effective tax rate includes the tax effects of the aforementioned U.S. Tax Reform. The Company recorded an estimated net tax benefit of approximately $1.0 billion resulting in a reduction to the effective tax rate of 90.4%. Due to the complexity of
the new global intangible low tax income (“GILTI”) tax rules, as well as the new base erosion anti-abuse tax (“BEAT”), the Company is continuing to evaluate the effect of these taxes on the future effective tax rate. Notwithstanding the aforementioned complexities, the Company does not expect the GILTI and BEAT to have a material adverse effect on the effective tax rate; moreover, as result of the change in the U.S. federal corporate tax rate from 35% to 21%, the Company expects a lower overall effective tax rate in future years.
The Company tests the recoverability for each year of business at issue before establishing additional DAC. The Company also performs annual tests to establish that DAC remain recoverable at all times, and if financial performance significantly deteriorates to the point where a deficiency exists, a cumulative charge to current operations will be recorded. No such adjustments related to DAC recoverability were made in 2017, 2016 and 2015.
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 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 and are recognized in net income or in certain cases in other comprehensive income. The Company’s accounting for income taxes represents management’s best estimate of various events and transactions considering the laws enacted as of the reporting date. The aforementioned U.S. Tax Reform creates additional complexity due to various provisions that require management judgment and assumptions, which are subject to change.
within other liabilities and are charged to earnings in the period that such determination is made. The Company classifies interest related to tax uncertainties as interest expense whereas penalties related to tax uncertainties are classified as a component of income tax.
The U.S. and Latin America Traditional segment provides individual and group life and health reinsurance to domestic clients for a variety of products through yearly renewable term, coinsurance and modified coinsurance agreements. These reinsurance arrangements may involve either facultative or automatic agreements.
Net premiums increased $106.8 million, or 2.0%, and $442.9 million, or 9.2% in 2017 and 2016, respectively. The increase in 2017 was primarily due to expected organic premium growth in yearly renewable term and coinsurance business offset somewhat by a negotiated modification of a health treaty. The increase in 2016 was primarily due to large in force block transactions executed during the latter part of 2015, significant individual health and group life transactions executed in the first six months of 2016, and organic premium growth. The segment added new life business production, measured by face amount of insurance in force, of $99.4 billion, $126.4 billion and $203.9 billion during 2017, 2016 and 2015, respectively. Contributing to the increases in 2015 were large in force block transactions of $114.5 billion. Total face amount of life business in force was $1,609.8 billion, $1,609.3 billion and $1,594.3 billion as of December 31, 2017, 2016 and 2015, respectively.
Net investment income increased $28.2 million, or 4.0%, and $63.1 million, or 9.9%, in 2017 and 2016, respectively. The increase in 2017 was primarily due to strong variable investment income associated with a higher level of bond make-whole premiums and distributions from joint ventures and limited partnerships, and an increase in the average invested asset base partially offset by a lower investment yield. The increase in 2016 was primarily due to an increase in the average invested asset base primarily associated with the aforementioned in force block transactions along with strong variable investment income partially offset by a lower investment yield. Investment related gains increased by $2.6 million in 2017, and decreased by $6.5 million in 2016. The increase in 2017 was primarily driven by changes in the value of the embedded derivatives associated with one reinsurance treaty structured on a modco basis.
in the traditional life mortality business due to a decrease in the average claim size. In addition, in 2015 the group disability business was negatively affected by an increase in new and reopened claims.
Interest credited expense decreased by $2.8 million, or 3.3%, in 2017 and increased by $7.5 million, or 9.7%, in 2016. The decrease in 2017 relates to primarily to one treaty in which the interest credited will vary depending on the number of deaths in any given year. The decrease is primarily offset by a decrease in investment income. The increase in 2016 was the result of a full year of expense on a new treaty signed in April of 2015. The variances in interest credited expense are largely offset by variances in investment income. Interest credited in this segment relates to amounts credited on cash value products which also have a significant mortality component. Income before income taxes is affected by the spread between the investment income and the interest credited on the underlying products.
Policy acquisition costs and other insurance expenses as a percentage of net premiums were 14.1%, 14.3% and 14.0% in 2017, 2016 and 2015, respectively. Overall, while these ratios are expected to remain in a predictable range, they may fluctuate from period to period due to varying allowance levels within coinsurance-type arrangements. In addition, the amortization pattern of previously capitalized amounts, which are subject to the form of the reinsurance agreement and the underlying insurance policies, may vary. Also, the mix of first year coinsurance business versus yearly renewable term business can cause the percentage to fluctuate from period to period. In recent years, reinsurance treaties weighted toward yearly renewable term structures have contributed to relatively stable rates.
Embedded Derivatives - Modco/Funds Withheld Treaties - Represents the change in the fair value of embedded derivatives on funds withheld at interest associated with treaties written on a modco or funds withheld basis. The fair value changes of embedded derivatives on funds withheld at interest associated with treaties written on a modco or funds withheld basis are reflected in revenues, while the related impact on deferred acquisition expenses is reflected in benefits and expenses. The Company’s utilization of a credit valuation adjustment did not have a material effect on the change in fair value of these embedded derivatives for the years ended December 31, 2017, 2016 and 2015.
The change in fair value of the embedded derivatives - modco/funds withheld treaties increased (decreased) income before income taxes by $75.9 million, $18.7 million and $(42.5) million in 2017, 2016 and 2015, respectively. The increases in income in 2017 and 2016 were primarily due to tightening credit spreads. The decrease in income in 2015 was primarily due to widening credit spreads and increasing risk-free rates.
The change in fair value of the guaranteed minimum benefits, after allowing for changes in the associated free standing derivatives, decreased income before income taxes by $13.3 million, $28.8 million and $9.4 million in 2017, 2016 and 2015, respectively. The decrease in income for all periods is primarily due to the annual update of best estimate actuarial assumptions to account for lower policyholder termination experience.
Income before income taxes and certain derivatives increased by $20.3 million and $21.1 million in 2017 and 2016, respectively. The increase in income in 2017, was primarily due to the impact of rising equity markets associated with the
Revenue before certain derivatives increased by $172.5 million and by $57.9 million in 2017 and 2016, respectively. The increase in 2017 was primarily due to the change in fair value of equity options associated with the reinsurance of EIAs, investment income from a new coinsurance transaction in 2017, and higher investment related gains (losses) associated with coinsurance and funds withheld portfolios. The increase in 2016 was primarily due to the increase in fair value of equity options associated with the reinsurance of EIAs and the full year impact in 2016 from the acquisition of Aurora National in the second quarter of 2015. The effect on investment income related to equity options is substantially offset by a corresponding change in interest credited.
Income before income taxes increased by $21.6 million, or 36.5%, and $4.2 million, or 7.7%, in 2017 and 2016, respectively. The increases in 2017 and 2016 were primarily related to the growth from new transactions.
At December 31, 2017, 2016 and 2015, the amount of reinsurance assumed from client companies, as measured by pre-tax statutory surplus, risk based capital and other financial reinsurance structures, was $13.1 billion, $8.8 billion and $7.2 billion, respectively. The increases in both 2017 and 2016 can primarily be attributed to an increase in the number of new transactions executed each year and is consistent with the increase in related income. 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.
Income before income taxes decreased by $5.8 million, or 4.1%, and increased by $4.6 million, or 3.3%, in 2017 and 2016, respectively. The decrease in income for 2017 was primarily due to unfavorable traditional individual life mortality experience compared to favorable experience in 2016, partially offset by favorable experience on longevity business. The increase in income
Net premiums decreased by $26.7 million, or 2.9%, and increased by $89.7 million, or 10.7%, in 2017 and 2016, respectively. The decrease in 2017 was primarily due to an anticipated decrease in creditor premiums of $80.4 million partially offset by an increase in traditional individual life business premiums from annually increasing premium rates on yearly renewable term treaties and favorable foreign currency exchange fluctuation. The increase in 2016 was primarily due to an increase in creditor premiums of $70.0 million and premiums from new business production partially offset by adverse currency exchange fluctuation. Foreign currency exchange fluctuation in the Canadian dollar resulted in an increase in net premiums of $18.5 million and a decrease of $33.0 million in 2017 and 2016, respectively. The segment added new business production, measured by face amount of insurance in force, of $35.6 billion, $34.9 billion and $38.6 billion during 2017, 2016 and 2015, respectively.
Net investment income increased $10.1 million, or 5.6%, and decreased by $3.7 million, or 2.0%, in 2017 and 2016, respectively. The effect of changes in the Canadian dollar exchange rates resulted in an increase in net investment income of $4.0 million and a decrease of $6.6 million in 2017 and 2016, respectively. Increases in the invested asset base increased net investment income in 2017 and 2016.
Loss ratios for the segment were 84.0%, 76.2% and 79.9% in 2017, 2016 and 2015, respectively. The increase in the 2017 loss ratio was due to unfavorable traditional life mortality experience compared to favorable experience in 2016 and a decrease in creditor business premiums. The decrease in the 2016 loss ratio was due to an increase in creditor premiums partially offset by less favorable life mortality experience, as compared to 2015. Loss ratios for the individual life mortality business were 97.2%, 93.5% and 92.4% in 2017, 2016 and 2015, respectively. Historically, the loss ratio increased primarily as the result of several large permanent level premium in force blocks assumed in 1997 and 1998. These blocks are mature blocks of long-term permanent level premium business in which mortality as a percentage of net premiums is expected to be higher than historical ratios. The nature of permanent level premium policies requires the Company to set up actuarial liabilities and invest the amounts received in excess of early-year claims costs to fund claims in later years when premiums, by design, continue to be level as compared to expected increasing mortality or claim costs. As such, investment income becomes a more significant component of profitability of these in force blocks. Excluding creditor business, claims and other policy benefits, as a percentage of net premiums and investment income were 76.5%, 73.7% and 72.2% in 2017, 2016 and 2015, respectively.
Policy acquisition costs and other insurance expenses as a percentage of net premiums for traditional individual life business were 21.3%, 25.7% and 23.0% in 2017, 2016 and 2015, respectively. Overall, while these ratios are expected to remain in a predictable range, they may fluctuate from period to period due to varying allowance levels and product mix. The decrease in 2017 reflects a lower level of creditor business which typically has a higher level of acquisition costs. In addition, the amortization pattern of previously capitalized amounts, which are subject to the form of the reinsurance agreement and the underlying insurance policies, may vary.
Other operating expenses decreased by $4.4 million, or 11.7%, and increased by $2.0 million, or 5.6%, in 2017 and 2016, respectively. Foreign currency exchange fluctuation in the Canadian dollar resulted in an increase in other operating expenses of $0.7 million and a decrease of $1.2 million in 2017 and 2016, respectively. The decrease in other operating expenses in 2017 is primarily due to decrease in allocated expense from corporate operations. The increase in other operating expenses in 2016 is primarily due to higher compensation costs. Other operating expenses as a percentage of net premiums were 3.7%, 4.1% and 4.2% in 2017, 2016 and 2015, respectively.
Claims and other policy benefits decreased by $6.6 million, or 18.3%, and increased by $7.0 million, or 24.0%, in 2017 and 2016, respectively. The decrease in 2017 was primarily due to favorable experience on longevity business while the increase in 2016 was primarily due to unfavorable experience on longevity business. The effect of changes in the Canadian dollar exchange rates resulted in an increase in claims and other policy benefits of $0.6 million and a decrease of $0.8 million in 2017 and 2016, respectively.
The Europe, Middle East and Africa (“EMEA”) segment includes business generated by its offices principally in the United Kingdom (“UK”), South Africa, France, Germany, Ireland, Italy, the Netherlands, Poland, Spain and the Middle East region. EMEA consists of two major segments: Traditional and Financial Solutions. The Traditional segment primarily provides reinsurance through yearly renewable term and coinsurance agreements on a variety of life, health and critical illness products. Reinsurance agreements may be facultative or automatic agreements covering primarily individual risks and, in some markets, group risks. The Financial Solutions segment consists of reinsurance and other transactions associated with longevity closed blocks, payout annuities, capital management solutions and financial reinsurance.
Net premiums increased by $161.6 million, or 14.2%, and $18.5 million, or 1.7%, in 2017 and 2016, respectively. The increase in 2017 was primarily due to increased business volumes, most notably in Italy, South Africa, the Middle East and the Netherlands related to new treaties in 2017 and favorable growth from existing treaties. The increase in 2016 was primarily due to increased individual life and health premiums somewhat offset by unfavorable foreign currency exchange fluctuations. The segment added new business production, measured by face amount of insurance in force, of $181.5 billion, $169.8 billion and $171.6 billion during 2017, 2016 and 2015, respectively. The face amount of reinsurance in force totaled $739.0 billion, $603.0 billion, and $602.7 billion at December 31, 2017, 2016 and 2015, respectively. Foreign currency fluctuations favorably affected the face amount of reinsurance in force by $64.7 billion and unfavorably by $72.1 billion in 2017 and 2016, respectively. Foreign currency exchange fluctuations contributed to a decrease in net premiums of $8.3 million and $113.1 million in 2017 and 2016, respectively. The segment’s primary currencies are the British pound, the Euro and the South African rand.
Net investment income increased by $5.2 million, or 10.4%, and decreased by $1.1 million, or 2.1%, in 2017 and 2016, respectively. The increase in 2017 was primarily due to an increase in the invested asset base related to increased business volumes. The decrease in 2016 was primarily due to unfavorable foreign exchange fluctuations, offset partly by an increase in the invested asset base related to increased business volume. Foreign currency exchange fluctuations resulted in an increase in net investment income of $0.1 million and a decrease of $4.5 million in 2017 and 2016, respectively.
the 2017 policy acquisition cost ratio below. The increase in the loss ratio in 2016 was due to variability in life and critical illness claims experience. Management views recent claims experience as normal volatility that is inherent in the business.
Interest credited expense remained level in 2017 and decreased by $9.6 million, or 100.0%, in 2016. Beginning in 2016, interest credited related to unit-linked products and the related investment income is reflected in the Financial Solutions segment.
Policy acquisition costs and other insurance expenses as a percentage of net premiums were 7.1%, 5.6% and 5.6% for 2017, 2016 and 2015, respectively. The increase in policy acquisition cost ratio in 2017 is due primarily to changes in the mix of business reflecting increased volumes of new business with higher commissions.
Claims and other policy benefits decreased $22.1 million, or 13.4%, and increased by $3.0 million, or 1.8%, in 2017 and 2016, respectively. The decrease in 2017 was primarily due to the aforementioned new longevity retrocession treaty that cedes longevity risk to third parties, net of an increase in claims and other policy benefits from new transactions. Claims and other policy benefits increased in 2016 due to increased benefits associated with payout annuity reinsurance transactions executed in the fourth quarter of 2015, largely offset by favorable policy benefit experience.
Interest credited expense decreased by $2.1 million, or 15.6%, in 2017. Interest credited in this segment relates to amounts credited to the contractholders of unit-linked products. This amount will fluctuate according to contractholder investment selections, equity returns and interest rates. The effect on interest credited related to unit-linked products is substantially offset by a corresponding change in investment income.
Other operating expenses increased by $7.4 million, or 30.0%, and $7.1 million, or 40.7%, in 2017 and 2016, respectively. The increase in 2017 was primarily due to increased administration costs related to longevity transactions, costs related to a potential acquisition and by the effect of foreign currency exchange fluctuations. The increase in 2016 was primarily due to administration costs related to increased longevity business, increased incentive compensation expense and an increase in expenses related to an acquisition in the Netherlands completed in the fourth quarter of 2015. Foreign currency exchange fluctuations resulted in an increase in operating expenses of $0.4 million and a decrease of $1.4 million 2017 and 2016, respectively.
Income before income taxes increased by $43.9 million, or 37.2%, and decreased by $7.3 million, or 5.8%, in 2017 and 2016, respectively. The increase in income before income taxes in 2017 was primarily due to higher income from offices in Asia driven by business growth, most notably in Hong Kong and Southeast Asia. The decrease in income before income taxes in 2016 was primarily attributable to unfavorable individual disability claims experience in Australia and unfavorable lapse experience from a closed Financial Solutions treaty in Japan. These unfavorable variances in 2016 are partially offset by favorable claims experience from offices in Asia and gains on derivatives associated with the hedging programs to mitigate currency risks. Foreign currency exchange fluctuations contributed to a decrease in income before income taxes of $1.1 million and an increase of $0.7 million in 2017 and 2016, respectively.
Income before income taxes increased by $34.9 million, or 30.6%, and $8.3 million, or 7.8%, in 2017 and 2016, respectively. The increase in income before income taxes in 2017 was primarily due to higher income from offices in Asia driven by business growth. The increase in income before income taxes in 2016 was primarily driven by improved mortality experience in Asia. Unfavorable individual disability claims experience in Australia partially offset the increase in income in 2016. Foreign currency exchange fluctuations contributed to a decrease in income before income taxes of $1.4 million and $0.8 million in 2017 and 2016, respectively.
Policy acquisition costs and other insurance expenses as a percentage of net premiums were 13.5%, 9.7% and 12.1% for 2017, 2016 and 2015, respectively. The low ratio in 2016 was due primarily to a $40.0 million decrease in policy acquisition costs
and other insurance expenses due to adjustments associated with delays in client reporting on a large treaty in Hong Kong. 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 variations in the mixture of business and client-related actions.
Other operating expenses increased $0.4 million, or 0.2%, and $12.5 million, or 9.2%, in 2017 and 2016, respectively. Operating expenses remained flat in 2017; however, the 2016 increase in other operating expenses is mainly due to increased compensation costs relating to new positions filled during the second half of 2015, primarily in the growing Asian operations based in Hong Kong. Foreign currency exchange fluctuations resulted in an increase in operating expenses of $1.2 million and $0.7 million in 2017 and 2016, respectively. Other operating expenses as a percentage of net premiums totaled 7.2%, 8.8% and 8.7% in 2017, 2016 and 2015, respectively. The timing of premium flows and the level of costs associated with the entrance into and development of new markets in the Asia Pacific segment may cause other operating expenses as a percentage of net premiums to fluctuate over periods of time.
Net premiums decreased by $3.0 million, or 55.4%, and $14.0 million, or 72.1%, in 2017 and 2016, respectively. The decreases were primarily due to policy lapses on the previously mentioned treaty in Japan.
Net investment income increased $10.9 million, or 46.0%, and $5.0 million, or 26.6%, in 2017 and 2016, respectively. The increases in investment income were primarily due to increases in the invested asset base.
Claims and other policy benefits decreased by $7.2 million, or 28.4%, and increased by $8.9 million, or 54.5%, in 2017 and 2016, respectively. The decrease in 2017 was attributable to lower lapses from policies from a closed block of business in Japan. The increase in 2016 was attributable to the aforementioned unfavorable lapse experience on a closed treaty in Japan. Management views recent experience as normal short-term volatility that is inherent in the business.
Other operating expenses decreased by $0.2 million, or 1.3%, and increased by $1.6 million, or 11.9%, in 2017 and 2016, respectively. The timing of premium flows and the level of costs associated with the entrance into and development of new markets in the Asia Pacific segment may cause other operating expenses to fluctuate over periods of time.
Total revenues decreased $25.8 million, or 14.3%, and increased by $112.1 million, or 162.7%, in 2017 and 2016, respectively. The decrease in revenues in 2017 was primarily due to a reduction in investment related gains (losses), net related to higher impairments on fixed maturity and other securities of $21.3 million and a reduction in net gains on the sale of fixed maturity securities of $29.7 million. The decrease was partially offset by an increase of $31.9 million in investment income related to an increase in unallocated invested assets and higher investment yields. The increase in revenues in 2016 was primarily caused by increased net investment related gains of $116.4 million, due to a $32.7 million reduction in other-than-temporary impairments on fixed maturities and net gains on the sale of fixed maturities, along with an increase in other revenues of $2.3 million.
The following table displays DAC balances for the Traditional and Financial Solutions segments as of December 31, 2017:
The current interest rate environment in select markets, primarily the U.S. and Canada, continues to negatively affect the Company’s earnings. The Company’s average investment yield, excluding spread related business, for 2017 was at 4.55%, slightly below the comparable 2016 rate. The Company’s insurance liabilities, in particular its annuity products, are sensitive to changing market factors. Gross unrealized gains on fixed maturity and equity securities available-for-sale were $2,983.7 million and $2,246.5 million at December 31, 2017 and 2016, respectively. Gross unrealized losses totaled $117.0 million and $374.9 million at December 31, 2017 and 2016, respectively.
The Company continues to be in a position to hold any investment security showing an unrealized loss until recovery, provided it remains comfortable with the credit of the issuer. As indicated above, gross unrealized gains on investment securities of $2,983.7 million remain well in excess of gross unrealized losses of $117.0 million as of December 31, 2017. Historically low interest rates continued to put pressure on the Company’s investment yield. The Company does not rely on short-term funding or commercial paper and to date it has experienced no liquidity pressure, nor does it anticipate such pressure in the foreseeable future.
RGA established an intercompany revolving credit facility where certain subsidiaries can lend to or borrow from each other and from RGA in order to manage capital and liquidity more efficiently. The intercompany revolving credit facility, which is a series of demand loans among RGA and its affiliates, is permitted under applicable insurance laws. This facility reduces overall borrowing costs by allowing RGA and its operating companies to access internal cash resources instead of incurring third-party transaction costs. The statutory borrowing and lending limit for RGA’s Missouri-domiciled insurance subsidiaries is currently 3% of the insurance company’s admitted assets as of its most recent year-end. There were no borrowings and $25.0 million outstanding under the intercompany revolving credit facility as of December 31, 2017 and 2016, respectively. In addition to loans associated with the intercompany revolving credit facility, RGA and its subsidiary, RGA Capital LLC, provided loans to RGA Australian Holdings Pty Limited with a total outstanding balance of $46.9 million and $43.2 million as of December 31, 2017 and 2016, respectively.
See Note 13 - “Debt” and Note 18 - “Equity” in the Notes to Consolidated Financial Statements for additional information regarding the Company’s securities transactions.
RCM, RGA Reinsurance and Chesterfield Re are subject to Missouri statutory provisions that restrict the payment of dividends. They may not pay dividends in any 12-month period in excess of the greater of the prior year’s statutory net gain from operations or 10% of statutory capital and surplus at the preceding year-end, without regulatory approval. Aurora National is subject to California statutory provisions that are identical to those imposed by Missouri regarding the ability of Aurora National to pay dividends to RGA Reinsurance. 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. Chesterfield Re would pay dividends to its immediate parent Chesterfield Financial, which would in turn pay dividends to RCM, subject to the terms of the indenture for the embedded value securitization transaction, in which Chesterfield Financial cannot declare or pay any dividends so long as any private placement notes are outstanding. The MDOI allows RCM to pay a dividend to RGA to the extent RCM received the dividend from its subsidiaries, without limitation related to the level of unassigned surplus. Dividend payments from other subsidiaries are subject to regulations in the jurisdiction of domicile, which are generally based on their earnings and/or capital level.
As of December 31, 2017 and 2016, the Company had $2.8 billion and $3.1 billion, respectively, in outstanding borrowings under its debt agreements and was in compliance with all covenants under those agreements. As of December 31, 2017, the average interest rate on long-term debt outstanding was 5.24% compared to 5.16% at the end of 2016. The ability of the Company to make debt principal and interest payments depends on the earnings and surplus of subsidiaries, investment earnings on undeployed capital proceeds, available liquidity at the holding company, and the Company’s ability to raise additional funds.
Regulation XXX, implemented in the U.S. for various types of life insurance business beginning January 1, 2000, significantly increased the level of reserves that U.S. life insurance and life reinsurance companies must hold on their statutory financial statements for various types of life insurance business, primarily certain level premium term life products. The reserve levels required under Regulation XXX increase over time and are normally in excess of reserves required under GAAP. In situations
where primary insurers have reinsured business to reinsurers that are unlicensed and unaccredited in the U.S., the reinsurer must provide collateral equal to its reinsurance reserves in order for the ceding company to receive statutory financial statement credit. In order to manage the effect of Regulation XXX on its statutory financial statements, RGA Reinsurance has retroceded a majority of Regulation XXX reserves to unaffiliated and affiliated reinsurers, both licensed and unlicensed.
The demand for financing of the ceded reserve credits associated with the Company’s assumed term life business has grown at a slower rate in recent years. The Company has been able to utilize its certified reinsurer, RGA Americas, as a means of reducing the burden of financing Regulation XXX and other types of reserves. The Company’s Regulation XXX statutory reserve requirements associated with term life business and other statutory reserve requirements continues to require the Company to obtain additional letters of credit, put additional assets in trust, or utilize other funding mechanisms to support reserve credits. If the Company is unable to support the reserve credits, the regulatory capital levels of several of its subsidiaries may be significantly reduced, while the regulatory capital requirements for these subsidiaries would not change. The reduction in regulatory capital would not directly affect the Company’s consolidated shareholders’ equity under GAAP; however, it could affect the Company’s ability to write new business and retain existing business.
Affiliated captives are commonly used in the insurance industry to help manage statutory reserve and collateral requirements and are often domiciled in the same state as the insurance company that sponsors the captive. The NAIC has analyzed the insurance industry’s use of affiliated captive reinsurers to satisfy certain reserve requirements and has adopted measures to promote uniformity in both the approval and supervision of such reinsurers. New standards to address the use of captive reinsurers were implemented, allowing current captives to continue in accordance with their currently approved plans. State insurance regulators that regulate the Company’s domestic insurance companies have placed additional restrictions on the use of newly established captive reinsurers which may increase costs and add complexity. As a result, the Company may need to alter the type and volume of business it reinsures, increase prices on those products, raise additional capital to support higher regulatory reserves or implement higher cost strategies, all of which could adversely affect the Company’s competitive position and its results of operations. It is also possible that the NAIC could place limits on the recognition of capital held in related party captives when adopting its group capital calculation. Doing so would adversely impact the amount of capital that the group would otherwise be able to recognize and report as capital resident in the group.
Proceeds from the notes issued by Timberlake Financial and RGA’s direct investment in Timberlake Financial were deposited into a series of trust accounts as collateral and are not available to satisfy the general obligations of the Company. As
of December 31, 2017 the Company held deposits in trust and in custody of $841.5 million for this purpose, which is not included in the figures above. A reserve account has been established to cover interest payments on notes issued by Chesterfield Financial that are not available to satisfy the general obligations of the Company. As of December 31, 2017 the Company held deposits in trust of $19.4 million for this purpose, which is not included in the figures above. See “Collateral Finance and Securitization Notes and Statutory Reserve Funding” above for additional information on the Timberlake Financial and Chesterfield Financial notes.
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 a revolving credit facility, under which the Company had availability of $753.4 million as of December 31, 2017. The Company also has $1.1
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 $24,372.9 million exceeds the liability amount of $16,227.6 million included on the consolidated balance sheets principally due to the lack of discounting and accounting for separate account contracts.
In addition, the Company has also entered into funding agreements with the FHLB under guaranteed investment contracts whereby the Company has issued the funding agreements in exchange for cash and for which the FHLB has been granted a blanket lien on the Company’s commercial and residential mortgage-backed securities and commercial mortgage loans used to collateralize the Company’s obligations under the funding agreements. The Company maintains control over these pledged assets, and may use, commingle, encumber or dispose of any portion of the collateral as long as there is no event of default and the remaining qualified collateral is sufficient to satisfy the collateral maintenance level. The funding agreements and the related security agreements represented by this blanket lien provide that upon any event of default by the Company, the FHLB’s recovery is limited to the amount of the Company’s liability under the outstanding funding agreements. The amount of the Company’s liability for the funding agreements with the FHLB under guaranteed investment contracts was $1.4 billion and $1.1 billion at December 31, 2017 and 2016, respectively, which is included in interest sensitive contract liabilities on the Company’s consolidated balance sheets. The advances on these agreements are collateralized primarily by commercial and residential mortgage-backed securities, commercial mortgage loans, and U.S. Treasury and government agency securities. The amount of collateral exceeds the liability and is dependent on the type of assets collateralizing the guaranteed investment contracts.
The Company’s investment and derivative strategies involve matching the characteristics of its reinsurance products and other obligations and to seek to closely approximate the interest rate sensitivity of the assets with estimated interest rate sensitivity of the reinsurance liabilities. The Company achieves its income objectives through strategic and tactical asset allocations, security and derivative strategies within an asset/liability management and disciplined risk management framework. Derivative strategies are employed within the Company’s risk management framework to help manage duration, currency, and other risks in assets and/or liabilities and to replicate the credit characteristics of certain assets. For a discussion of the Company’s risk management process see “Market and Credit Risk” in the “Enterprise Risk Management” section below.
The Company had total cash and invested assets of $53.0 billion and $46.0 billion at December 31, 2017 and 2016, respectively, as illustrated below (dollars in thousands):
As of December 31, 2017, the Company’s investments in Canadian government securities represented 11.1% of the fair value of total fixed maturity securities compared to 11.4% of the fair value of total fixed maturity securities at December 31, 2016. These assets are primarily high-quality long duration provincial strips, the valuation of which is closely linked to the interest rate curve. These assets are longer in duration and held primarily for asset/liability management to meet Canadian regulatory requirements. See “Fixed Maturity and Equity Securities Available-for-Sale” in Note 4 - “Investments” in the Notes to Consolidated Financial Statements for tables showing the various sectors as of December 31, 2017 and 2016.
investments to match specific floating rate liabilities primarily reflected in the consolidated balance sheets as collateral finance notes, as well as to enhance asset management strategies.
The Company references rating agency designations in some of its investments disclosures. These designations are based on the ratings from nationally recognized statistical rating organizations, primarily Moody’s, S&P and Fitch. Structured securities (mortgage-backed and asset-backed securities) held by the Company’s insurance subsidiaries that maintain the NAIC statutory basis of accounting utilize the NAIC rating methodology. The NAIC assigns designations to publicly traded as well as privately placed securities. The designations assigned by the NAIC range from class 1 to class 6, with designations in classes 1 and 2 generally considered investment grade (BBB or higher rating agency designation). NAIC designations in classes 3 through 6 are generally considered below investment grade (BB or lower rating agency designation).
The Company’s fixed maturity portfolio includes structured securities. The following table shows the types of structured securities the Company held at December 31, 2017 and 2016 (dollars in thousands):
The Company’s ABS include credit card receivables, railcar leasing, student loans, single-family rentals, home equity loans and collateralized debt obligations (primarily collateralized loan obligations). The principal risks specific to holding ABS are structural, credit and capital market risks. Structural risks include the securities’ cash flow priority in the capital structure and the inherent prepayment sensitivity of the underlying collateral. Credit risks include the adequacy and ability to realize proceeds from the collateral. Credit risks are mitigated by credit enhancements which include excess spread, over-collateralization and subordination. Capital market risks include general level of interest rates and the liquidity for these securities in the marketplace.
At December 31, 2017 and 2016, the Company had $117.0 million and $374.9 million, respectively, of gross unrealized losses related to its fixed maturity and equity securities. The distribution of the gross unrealized losses related to these securities is shown below:
See “Unrealized Losses for Fixed Maturity and Equity Securities Available-for-Sale” in Note 4 - “Investments” in the Notes to Consolidated Financial Statements for tables that present the estimated fair values and gross unrealized losses, including other-than-temporary impairment losses reported in AOCI, for fixed maturity and equity securities that have estimated fair values below amortized cost, by class and grade security, as well as the length of time the related market value has remained below amortized cost as of December 31, 2017 and 2016.
As of December 31, 2017 and 2016, respectively, the Company classified approximately 5.9% and 6.9% of its fixed maturity securities in the Level 3 category (refer to Note 6 - “Fair Value of Assets and Liabilities” in the Notes to Consolidated Financial Statements for additional information). These securities primarily consist of private placement corporate securities, bank
loans, Canadian provincial strips, below investment grade mortgage-backed securities and subprime asset-backed securities with inactive trading markets.
Mortgage loans represented approximately 8.3% and 8.2% of the Company’s cash and invested assets as of December 31, 2017 and 2016, respectively. The Company’s mortgage loan portfolio consists of U.S. and Canada based investments primarily in commercial offices, light industrial properties and retail locations. The mortgage loan portfolio is diversified by geographic region and property type. Most of the mortgage loans in the Company’s portfolio range in size up to $30.0 million, with the average mortgage loan investment as of December 31, 2017 totaling approximately $9.5 million. The mortgage loan portfolio was diversified by geographic region and property type as discussed further under “Mortgage Loans on Real Estate” in Note 4 - “Investments” in the Notes to Consolidated Financial Statements.
Policy loans comprised approximately 2.6% and 3.1% of the Company’s cash and invested assets as of December 31, 2017 and 2016, respectively, substantially all of which are associated with one client. These policy loans present no credit risk because the amount of the loan cannot exceed the obligation due the ceding company upon the death of the insured or surrender of the underlying policy. The provisions of the treaties in force and the underlying policies determine the policy loan interest rates. The Company earns a spread between the interest rate earned on policy loans and the interest rate credited to corresponding liabilities.
Funds withheld at interest comprised approximately 11.5% and 12.8% of the Company’s cash and invested assets as of December 31, 2017 and 2016, respectively. For reinsurance agreements written on a modified coinsurance basis and certain agreements written on a coinsurance basis, assets equal to the net statutory reserves are withheld and legally owned and managed by the ceding company, and are reflected as funds withheld at interest on the Company’s consolidated balance sheets. In the event of a ceding company’s insolvency, the Company would need to assert a claim on the assets supporting its reserve liabilities. However, the risk of loss to the Company is mitigated by its ability to offset amounts it owes the ceding company for claims or allowances with amounts owed by the ceding company. Ceding companies with funds withheld at interest had an average financial
The Company utilizes derivative financial instruments to protect the Company against possible changes in the fair value of its investment portfolio as a result of interest rate changes, to hedge against risk of changes in the purchase price of securities, to hedge liabilities associated with the reinsurance of variable annuities with guaranteed living benefits and to manage the portfolio’s effective yield, maturity and duration. In addition, the Company utilizes derivative financial instruments to reduce the risk associated with fluctuations in foreign currency exchange rates. The Company uses both exchange-traded and customized over-the-counter derivative financial instruments.
See Note 5 - “Derivative Instruments” in the Notes to Consolidated Financial Statements for a table that presents the notional amounts and fair value of investment related derivative instruments held at December 31, 2017 and 2016.
RGA maintains a dedicated Enterprise Risk Management (“ERM”) function that is responsible for analyzing and reporting the Company’s risks on an aggregated basis; facilitating monitoring to ensure the Company’s risks remain within its appetites and limits; and ensuring, on an ongoing basis, that RGA’s ERM objectives are met. This includes ensuring proper risk controls are in place; risks are effectively identified, assessed, and managed; and key risks to which the Company is exposed are disclosed to appropriate stakeholders. The ERM function plays an important role in fostering the Company’s risk management culture and practices.
Business Specific Limits/Controls: These limits/controls provide additional safeguards against undesired risk exposures and are embedded in business processes. Examples include maximum retention limits, pricing and underwriting reviews, per issuer limits, concentration limits, and standard treaty language.
Proactive risk monitoring and reporting enable early detection and mitigation of emerging risks. The RMSC and its subcommittees monitor adherence to risk limits through the ERM function, which reports regularly to the RMSC and FIRM Committee. The frequency of monitoring is tailored to the volatility assessment and relative priority of each risk. Risk escalation channels coupled with open communication lines enhance the mitigants explained above. The Company has devoted significant resources to developing its ERM program and expects to continue to do so in the future. Nonetheless, the Company’s policies and procedures to identify, manage, and monitor risks may not be fully effective. Many of the Company’s methods for managing risk are based on historical information, which may not be a good predictor of future risk exposures, such as the risk of a pandemic causing a large number of deaths. Management of operational, legal, and regulatory risk relies on policies and procedures which may not be fully effective under all scenarios.
The Company groups its risks into the following categories: Insurance risk, Market and Credit risk, Capital risk, Operational risk and Strategic risk. Specific risk assessments and descriptions can be found below and in Item 1A - “Risk Factors.”
Insurance risk is the risk of lower or negative earnings and potentially a reduction in enterprise value due to a greater amount of benefits and related expenses paid than expected, or from non-market related adverse policyholder or client behavior. The Company uses multiple approaches to managing insurance risk: active insurance risk assessment and pricing appropriately for the risks assumed, transferring undesired risks, and managing the retained exposure prudently. These strategies are explained below.
Misestimation of any key risk can threaten the long term viability of the enterprise. Further, the pricing process is a key operational risk and significant effort is applied to ensuring the appropriateness of pricing assumptions. Some of the safeguards the Company uses to ensure proper pricing are: experience studies, strict underwriting, sensitivity and scenario testing, pricing guidelines and controls, authority limits and internal and external pricing reviews. In addition, the ERM function provides pricing oversight which includes periodic pricing audits.
The Company accesses the markets each year for annual catastrophic coverages and reviews current coverage and pricing of current and alternate designs. The coverage may vary from year to year based on the Company’s perceived value of such protection. The current policy covers events involving 8 or more insured deaths from a single occurrence and covers $100.0 million of claims in excess of the Company’s $25.0 million deductible.
The following table presents the account values by each minimum guaranteed rate, rounded to the nearest percentage, by class of interest-sensitive product as of December 31, 2017 and 2016 (dollars in thousands):
The spread profits on the Company’s fixed annuity and interest-sensitive whole life, universal life (“UL”) and fixed portion of variable universal life (“VUL”) insurance policies are at risk if interest rates decline and remain relatively low for a period of time, which has generally been the case in recent years. Should interest rates remain at current levels, which are significantly lower than those existing prior to the declines of recent years, the average earned rate of return on the Company’s annuity and UL investment portfolios will continue to decline. Declining portfolio yields may cause the spreads between investment portfolio yields and the interest rate credited to contract holders to deteriorate as the Company’s ability to manage spreads can become limited by minimum guaranteed rates on annuity and UL policies. In 2017, minimum guaranteed rates on non-variable annuity and UL policies generally ranged from 0.50% to 6.00%, with an average guaranteed rate of approximately 2.74%. In 2016, minimum guaranteed rates on non-variable annuity and UL policies generally ranged from 0.50% to 6.00%, with an average guaranteed rate of approximately 2.69%.
The Company reinsures annuities with benefits indexed to the cost of living. Some of these benefits are hedged with a combination of CPI swaps and indexed bonds when material.
The Company does not hedge the income statement risk associated with translating foreign currencies. The foreign exchange risk sensitivity of the Company’s consolidated pre-tax income is assessed using hypothetical test scenarios. Actual results may differ from the results noted below particularly due to assumptions utilized or if events occur that were not included in the methodology. For more information on this risk, see “Item 1A - Risk Factors - Risks Related to Our Business.” In general, a weaker U.S. dollar relative to foreign currencies has a favorable impact on the Company’s income before income taxes. The following tables summarize the impact on the Company’s reported income before income taxes of an immediate favorable or unfavorable change in each of the foreign exchange rates to which the Company has exposure (dollars in thousands):
Alternative investments are investments in non-traditional asset classes that primarily back the Company’s capital and surplus. The Company generally restricts the alternative investments portfolio to non-liability supporting assets: that is, free surplus. Alternative investments generally encompass: hedge funds, emerging markets debt, distressed debt, commodities, infrastructure, tax credits, and equities, both public and private. The Company mitigates its exposure to alternative investments by limiting the size of the alternative investments holding and using per-issuer investment limits.
Generally, RGA’s insurance subsidiaries retrocede amounts in excess of their retention to certain other RGA insurance subsidiaries. External retrocessions are arranged through the Company’s retrocession pools for amounts in excess of its retention. As of December 31, 2017, all retrocession pool members in this excess retention pool rated by the A.M. Best Company were rated “A-” or better. A rating of “A-” is the fourth highest rating out of sixteen possible ratings. For a majority of the retrocessionaires that were not rated, letters of credit or trust assets have been given as additional security. In addition, the Company performs annual financial and in force reviews of its retrocessionaires to evaluate financial stability and performance.
Tax risk is the risk that current and future tax positions are different than expected. The Company monitors tax risks related to the evolving tax and regulatory environment, business transactions, legal entity reorganizations, tax compliance obligations, and financial reporting.
Human capital risk is related to workforce management, including talent acquisition, development, retention, and employment relations/regulations. The Company actively monitors human capital risks using multiple practices which include but are not limited to human resource and compliance policies and procedures, regularly reviewing key risk indicators, performance evaluations, compensation and benefits benchmarking, succession planning, employee engagement surveys and associate exit interviews.
See “New Accounting Pronouncements” in Note 2 - “Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements.
Financial Statements as of December 31, 2017 and 2016 and for the years ended December 31, 2017, 2016 and 2015:
accretion of discounts and prepayment fees are reported in investment income, net of related expenses in the consolidated statements of income.
related expenses. Limited partnership interests and structured loans are primarily carried at cost. Based on the nature and structure of these investments, they do not meet the characteristics of an equity security in accordance with applicable accounting standards. Joint ventures and certain limited partnerships are reported using the equity method of accounting.
The Company participates in a repurchase program in which securities, reflected as investments on the Company’s consolidated balance sheets, are pledged to a third party. In return, the Company receives cash from the third party, which is reflected as a payable to a third party, included in other liabilities on the consolidated balance sheets. The Company is required to maintain a minimum collateral balance with a fair value of 102% of the cash received.
The Company reviews all securities on a case-by-case basis 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 issuers financial position and access to capital; 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, the Company’s 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.
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 Company’s funds withheld at interest balances are primarily associated with its reinsurance treaties structured on a modified coinsurance or funds withheld basis, the majority of which were subject to the general accounting principles for Derivatives and Hedging related to embedded derivatives. Management believes the embedded derivative feature in each of these reinsurance treaties is similar to a total return swap on the assets held by the ceding companies. The valuation of embedded derivatives is sensitive to the investment credit spread environment. Changes in investment credit spreads are also affected by the application of a credit valuation adjustment (“CVA”). The fair value calculation of an embedded derivative in an asset position utilizes a CVA based on the ceding company’s credit risk. Conversely, the fair value calculation of an embedded derivative in a liability position utilizes a CVA based on the Company’s credit risk. Generally, an increase in investment credit spreads, ignoring changes in the CVA, will have a negative impact on the fair value of the embedded derivative (decrease in income). The fair value of the embedded derivatives is included in the funds withheld at interest line item on the consolidated balance sheets. The change in the fair value of the embedded derivatives is recorded in investment related gains (losses), net on the consolidated statements of income.
The Company has entered into various financial reinsurance treaties on a funds withheld and modified coinsurance basis. These treaties do not transfer significant insurance risk and are recorded on a deposit method of accounting with the Company earning a net fee. As a result of the experience refund provisions contained in these treaties, the value of the embedded derivatives in these
If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the fair value measurement of the asset or liability.
The Company tests the recoverability for each year of business at issue before establishing additional deferred acquisition costs (“DAC”). The Company also performs annual tests to establish that DAC are expected to remain recoverable, and if financial performance significantly deteriorates to the point where a deficiency exists, a cumulative charge to current operations will be recorded. No such adjustments related to DAC recoverability were made in 2017, 2016 and 2015.
Computer software, which is included in other assets, is stated at cost, less accumulated amortization. Purchased software costs, as well as certain internal and external costs incurred to develop internal-use computer software during the application development stage, are capitalized. Amortization of software costs is recorded on a straight-line basis over periods ranging from three to ten years. Carrying values are reviewed periodically for indicators of impairment in value. Unamortized computer software costs were $145.5 million and $139.8 million at December 31, 2017 and 2016, respectively. Amortization expense was $35.7 million, $10.3 million, and $14.0 million for the years ended December 31, 2017, 2016 and 2015, respectively. The Company recognized capital project write-offs of $24.5 million, $0.6 million and $6.0 million in 2017, 2016 and 2015, respectively.
The Company establishes future policy benefits for guaranteed minimum death benefits (“GMDB”) relating to the reinsurance of certain variable annuity contracts by estimating the expected value of death benefits in excess of the projected account balance and recognizing the excess proportionally over the accumulation period based on total expected assessments. The Company regularly evaluates estimates used and adjusts the additional liability balance, with a related charge or credit to claims and other policy benefits, if actual experience or other evidence suggests that earlier assumptions should be revised. The assumptions used in estimating the GMDB liabilities are consistent with those used for amortizing DAC, and are thus subject to the same variability and risk. The Company’s GMDB liabilities at December 31, 2017 and 2016 were not material.
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 reinsures asset-intensive products, including annuities and corporate-owned life insurance. The investment portfolios for these products are segregated for management purposes within the general account of RGA Reinsurance Company (“RGA Reinsurance”). The liabilities under asset-intensive insurance contracts or reinsurance contracts reinsured on a coinsurance basis are included in interest-sensitive contract liabilities on the consolidated balance sheets. Asset-intensive contracts principally include individual fixed annuities in the accumulation phase, single premium immediate annuities, equity-indexed annuities, individual variable annuities, corporate-owned life and interest-sensitive whole life insurance contracts. Interest-sensitive contract liabilities are equal to (i) policy account values, which consist of an accumulation of gross premium payments; (ii) credited interest less expenses, mortality charges, and withdrawals; and (iii) fair value adjustments relating to business combinations. Liabilities for immediate annuities are calculated as the present
Claims payable for incurred but not reported losses are determined using case-basis estimates and lag studies of past experience. The time lag from the date of the claim or death to when the ceding company reports the claim to the Company can vary significantly by ceding company, business segment and product type, but generally averages around 3.6 months. Incurred but not reported claims are estimates on an undiscounted basis, using actuarial estimates of historical claims expense, adjusted for current trends and conditions. These estimates are continually reviewed and the ultimate liability may vary significantly from the amount recognized, which are reflected in claims and other policy benefits in the consolidated statements of income in the period in which they are determined.
Other liabilities primarily include investments in transit, separate accounts, employee benefits, cash collateral received on derivative positions and current federal income taxes payable.
The U.S. consolidated tax return includes the operations of RGA and all eligible subsidiaries. Aurora National Life Assurance Company’s (“Aurora National”) files a separate U.S. income tax return as it is ineligible for inclusion in the consolidated federal tax return until 2021. The Company’s foreign subsidiaries are taxed under applicable local statutes.
Collateral finance and securitization notes represent private placement asset-backed structured financing transactions. Collateral finance notes are issued on specified insurance policies reinsured by the Company’s regulated subsidiaries. Transaction costs, primarily interest expense, are reflected in collateral finance and securitization expense. See Note 14 - “Collateral Finance and Securitization Notes” for additional information.
In February 2018, the FASB updated the general accounting principle for Reporting Comprehensive Income to require reclassification from accumulated other comprehensive income to retained earnings for the stranded tax effects resulting from the newly enacted U.S. federal corporate income tax rate. The amount of the reclassification would be the difference between the historical U.S. federal corporate income tax rate and the newly enacted 21 percent tax rate. The Company adopted the new guidance on December 31, 2017 by reclassifying certain income tax effects of items within accumulated other comprehensive income to retained earnings as a result of the Tax Cuts and Jobs Act of 2017. The impact of adopting this standard was an increase in accumulated other comprehensive income and a reduction in retained earnings of approximately $156.4 million.
In January 2016, the FASB amended the general accounting principle for Financial Instruments, which requires equity investments that are not accounted for under the equity method of accounting to be measured at fair value with changes recognized in net income and also updates certain presentation and disclosure requirements. The new guidance became effective for the Company beginning January 1, 2018 and required a cumulative-effect adjustment for certain items upon adoption. The adoption of the new guidance was not material to the Company’s consolidated financial statements.
In June 2016, the FASB amended the existing impairment guidance of Financial Instruments. The amendment adds to U.S. GAAP an impairment model, known as current expected credit loss (“CECL”) model that is based on expected losses rather than incurred losses. For traditional and other receivables, held-to-maturity debt securities, loans and other instruments entities will be required to use the new forward-looking “expected loss” model that generally will result in earlier recognition of allowance for losses. For available-for-sale debt securities with unrealized losses, entities will measure credit losses similar to what they do today, except the losses will be recognized as allowances rather than reduction to the amortized cost of the securities. This guidance is effective for the Company January 1, 2020, with early adoption permitted. The guidance will be adopted through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (that is, a modified-retrospective approach). The Company is currently evaluating the impact of this amendment on its consolidated financial statements.
In October 2016, the FASB amended the general accounting principal for Income Taxes, effective for the Company January 1, 2018. The amendment requires entities to recognize the tax consequences of intercompany asset transfers, except for inventory, at the transaction date. Current GAAP prohibits entities from recognizing the income tax consequences from intercompany asset transfers. The seller defers any net tax effect, and the buyer is prohibited from recognizing a deferred tax asset on the difference between the newly created tax basis of the asset in its tax jurisdiction and its financial statement carrying amount as reported in the consolidated financial statements. The amendment requires entities to recognize these tax consequences in the period in which the transfer occurred. There will be an immediate effect on earnings if the tax rates in the seller’s and buyer’s tax jurisdictions are
The Company monitors its concentrations of financial instruments on an ongoing basis, and mitigates credit risk by maintaining a diversified investment portfolio which limits exposure to any one issuer. The Company’s exposure to concentrations of credit risk from single issuers greater than 10% of the Company’s stockholders’ equity included securities of the U.S. government and its agencies, as well as the securities disclosed below, as of December 31, 2017 and 2016 (dollars in thousands):
The tables below show the major industry types of the Company’s corporate fixed maturity holdings as of December 31, 2017 and 2016 (dollars in thousands):
As discussed in Note 2 - “Summary of Significant Accounting Policies,” a portion of certain other-than-temporary impairment (“OTTI”) losses on fixed maturity securities is recognized in AOCI. For these securities, the net amount recognized in the consolidated statements of income (“credit loss impairments”) represents the difference between the amortized cost of the security and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security prior to impairment. Any remaining difference between the fair value and amortized cost is recognized in AOCI. The following table sets forth the amount of pre-tax credit loss impairments on fixed maturity securities held by the Company as of the dates indicated, for which a portion of the OTTI loss was recognized in AOCI, and the corresponding changes in such amounts (dollars in thousands):
The following table presents the total gross unrealized losses for the 1,116 and 1,535 fixed maturity and equity securities at December 31, 2017 and 2016, respectively, where the estimated fair value had declined and remained below amortized cost by the indicated amount (dollars in thousands):
At December 31, 2017 and 2016 the Company held non-income producing securities with amortized costs of $38.8 million and $35.4 million, and estimated fair values of $39.3 million and $47.3 million, respectively. Generally, securities are non-income producing when principal or interest is not paid primarily as a result of bankruptcies or credit defaults, but also include securities where amortization has been discontinued. During 2017, 2016 and 2015 the Company sold fixed maturity and equity securities with fair values of $2,727.8 million, $1,181.6 million, and $1,523.6 million, which were below amortized cost, at gross realized losses of $41.7 million, $50.0 million and $71.9 million, respectively. The Company generally does not engage in short-term buying and selling of securities.
The Company also held cash collateral for securities lending and the repurchase program/reverse repurchase programs of $31.2 million and $28.8 million at December 31, 2017 and 2016, respectively. No cash or securities have been pledged by the Company for its securities borrowing program as of December 31, 2017 and 2016.
The following tables set forth certain key credit quality indicators of the Company’s recorded investment in mortgage loans as of December 31, 2017 and 2016 (dollars in thousands):
The age analysis of the Company’s past due recorded investments in mortgage loans as of December 31, 2017 and 2016 (dollars in thousands):
Information regarding the Company’s loan valuation allowances for mortgage loans as of December 31, 2017, 2016 and 2015 are as follows (dollars in thousands):
Information regarding the portion of the Company’s mortgage loans that were impaired as of December 31, 2017 and 2016 is as follows (dollars in thousands):
The Company did not acquire any impaired mortgage loans during the years ended December 31, 2017 and 2016. The Company had no mortgage loans that were on a nonaccrual status at December 31, 2017 and 2016.
Loan Bank of Des Moines (“FHLB”) common stock, equity release mortgages and structured loans, all of which are included in other in the table below. Other invested assets represented approximately 3.1% and 3.6% of the Company’s total investments as of December 31, 2017 and 2016, respectively. Carrying values of these assets as of December 31, 2017 and 2016 are as follows (dollars in thousands):
A regression analysis was used, both at inception of the hedge and on an ongoing basis, to determine whether each derivative used in a hedged transaction is highly effective in offsetting changes in the hedged item. For the foreign currency swaps, the change in fair value related to changes in the benchmark interest rate and credit spreads are excluded from the hedge effectiveness. For the years ended December 31, 2017, 2016 and 2015, $2.0 million, $0.4 million and $0.8 million, respectively, of the change in the estimated fair value of derivatives, was excluded from hedge effectiveness.
The following table presents the effective portion of derivatives in cash flow hedging relationships on the consolidated statements of income and the consolidated statements of stockholders’ equity for the years ended December 31, 2017, 2016 and 2015 (dollars in thousands):
The cumulative foreign currency translation gain recorded in AOCI related to these hedges was $113.7 million and $161.6 million at December 31, 2017 and 2016, respectively. If a hedged foreign operation was sold or substantially liquidated, the amounts in AOCI would be reclassified to the consolidated statements of income. A pro rata portion would be reclassified upon partial sale of a hedged foreign operation.
Foreign currency swaps are used by the Company to reduce the risk from fluctuations in foreign currency exchange rates associated with its assets and liabilities denominated in foreign currencies. With a foreign currency swap transaction, the Company agrees with another party to exchange, at specified intervals, the difference between one currency and another at a forward exchange rate calculated by reference to an agreed upon principal amount. The principal amount of each currency is exchanged at the termination of the currency swap by each party. The Company uses foreign currency swaps in hedges of net investments in foreign operations, fair value hedges and non-qualifying hedge relationships.
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 guaranteed minimum withdrawal benefits, guaranteed minimum accumulation benefits, and guaranteed minimum income benefits. The changes in fair values of embedded derivatives on equity-indexed annuities described below relate to changes in the fair value associated with capital market and other related assumptions. The Company’s utilization of a credit valuation adjustment did not have a material effect on the change in fair value of its embedded derivatives for the years ended December 31, 2017, 2016 and 2015. The related gains (losses) and the effect on net income after amortization of DAC and income taxes for the years ended December 31, 2017, 2016 and 2015 are reflected in the following table (dollars in thousands):
Level 1 - Unadjusted quoted prices in active markets for identical assets or liabilities. Active markets are defined as having the following characteristics for the measured asset/liability: (i) many transactions, (ii) current prices, (iii) price quotes not varying substantially among market makers, (iv) narrow bid/ask spreads and (v) most information publicly available. The Company’s Level 1 assets and liabilities are traded in active exchange markets.
The Company may utilize information from third parties, such as pricing services and brokers, to assist in determining the fair value for certain assets and liabilities; however, management is ultimately responsible for all fair values presented in the Company’s financial statements. This includes responsibility for monitoring the fair value process, ensuring objective and reliable valuation practices and pricing of assets and liabilities, and approving changes to valuation methodologies and pricing sources. The selection of the valuation technique(s) to apply considers the definition of an exit price and the nature of the asset or liability being valued and significant expertise and judgment is required.
The Company performs initial and ongoing analysis and review of the various techniques utilized in determining fair value to ensure that they are appropriate and consistently applied, and that the various assumptions are reasonable. The Company analyzes and reviews the information and prices received from third parties to ensure that the prices represent a reasonable estimate of the fair value and to monitor controls around pricing, which includes quantitative and qualitative analysis and is overseen by the Company’s investment and accounting personnel. Examples of procedures performed include, but are not limited to, review of pricing trends, comparison of a sample of executed prices of securities sold to the fair value estimates, comparison of fair value estimates to management’s knowledge of the current market, and ongoing confirmation that third party pricing services use, wherever possible, market-based parameters for valuation. In addition, the Company utilizes both internal and external cash flow models to analyze the reasonableness of fair values utilizing credit spread and other market assumptions, where appropriate. As a result of the analysis, if the Company determines there is a more appropriate fair value based upon the available market data,
the price received from the third party is adjusted accordingly. The Company also determines if the inputs used in estimated fair values received from pricing services are observable by assessing whether these inputs can be corroborated by observable market data.
Actuarial assumptions are based on experience studies performed internally in combination with available industry information and are reviewed on a periodic basis, at least annually.
For embedded derivative liabilities associated with the underlying products in reinsurance treaties, primarily equity-indexed and variable annuity treaties, the Company utilizes a discounted cash flow model, which includes an estimate of future equity option purchases and an adjustment for a CVA. The variable annuity embedded derivative calculations are performed by third parties based on methodology and input assumptions provided by the Company. To validate the reasonableness of the resulting fair value, the Company’s internal actuaries perform reviews and analytical procedures on the results. The capital market inputs to the model, such as equity indexes, short-term equity volatility and interest rates, are generally observable. The valuation also requires certain significant inputs, which are generally not observable and accordingly, the valuation is considered Level 3 in the fair value hierarchy, see “Level 3 Measurements and Transfers” below for a description.
The fair value of embedded derivatives associated with funds withheld reinsurance treaties is determined based upon a total return swap technique with reference to the fair value of the investments held by the ceding company that support the Company’s funds withheld at interest asset with an adjustment for a CVA. The fair value of the underlying assets is generally based on market observable inputs using industry standard valuation techniques. The valuation also requires certain significant inputs, which are generally not observable and accordingly, the valuation is considered Level 3 in the fair value hierarchy, see “Level 3 Measurements and Transfers” below for a description.
Credit Valuation Adjustment - The Company uses a structural default risk model to estimate a CVA. The input assumptions are a combination of externally derived and published values (default threshold and uncertainty), market inputs (interest rate, equity price per share, debt per share, equity price volatility) and insurance industry data (Loss Given Default), adjusted for market recoverability.
The reconciliations for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) are as follows:
The fair value of the Company’s private equity investments is based on external valuation models.
Other Invested Assets - This primarily includes limited partnership interests accounted for using the cost method, structured loans, FHLB common stock, cash collateral and equity release mortgages. The fair value of limited partnership interests and other investments accounted for using the cost method is determined using the NAV of the Company’s ownership interest as provided in the financial statements of the investees. The fair value of structured loans is estimated based on a discounted cash flow analysis using discount rates applicable to each structured loan, this is considered Level 3 in the fair value hierarchy. The fair value of the Company’s common stock investment in the FHLB is considered to be the carrying value and it is considered Level 2 in the fair value hierarchy. The fair value of the Company’s cash collateral is considered to be the carrying value and considered to be Level 1 in the fair value hierarchy. The fair value of the Company’s equity release mortgage loan portfolio, considered Level 3 in the fair value hierarchy, is estimated by discounting cash flows, both principal and interest, using a risk free rate plus an illiquidity premium. The cash flow analysis considers future expenses, changes in property prices, and actuarial analysis of borrower behavior, mortality and morbidity.
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, 2017 and 2016, no allowances were deemed necessary. The Company regularly evaluates the financial condition of the insurance companies from which it assumes and to which it cedes reinsurance.
The following table presents information for the Company’s ceded reinsurance receivable assets, including the respective amount and A.M. Best rating for each reinsurer representing in excess of five percent of the total as of December 31, 2017 and 2016 (dollars in thousands):
Included in the total ceded reinsurance receivables balance were $243.8 million and $242.0 million of claims recoverable, of which $1.9 million and $4.0 million were in excess of 90 days past due, as of December 31, 2017 and 2016, respectively.
In connection with the Company’s initial analysis of the impact of U.S. Tax Reform, it recorded a discrete provisional net tax benefit of $1,033.8 million in the period ending December 31, 2017. This estimated net benefit primarily consists of the U.S. federal rate reduction from 35 percent to 21 percent applied to the net deferred tax liability. The Company provisionally estimates there would be no one-time transition tax on unrepatriated earnings of foreign subsidiaries. However, this tax could change based on future clarification of U.S. Tax Reform, as well as due to the Company gathering additional information to more precisely compute the transition tax. Further, as a result of U.S. Tax Reform, the Company established a valuation allowance of $58.9 million related to U.S. foreign tax credit carryforwards. The valuation allowance relates to the Company’s interpretation of the changes in the ability to use existing foreign tax credit carryforwards against future foreign branch profits. The valuation allowance could change based on future interpretation and analysis of U.S. Tax Reform.
Pre-tax income for the years ended December 31, 2017, 2016 and 2015 consists of the following (dollars in thousands):
The Company’s effective tax rate differed from the U.S. federal income tax statutory rate of 35% as a result of the following for the years ended December 31, 2017, 2016 and 2015 (dollars in thousands):
Total income taxes for the years ended December 31, 2017, 2016 and 2015 were as follows (dollars in thousands):
The tax effects of temporary differences that give rise to significant portions of the deferred income tax assets and liabilities at December 31, 2017 and 2016, are presented in the following tables (dollars in thousands):
As of December 31, 2016, a valuation allowance for deferred tax assets of approximately $133.4 million was provided on the total deferred tax assets in certain jurisdictions. The valuation allowance is primarily related to numerous branches and legal entities for which there is no history of earnings in recent years. Further there is a partial valuation allowance on RGA South Africa, RGA Australia, and Aurora National net operating losses, as well as RGA International’s foreign tax credit. The Company utilizes valuation allowance when it believes, based on the weight of the available evidence, that it is more likely than not that the deferred income tax asset will not be utilized.
The Company files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The Company is under continuous examination by the Internal Revenue Service and is subject to audit by taxing authorities in other foreign jurisdictions in which the Company has significant business operations. The income tax years under examination vary by jurisdiction. The Company is no longer subject to U.S. federal income tax examinations by tax authorities for years prior to 2014, Canadian tax authorities for years prior to 2013 and with a few exceptions, the Company is no longer subject to state and foreign income tax examinations by tax authorities for years prior to 2012.
Certain subsidiaries of the Company are sponsors or administrators of both qualified and non-qualified defined benefit pension plans (“Pension Plans”). The largest of these plans is a non-contributory qualified defined benefit pension plan sponsored by RGA Reinsurance that covers U.S. employees. The benefits under the Pension Plans are generally based on years of service and compensation levels.
A December 31 measurement date is used for all of the defined benefit and postretirement plans. The status of these plans as of December 31, 2017 and 2016 is summarized below (dollars in thousands):
The following table presents information for pension plans with an accumulated benefit obligation in excess of plan assets as of December 31, 2017 and 2016 (dollars in thousands):
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 $3.4 million and $1.1 million, respectively.
Target allocations of U.S. qualified pension plan assets are determined with the objective of maximizing returns and minimizing volatility of net assets through adequate asset diversification and partial liability immunization. Adjustments are made to target allocations based on the Company’s assessment of the effect of economic factors and market conditions. The target allocations for plan assets are 60% equity securities and 40% debt securities as of December 31, 2017 and 2016. 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.
Mutual funds were invested 27% in U.S. equity funds, 36% in U.S. fixed income funds, 22% in non-U.S. equity funds and 15% in other.
Mutual funds were invested 28% in U.S. equity funds, 37% in U.S. fixed income funds, 20% in non-U.S. equity funds and 15% in other.
As of December 31, 2017 and 2016, the Company classified all of its qualified pension plan assets in the Level 1 category as quoted prices in active markets are available for these assets. See Note 6 - “Fair Value of Asset and Liabilities” for additional detail on the fair value hierarchy.
In 2017, the Company contributed to RGA Americas Reinsurance Company, Ltd. all of the outstanding shares of its wholly-owned subsidiary, RGA Australia. Periods prior to 2017 have been adjusted to reflect this contribution.
The Company’s foreign insurance subsidiaries prepare financial statements in accordance with local regulatory requirements. The regulatory authorities in these foreign jurisdictions establish some form of minimum regulatory capital and surplus requirements.
All of the Company’s foreign insurance subsidiaries have regulatory capital and surplus that exceed the local minimum requirements. These requirements do not represent a significant constraint for the payment of dividends by the Company’s foreign insurance companies.
Dividend payments from non-U.S. operations are subject to similar restrictions established by local regulators. The non-U.S. regulatory regimes also commonly limit the dividend payments to the parent to a portion of the prior year’s statutory income, as determined by the local accounting principles. The regulators of the Company’s non-U.S. operations may also limit or prohibit profit repatriations or other transfers of funds to the U.S. if such transfers are deemed to be detrimental to the solvency or financial strength of the non-U.S. operations, or for other reasons. Most of the non-U.S. operating subsidiaries are second tier subsidiaries which are owned by various non-U.S. holding companies. The capital and rating considerations applicable to the first tier subsidiaries may also impact the dividend flow to RGA.
The Company’s commitments to fund investments as of December 31, 2017 and 2016 are presented in the following table (dollars in thousands):
Rent expenses amounted to approximately $15.7 million, $13.7 million and $12.1 million for the years ended December 31, 2017, 2016 and 2015, respectively.
RGA, through wholly-owned subsidiaries, has committed to provide statutory reserve support to third-parties, in exchange for a fee, by funding loans if certain defined events occur. Such statutory reserves are required under the U.S. Valuation of Life Policies Model Regulation (commonly referred to as Regulation XXX for term life insurance policies and Regulation A-XXX for universal life secondary guarantees). The third-parties have recourse to RGA should the subsidiary fail to provide the required funding, however, as of December 31, 2017, the Company does not believe that it will be required to provide any funding under these commitments as the occurrence of the defined events is considered remote. The following table presents the maximum potential obligation for these commitments as of December 31, 2017 (dollars in millions):
The Company maintains nine committed credit facilities, a syndicated revolving credit facility with a capacity of $850.0 million and eight letter of credit facilities with a combined capacity of $1,266.5 million. The Company may borrow cash and obtain letters of credit in multiple currencies under its syndicated revolving credit facility. The following table provides additional information on the Company’s existing committed credit facilities as of December 31, 2017 and 2016 (dollars in thousands):
Company’s letters of credit were $10.5 million, $7.9 million and $10.9 million for the years ended December 31, 2017, 2016 and 2015, respectively, and are included in policy acquisition costs and other insurance expenses.
In June 2006, RGA’s subsidiary, Timberlake Financial L.L.C. (“Timberlake Financial”), issued $850.0 million of Series A Floating Rate Insured Notes, due June 2036, in a private placement. The notes were issued to fund the collateral requirements for statutory reserves required by Regulation XXX on specified term life insurance policies reinsured by RGA Reinsurance and retroceded to Timberlake Re. Proceeds from the notes, along with a $112.8 million direct investment by RGA, were deposited into a series of accounts that collateralize the notes and are not available to satisfy the general obligations of the Company. As of December 31, 2017 and 2016, respectively, the Company held assets in trust and in custody of $841.5 million and $893.8 million, of which $39.7 million and $24.1 million were held in a Debt Service Coverage account to cover interest payments on the notes. Interest on the notes accrues at an annual rate of 1-month LIBOR plus a base rate margin, payable monthly, and totaled $6.4 million, $4.2 million and $3.8 million in 2017, 2016 and 2015, respectively.
In May 2015, RGA’s subsidiary, RGA Reinsurance Company (Barbados) Ltd. (“RGA Barbados”) obtained CAD$200.0 million of collateral financing from a third party through 2020, enabling RGA Barbados to support collateral requirements for Canadian reinsurance transactions. Capitalized issuance costs were approximately $1.3 million. The obligation is reflected on the consolidated balance sheets in collateral finance and securitization notes. Interest on the collateral financing is payable quarterly and accrues at 3-month Canadian Dealer Offered Rate plus a margin and totaled $4.2 million, $4.0 million and $2.3 million in 2017, 2016 and 2015, respectively.
The Canada Traditional segment is primarily engaged in individual life reinsurance, as well as creditor, group life and health, critical illness and disability reinsurance, through yearly renewable term and coinsurance agreements. The Canada Financial Solutions segment concentrates on assisting clients with longevity risk transfer structures within underlying annuities and pension benefit obligations, and on assisting clients in meeting applicable regulatory requirements while enhancing their financial strength and regulatory surplus position through financial reinsurance structures.
Corporate and Other operations include investment income from invested assets not allocated to support segment operations and proceeds from the Company’s capital-raising efforts that have not been deployed yet, in addition to investment related gains or losses. Additionally, Corporate and Other includes results associated with the Company’s collateral finance and securitization notes and results from certain wholly-owned subsidiaries and joint ventures that, among other activities, develop and market technology solutions for the insurance industry.
The following is unaudited supplementary information about average historical claims duration as of December 31, 2017:
The calculation of common equivalent shares does not include the impact of options having a strike or conversion price that exceeds the average stock price for the earnings period, as the result would be antidilutive. The calculation of common equivalent
shares also excludes the impact of outstanding performance contingent shares, as the conditions necessary for their issuance have not been satisfied as of the end of the reporting period. Approximately 0.2 million and 0.3 million outstanding stock options were not included in the calculation of common equivalent shares during 2017 and 2015, respectively. During 2016, all outstanding options were included in the calculation of common equivalent shares. Approximately 0.3 million, 0.4 million and 0.4 million performance contingent shares were excluded from the calculation of common equivalent shares during 2017, 2016 and 2015, respectively.
During 2017, RGA’s board of directors authorized and amended a share repurchase program, with no expiration date, to repurchase up to $400.0 million of RGA’s outstanding common stock. In connection with this authorization, the board of directors terminated the stock repurchase authority granted in 2016. During 2017, RGA repurchased 208,680 shares of common stock under this program for $26.9 million.
The following table presents the amounts of AOCI reclassifications for the years ended December 31, 2017 and 2016 (dollars in thousands):
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, 2017, shares authorized for the granting of Benefits under the Plan and the Directors Plan totaled 14,960,077 and 412,500 respectively. The Company uses treasury shares or shares made available from authorized but unissued shares to support the future exercise of options or settlement of awards granted under its stock plans.
Equity-based compensation expense of $22.3 million, $33.1 million, and $16.0 million related to grants or awards under the Stock Plans was recognized in 2017, 2016 and 2015, respectively. Equity-based compensation expense is principally related to the issuance of stock options, performance contingent restricted units, stock appreciation rights and restricted stock.
In general, restricted stock units (“RSUs”) become payable at the end of a three- or ten-year vesting period. Each RSU, if they vest, represents the right to receive one share of Company common stock. RSUs awarded under the plan generally have no strike price and are included in the Company’s shares outstanding.
We have audited the accompanying consolidated balance sheets of Reinsurance Group of America, Incorporated and subsidiaries (the "Company") as of December 31, 2017 and 2016, and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2017, and the related notes, and the schedules listed in the Index at Item 15 (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.
These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.