Most of the Company’s leases in the U.S. and other countries have lease terms of three to five years, although some leases have terms of up to 10 years. As provided in Note 12 - “Lease Commitments” in the Notes to Consolidated Financial Statements, the rental expense on operating leases for office space and equipment totaled $13.9 million for 2009.
The selected financial data presented for, and as of the end of, each of the years in the five-year period ended December 31, 2009, have been prepared in accordance with accounting principles generally accepted in the United States of America. All amounts shown are in millions, except per share and operating data. The following data should be read in conjunction with the Consolidated Financial Statements and the Notes to Consolidated Financial Statements appearing in Part II Item 8 and Management’s Discussion and Analysis of Financial Condition and Results of Operations appearing in Part II
The Company is primarily engaged in traditional individual and group life, annuity, critical illness and financial reinsurance. RGA and its predecessor, the Reinsurance Division of General American, a Missouri life insurance company, have been engaged in the business of life reinsurance since 1973. Approximately 68.7% of the Company’s 2009 net premiums were from its more established operations in North America, represented by its U.S. and Canada segments.
The Company has five main geographic-based operational segments, each of which is a distinct reportable segment: U.S., Canada, Europe & South Africa, Asia Pacific and Corporate and Other. The U.S. operations provide traditional life, long-term care, annuity, and financial reinsurance primarily to domestic clients. The Canada operations provide insurers with reinsurance of traditional life products as well as creditor reinsurance, group life and health reinsurance and non-guaranteed critical illness products. Europe & South Africa operations include traditional life reinsurance and critical illness business from Europe & South Africa, in addition to other markets the Company is developing. Asia Pacific operations provide primarily traditional and group life reinsurance, critical illness and, to a lesser extent, financial reinsurance. Corporate and Other includes results from, among others, RTP, a wholly-owned subsidiary that develops and markets technology solutions for the insurance industry and the investment income and expense associated with the Company’s collateral finance facility. Effective January 1, 2009, due to immateriality, the discontinued accident and health operations were included in the results of the Corporate and Other segment. The consolidated statements of income for 2008 and 2007 reflect this line of business as a discontinued operation. More information about the Company’s discontinued accident and health division may be found in Note 21 - “Discontinued Operations” in the Notes to Consolidated Financial Statements. The Company measures segment performance based on profit or loss from operations before income taxes.
Consolidation and Reorganization Within the Life Reinsurance and Life Insurance Industry. As a result of consolidations in recent years within the life reinsurance industry, there are fewer competitors. According to the SOA survey, as of December 31, 2008, the top five companies held approximately 71.0% of the market share in North America based on life reinsurance in force, whereas in 1998, the top five companies held approximately 54.2% of the market share. As a consequence, the Company believes the life reinsurance pricing environment will remain attractive for the remaining life reinsurers, particularly those with a significant market presence and strong ratings.
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 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. In every year since 2007, the Company’s U.S. facultative operation has processed over 100,000 facultative submissions.
As previously indicated, the Company generally starts new operations in these markets from the ground up as opposed to acquiring existing operations, and it often enters these markets to support its large international clients as they expand into additional markets. Many of the markets that the Company has entered since 1994, or may enter in the future, are not utilizing life reinsurance, including facultative life reinsurance, at the same levels as the North American market, and therefore, the Company believes these markets represent opportunities for increasing reinsurance penetration. In particular, management believes
The Company recognizes in consolidated income from continuing operations, changes in the fair value of embedded derivatives on modified coinsurance or funds withheld treaties, equity-indexed annuity treaties (“EIAs”) and variable annuity products. The change in the value of embedded derivatives related to 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 unrealized gains and losses associated with these embedded derivatives, after adjustment for deferred acquisition costs, had a favorable effect on income from continuing operations of $139.2 million in 2009 and an unfavorable effect of $93.3 million in 2008, 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, affected income from continuing operations favorably by $11.6 million in 2009 and unfavorably by $9.9 million in 2008, 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, affected income from continuing operations unfavorably by $30.5 million and $0.9 million in 2009 and 2008, respectively, as compared to the prior years.
The combined changes in these three types of embedded derivatives, after adjustment for deferred acquisition costs and retrocession, resulted in an increase of approximately $120.4 million and a decrease of approximately $104.1 million in consolidated income from continuing operations in 2009 and 2008, respectively, as compared to the prior years. These fluctuations do not affect current cash flows, crediting rates or spread performance on the underlying treaties. Therefore, management believes it is helpful to distinguish between the effects of changes in these embedded derivatives and the
The Company’s accounting policies are described in Note 2 - “Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements. The Company believes its most critical accounting policies include the capitalization and amortization of deferred acquisition costs (“DAC”); the establishment of liabilities for future policy benefits, other policy claims and benefits, including incurred but not reported claims; the valuation of fixed maturity investments and investment impairments, if any; embedded derivatives; accounting for income taxes; and the establishment of arbitration or litigation reserves. The balances of these accounts require extensive use of assumptions and estimates, particularly related to the future performance of the underlying business.
Costs of acquiring new business, which vary with and are primarily related to the production of new business, have been deferred to the extent that such costs are deemed recoverable from future premiums or gross profits. DAC amounts reflect the Company’s expectations about the future experience of the business in force and include commissions and allowances as well as certain costs of policy issuance and underwriting. Some of the factors that can affect the carrying value of DAC include mortality assumptions, interest spreads and policy lapse rates. For traditional life and related coverages, the Company performs periodic tests to determine that DAC remains recoverable at all times, including at issue, and the cumulative amortization is re-estimated and, if necessary, adjusted by a cumulative charge to current operations. For its asset-intensive business, the Company updates the estimated gross profits with actual gross profits each reporting period, resulting in an increase or decrease to DAC to reflect the difference in the actual gross profits versus the previously estimated gross profits. As a result of recoverability testing for new business issues, a charge of approximately $7.7 million to current operations was recorded for in the Asset Intensive sub-segment in 2009 with projected revenue deemed insufficient to cover future benefits and expenses. As of December 31, 2009, the Company estimates that approximately 91.2% of its DAC balance is collateralized by surrender fees due to the Company and the reduction of policy liabilities, in excess of termination values, upon surrender or lapse of a policy.
to such estimates, if necessary, are reflected in current operations. The time lag from the date of the claim or death to the date when the ceding company reports the claim to the Company can be several months and can vary significantly by ceding company and business segment. The Company updates its analysis of incurred but not reported claims, including lag studies, on a periodic basis and adjusts its claim liabilities accordingly. The adjustments in a given period are generally not significant relative to the overall policy liabilities.
The Company primarily invests in fixed maturity securities, including bonds and redeemable preferred stocks. These securities are classified as available-for-sale and accordingly are carried at fair value on the consolidated balance sheets. The difference between amortized cost and fair value is reflected as an unrealized gain or loss, less applicable deferred taxes as well as related adjustments to deferred acquisition costs, if applicable, in accumulated other comprehensive income (“AOCI”) in stockholders’ equity. The determinations of fair value may require extensive use of assumptions and inputs. In addition, other-than-temporary impairment losses related to non-credit factors are recognized in AOCI.
The realization of deferred tax assets depends upon the existence of sufficient taxable income within the carryback or carryforward periods under the tax law in the applicable tax jurisdiction. The Company has significant deferred tax assets related to net operating and capital losses. Most of the Company’s exposure related to its deferred tax assets are within legal entities that file a consolidated United States federal income tax return. The Company has projected its ability to utilize its net operating losses and has determined that all of these losses are expected to be utilized prior to their expiration. The Company has also done extensive analysis of its capital losses and has determined that sufficient unrealized capital gains exist within its investment portfolios that should offset any capital loss realized. It is also the Company’s intention to hold all unrealized loss securities until maturity or until their market value recovers.
Income before income taxes for the U.S. operations segment increased by $242.6 million, or 367.1%, and decreased by $261.8 million, or 79.8%, in 2009 and 2008, respectively. The increase in income before income taxes in 2009 and decrease in 2008 can primarily be attributed to the impact of changes in credit spreads on the fair value of embedded derivatives associated with treaties written on a modified coinsurance or funds withheld basis. Decreases or increases in credit spreads result in an increase or decrease in value of the embedded derivative, and therefore, an increase or decrease in investment related gains or losses, respectively. In addition, the decrease in income in 2008 reflects an increase in investment impairments. See the discussion of “Investments” in the “Liquidity and Capital Resources” section of Management’s Discussion and Analysis for additional information on impairment losses. Higher than expected claims in the Traditional sub-segment adversely affected income before income taxes in 2009 and 2008.
The U.S. Traditional sub-segment provides 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. This sub-segment added new business production, measured by face amount of insurance in force, of $135.0 billion, $134.4 billion and $164.2 billion during 2009, 2008 and 2007, respectively. Management believes industry consolidation, reduced capital levels in the life insurance industry and the established practice
of reinsuring mortality risks should continue to provide opportunities for new business at levels comparable to 2009 and 2008.
Net investment income increased $33.6 million, or 8.5%, and $42.4 million, or 12.0%, in 2009 and 2008, respectively, primarily due to growth in the invested asset base. Additionally, 2008 reflects an increase in the average yield earned on investments compared to 2007. Investment related losses increased $12.0 million and $58.1 million in 2009 and 2008, respectively, due primarily to investment impairments associated with fixed maturity securities.
Investment income and investment related gains and losses are allocated to the various operating segments based on average assets and related capital levels deemed appropriate to support the segment business volumes. Investment performance varies with the composition of investments and the relative allocation of capital to the operating segments.
Claims and other policy benefits as a percentage of net premiums (“loss ratios”) were 85.6%, 86.1% and 81.7% in 2009, 2008 and 2007, respectively. The loss ratios in 2009 and 2008 reflect somewhat higher mortality than expected due primarily to an increase in the number of large claims ($1 million or more per claim), while mortality experience was favorable in 2007. Although reasonably predictable over a period of years, death claims can be volatile over shorter periods. Management views recent experience as normal volatility that is inherent in the business.
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 modified coinsurance or funds withheld basis, allowing for deferred acquisition expenses. Changes in the fair value of the embedded derivative are driven by changes in investment credit spreads, including the Company’s own credit spread. Generally, an increase in investment credit spreads, ignoring changes in the Company’s own credit spread, will have a negative impact on the fair value of the embedded derivative (decrease in income).
Guaranteed Minimum Benefit Riders- Represents the impact related to guaranteed minimum benefits associated with the Company’s reinsurance of variable annuities. The fair value changes of the guaranteed minimum benefits along with the changes in fair value of the free standing derivatives purchased by the Company to hedge the liability are reflected in revenues, while the related impact on deferred acquisition expenses is reflected in expenses. In 2009, the change in the fair value of the guaranteed minimum benefits, after allowing for changes in the associated free standing derivatives, was $38.9 million and deferred acquisition expenses were $76.9 million for a negative pre-tax income impact of $38.0 million. In 2008, the change in the fair value of the guaranteed minimum benefits after allowing for changes in the associated hedge instruments was negative $89.0 million and deferred acquisition expenses were negative $94.2 million for a pre-tax income impact of $5.2 million.
spreads), implied volatility and equity market performance, all of which are factors in the calculations of fair value. Therefore, management believes it is helpful to distinguish between the effects of changes in these derivatives and the primary factors that drive profitability of the underlying treaties, namely investment income, fee income, and interest credited.
The 2009 increase of $223.6 million and the 2008 decrease of $78.2 million in revenue before certain derivatives, was driven by changes in investment income related to equity options held in a funds withheld portfolio associated with equity-indexed annuity treaties. Increases and decreases in investment income related to equity options were mostly offset by corresponding increases and decreases in interest credited expense. Also impacting revenue were investment related gains and losses in the funds withheld portfolios which increased approximately $20.5 million in 2009 and decreased $15.3 million in 2008, both before deferred acquisition costs. These investment related gains and losses are reflected in investment income.
At December 31, 2009, 2008 and 2007, the amount of reinsurance assumed from client companies, as measured by pre-tax statutory surplus, was $1.2 billion, $0.5 billion and $0.5 billion, respectively. The pre-tax statutory surplus amounts include all business assumed or brokered by the Company in the U.S. Fees earned from this business can vary significantly depending on the size of the transactions and the timing of their completion, and therefore, can fluctuate from period to period.
The Company conducts reinsurance business in Canada through RGA Canada, a wholly-owned subsidiary. RGA Canada assists clients with capital management and mortality and morbidity risk management, and is primarily engaged in traditional individual life reinsurance, as well as creditor, critical illness, and group life and health reinsurance. Creditor insurance covers the outstanding balance on personal, mortgage or commercial loans in the event of death, disability or critical illness and is generally shorter in duration than traditional life insurance.
Income before income taxes increased by $4.1 million, or 4.0%, and $20.7 million, or 25.4%, in 2009 and 2008, respectively. The increase in income before income taxes in 2009 was primarily due to an increase in investment related gains of $24.6 million compared to 2008. This increase was largely offset by a generally weaker Canadian dollar, which resulted in a decrease in income before income taxes of approximately $5.8 million. The segment’s 2009 results also reflect slightly adverse mortality experience, excluding creditor business, compared to very favorable mortality in 2008. In addition, the 2008 income before income taxes reflects the favorable net effect of $6.8 million from the recaptures of a previously assumed and a previously retroceded treaty. The increase in income before income taxes in 2008 compared to 2007 was primarily due to higher premium volume, favorable mortality experience and an increase in the aforementioned recapture fees which added $6.8 million. The 2008 increase was largely offset by a decrease of $8.5 million in investment related gains and losses. In 2008, strength in the Canadian dollar resulted in an increase in income before income taxes of approximately $0.7 million.
Net premiums increased $80.6 million, or 15.1%, and $47.1 million, or 9.7%, in 2009 and 2008, respectively. Premiums from creditor treaties increased by $63.6 million in 2009 and $14.4 million in 2008. On a Canadian dollar basis, net premiums increased approximately 23.0% in 2009 compared to 2008. Creditor and group life and health premiums represented 29.0%, 20.9% and 17.5% of net premiums in 2009, 2008 and 2007, respectively. The remaining increases are primarily due to new business from both new and existing treaties. The segment added new business production, measured by face amount of insurance in force, of $43.9 billion, $51.2 billion and $46.8 billion during 2009, 2008 and 2007, respectively. Management believes industry consolidation, changing capital levels in the life insurance industry and the established practice of reinsuring mortality risks should continue to provide opportunities for new business, albeit at rates less than historically experienced. Additionally, foreign currency exchange fluctuation in the Canadian dollar resulted in a decrease in net premiums of approximately $42.2 million and an increase of approximately $2.2 million in 2009 and 2008,
Loss ratios for this segment were 81.5%, 85.4% and 87.3% in 2009, 2008 and 2007, respectively. The loss ratios on creditor reinsurance business are normally lower than traditional reinsurance, while allowances (policy acquisition costs) are normally higher as a percentage of premiums. Loss ratios for creditor business were 35.7%, 52.0% and 44.8% in 2009, 2008 and 2007, respectively. The higher creditor loss ratio in 2008 reflects the release of retroceded reserves of $10.4 million from the recapture of a previously retroceded block of creditor business. Excluding creditor business and the aforementioned recaptures in 2008, the loss ratios for this segment were 97.8%, 92.9% and 96.2% in 2009, 2008 and 2007, respectively. The higher loss ratio in 2009 is primarily the result of slightly adverse mortality experience compared to very favorable mortality experience in 2008. The lower loss ratio for 2008 is primarily due to favorable mortality experience compared to 2007. 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 mortality costs to fund claims in later years when those level premiums may not cover expected increasing mortality or claim costs. Excluding creditor business, claims and other policy benefits, as a percentage of net premiums and investment income were 75.0%, 70.1% and 73.5% in 2009, 2008 and 2007, respectively.
Policy acquisition costs and other insurance expenses as a percentage of net premiums totaled 23.9%, 20.6% and 18.7% in 2009, 2008 and 2007, respectively. Policy acquisition costs and other insurance expenses as a percentage of net premiums for creditor business were 55.5%, 51.6% and 49.6% in 2009, 2008 and 2007, respectively. Excluding foreign exchange and creditor business, policy acquisition costs and other insurance expenses as a percentage of net premiums were 12.6%, 12.4% and 11.6% in 2009, 2008 and 2007, 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, significantly caused by the mix of first year coinsurance business versus yearly renewable term business. 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.
Net premiums grew by $74.2 million, or 10.5%, and $29.2 million, or 4.3%, in 2009 and 2008, respectively. These increases were primarily the result of new business from both new and existing treaties. The segment added new business production, measured by face amount of insurance in force, of $121.1 billion, $87.5 billion and $61.3 billion during 2009, 2008 and 2007, respectively. During 2009 and 2008, there were unfavorable foreign currency exchange fluctuations, particularly from the British pound, the euro and the South African rand weakening against the U.S. dollar, which decreased net premiums by approximately $107.5 million and $47.7 million, respectively.
Net investment income decreased $0.8 million, or 2.3%, and increased $6.8 million, or 26.1%, in 2009 and 2008, respectively. The decrease in 2009 can primarily be attributed to a decrease in investment yield. The increase in 2008 can be attributed to growth in the invested asset base and increased investment yield. Investment income and investment related gains and losses are allocated to the various operating segments based on average assets and related capital levels deemed appropriate to support the segment business volumes. Investment performance varies with the composition of investments and the relative allocation of capital to the operating segments.
of years, death claims can be volatile over shorter periods. Management views recent experience as normal volatility that is inherent in the business.
Policy acquisition costs and other insurance expenses as a percentage of net premiums were 4.8%, 9.8% and 12.5% for 2009, 2008 and 2007, respectively. Excluding the aforementioned recaptures, policy acquisition costs and other insurance expenses as a percentage of net premiums were 6.3% in 2009 and 8.8% in 2008. These percentages fluctuate due to timing of client company reporting, variations in the mixture of business and the relative maturity of the business. In addition, as the segment grows, renewal premiums, which have lower allowances than first-year premiums, represent a greater percentage of the total net premiums.
respectively. Premium levels can be significantly influenced by currency fluctuations, large transactions and reporting practices of ceding companies and can fluctuate from period to period.
Loss ratios for this segment were 81.8%, 79.9% and 80.1% for 2009, 2008 and 2007, respectively. The increase in 2009 compared with 2008 was primarily related to an increase in benefits as a percentage of net premiums in Australia, New Zealand and Taiwan. Loss ratios between 2008 and 2007 were relatively consistent. Although reasonably predictable over a period of years, death claims can be volatile over shorter periods. Management views recent experience as normal volatility that is inherent in the business. Loss ratios will fluctuate due to timing of client company reporting, variations in the mixture of business and the relative maturity of the business.
Total revenues increased $71.3 million, or 140.4%, and decreased $46.2 million, or 47.6%, in 2009 and 2008, respectively. The increase in revenues in 2009 was due to an decrease in investment related losses of $22.9 million, reflecting improved economic conditions, and an increase in other revenues related to the recognition of a gain on the repurchase of long-term debt of $38.9 million and a $4.8 million foreign exchange gain on the repayment of debt related to the Company’s credit facility denominated in British pounds. Slightly offsetting these increases were investment related losses of $3.0 million related to the expected final disposition of the Company’s direct insurance operations in Argentina and a decrease in investment income of $2.6 million. The decrease in revenues in 2008 was due to a $17.7 million decrease in net investment income largely due to lower investment returns on floating rate investments used to fund the Company’s collateral finance facility and a $26.7 million increase in investment related losses due to realized investment losses as compared to the recognition of a $10.5 million currency translation loss recognized in 2007 related to the pending sale of the direct insurance operations in Argentina.
Total benefits and expenses decreased $9.3 million or 10.3%, and decreased $49.1 million or 35.3%, in 2009 and 2008, respectively. The decrease in total benefits and expenses in 2009 was primarily due to a $20.5 million decrease in collateral finance facility expense due to reduced variable interest rates and decreased interest expense of $6.2 million primarily due to lower interest provisions for income taxes related to uncertain tax positions. The decrease in interest expense related to the above-mentioned debt repurchase was largely offset by additional interest expense related to the issuance of $400.0 million in senior notes in the fourth quarter of 2009. These decreases were partially offset by a $15.6 million increase in other expenses due to increased compensation-related costs. The decrease in total benefits and expenses in 2008 was primarily due to a $23.3 million decrease in collateral finance facility expense due to substantially reduced variable interest rates in the current year. Additionally, other operating expenses decreased $15.2 million in 2008 primarily related to a decrease in equity based compensation and policy acquisition costs and other insurance expenses decreased $10.8 million, primarily due to increased charges to the operating segments for the use of capital.
Effective January 1, 2009, due to immateriality, the discontinued accident and health operations were included in the results of the Corporate and Other segment. The consolidated statements of income for 2008 and 2007 reflect this line of business as a discontinued operation. The calculation of the claim reserve liability for the entire portfolio of accident and health business requires management to make estimates and assumptions that affect the reported claim reserve levels. The loss from discontinued accident and health operations, net of income taxes, decreased to $11.0 million in 2008 from $14.4 million in 2007 due primarily to fewer settlements arising out of previously contested matters. Revenues associated with discontinued operations, which were not reported on a gross basis in the Company’s consolidated statements of income in 2008 and 2007 totaled $2.1 million and $2.0 million, respectively. As of December 31, 2009, there were no arbitrations or claims disputes associated with the Company’s discontinued accident and health operations.
See Note 3 - “Stock Transactions” and Note 15 - “Debt and Trust Preferred Securities” in the Notes to Consolidated Financial Statements for additional information regarding the Company’s securities transactions.
payment of the amount due, including principal, under the various agreements. Additionally, the Company’s debt agreements contain cross-default covenants, which would make outstanding borrowings immediately payable in the event of a material covenant default under any of the agreements which remains uncured, including, but not limited to, non-payment of indebtedness when due for an amount in excess of $100.0 million, bankruptcy proceedings, or any event which results in the acceleration of the maturity of indebtedness. The facility fee and interest rate for the Company’s credit facilities are based on its senior long-term debt ratings. A decrease in those ratings could result in an increase in costs for the credit facilities. As of December 31, 2009, the Company had $1,216.1 million in outstanding borrowings under its long-term debt agreements and was in compliance with all covenants under those agreements. The ability of the Company to make debt principal and interest payments depends primarily on the earnings and surplus of subsidiaries, investment earnings on undeployed capital proceeds, and the Company’s ability to raise additional funds.
In March 2007, RGA issued 5.625% Senior Notes due March 15, 2017 with a face amount of $300.0 million. These senior notes were registered with the Securities and Exchange Commission. The net proceeds from the offering were approximately $295.3 million, a portion of which were used to pay down $50.0 million of indebtedness under a U.S. bank credit facility. The remaining net proceeds are designated for general corporate purposes. Capitalized issue costs were approximately $2.4 million.
In June 2006, RGA’s subsidiary, Timberlake Financial, issued $850.0 million of Series A Floating Rate Insured Notes due June 2036 in a private placement. The notes were issued to fund the collateral requirements for statutory reserves required by the U.S. Valuation of Life Policies Model Regulation (commonly referred to as Regulation XXX) on specified term life insurance policies reinsured by RGA Reinsurance. Proceeds from the notes, along with a $112.8 million direct investment by the Company, were deposited into a series of accounts that collateralize the notes and are not available to satisfy the general obligations of the Company. As of December 31, 2009, the Company held assets in trust and in custody of $876.7 million for this purpose. Interest on the notes will accrue at an annual rate of 1-month LIBOR plus a base rate margin, payable monthly and totaled $8.3 million and $28.7 million in 2009 and 2008, respectively. The payment of interest and principal on the notes is insured by a monoline insurance company through a financial guaranty insurance policy. The notes represent senior, secured indebtedness of Timberlake Financial without legal recourse to RGA or its other subsidiaries. Timberlake Financial will rely primarily upon the receipt of interest and principal payments on a surplus note and dividend payments from its wholly-owned subsidiary, Timberlake Re, a South Carolina captive insurance company, to make payments of interest and principal on the notes. The ability of Timberlake Re to make interest and principal payments on the surplus note and dividend payments to Timberlake Financial is contingent upon South Carolina regulatory approval, the return on Timberlake Re’s investment assets and the performance of specified term life insurance policies with guaranteed level premiums retroceded by RGA’s subsidiary, RGA Reinsurance, to Timberlake Re.
Proceeds from the notes issued by Timberlake Financial and the Company’s direct investment in Timberlake Financial were deposited into a series of trust accounts as collateral and are not available to satisfy the general obligations of the Company. As of December 31, 2009 the Company held deposits in trust and in custody of $876.7 million for this purpose, which is not included above. See “Collateral Finance Facility” above for additional information on the Timberlake notes.
RGA has issued guarantees to third parties on behalf of its subsidiaries for the payment of amounts due under certain credit facilities, reinsurance treaties and office lease obligations, whereby if a subsidiary fails to meet an obligation, RGA or one of its other subsidiaries will make a payment to fulfill the obligation. In limited circumstances, treaty guarantees are granted to ceding companies in order to provide additional security, particularly in cases where RGA’s subsidiary is relatively new, unrated, or not of significant size, relative to the ceding company. Liabilities supported by the treaty guarantees, before consideration for any legally offsetting amounts due from the guaranteed party, totaled $330.3 million and $273.6 million as of December 31, 2009 and 2008, respectively, and are reflected on the Company’s consolidated balance sheets in future policy benefits. Potential guaranteed amounts of future payments will vary depending on production levels
and underwriting results. Guarantees related to trust preferred securities and credit facilities provide additional security to third parties should a subsidiary fail to make principal and/or interest payments when due. As of December 31, 2009, RGA’s exposure related to these guarantees was $159.2 million. RGA has issued payment guarantees on behalf of two of its subsidiaries in the event the subsidiaries fail to make payment under their office lease obligations, the exposure of which was $4.3 million as of December 31, 2009.
The Company’s net cash flows provided by operating activities for the years ended December 31, 2009, 2008 and 2007, were $1,364.2 million, $727.0 million and $1,099.3 million, respectively. Cash flows from operating activities are affected by the timing of premiums received, claims paid and working capital changes. Operating cash increased $637.3 million during 2009 as cash from premiums and investment income increased $277.7 million and $246.9 million, respectively, while operating net cash outlays decreased by $112.7 million. During 2008, operating cash decreased $372.3 million as cash from premiums increased $357.2 million but was more than offset by decreased investment income of $40.7 million and by higher operating net cash outlays of $688.8 million. The Company believes the short-term cash requirements
Excluded from the table above are deferred income tax liabilities, unrecognized tax benefits, and accrued interest of $613.2 million, $221.0 million, and $34.1 million, respectively, for which the Company cannot reliably determine the timing of payment. Current income tax payable is also excluded from the table.
The net funded status of the Company’s pension and other postretirement liabilities included within other liabilities has been excluded from the amounts presented in the table above. As of December 31, 2009, the Company had a net unfunded balance of $47.4 million related to pension and other postretirement liabilities. See Note 10 - “Employee Benefit Plans” in the Notes to Consolidated Financial Statements for information related to the Company’s obligations and funding requirements for pension and other post-employment benefits.
The Company has obtained letters of credit, issued by banks, in favor of various affiliated and unaffiliated insurance companies from which the Company assumes business. These letters of credit represent guarantees of performance under the reinsurance agreements and allow ceding companies to take statutory reserve credits. Certain of these letters of credit contain financial covenant restrictions similar to those described in the “Debt and Trust Preferred Securities” discussion above. At December 31, 2009, there were approximately $21.4 million of outstanding bank letters of credit in favor of third parties. Additionally, the Company utilizes letters of credit to secure statutory reserve credits when it retrocedes business to its subsidiaries, including Parkway Re, RGA Americas, RGA Barbados and RGA Atlantic. The Company cedes business to its affiliates to help reduce the amount of regulatory capital required in certain jurisdictions, such as the U.S. and the UK. The capital required to support the business in the affiliates reflects more realistic expectations than the original jurisdiction of the business, where capital requirements are often considered to be quite conservative. As of December 31, 2009, $617.5 million in letters of credit from various banks were outstanding, but undrawn, backing reinsurance between the various subsidiaries of the Company.
The Company maintains a syndicated revolving credit facility with an overall capacity of $750.0 million, which is scheduled to mature in September 2012. The Company may borrow cash and may obtain letters of credit in multiple currencies under the facility. At December 31, 2009, the Company had $373.9 million in issued, but undrawn, letters of credit under this facility, which is included in the total above. Applicable letter of credit fees and fees payable for the credit facility depend upon the Company’s senior unsecured long-term debt rating. In September 2009, the Company entered into a ten-year, $200.0 million letter of credit facility agreement. This letter of credit is expected to be fully utilized through 2016 and then amortize to zero by 2019. As of December 31, 2009, the Company had $200.0 million in issued, but undrawn, letters of credit under this new facility, which is included in the total above. Letter of credit fees for this facility are fixed for the term of the facility. Fees associated with the Company’s other letters of credit are not fixed for periods in excess of one year and are based on the Company’s ratings and the general availability of these instruments in the marketplace.
The Company manages its invested assets using an approach that is intended to balance quality, diversification, asset/liability matching, liquidity and investment return. The goals of the investment process are to optimize after-tax, risk-adjusted investment income and after-tax, risk-adjusted total return while managing the assets and liabilities on a cash flow and duration basis.
The Company’s liquidity position (cash and cash equivalents and short-term investments) was $633.1 million and $933.5 million at December 31, 2009 and December 31, 2008, respectively. Liquidity needs are determined from valuation analyses conducted by operational units and are driven by product portfolios. Periodic evaluations of demand liabilities and short-term liquid assets are designed to adjust specific portfolios, as well as their durations and maturities, in response to anticipated liquidity needs.
In addition, RGA Reinsurance has also entered into funding agreements with the FHLB under guaranteed investment contracts whereby RGA Reinsurance has issued the funding agreements in exchange for cash and for which the FHLB has been granted a blanket lien on RGA Reinsurance’s commercial and residential mortgage-backed securities and commercial mortgage loans used to collateralize RGA Reinsurance’s obligations under the funding agreements. RGA Reinsurance 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 RGA Reinsurance, the FHLB’s recovery is limited to the amount of RGA Reinsurance’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 $399.3 million and $199.3 million at December 31, 2009 and 2008, respectively, which is included in interest sensitive contract liabilities. The advances on these agreements are collateralized primarily by commercial and residential mortgage-backed securities and commercial mortgage loans.
The Company’s asset-intensive products are primarily supported by investments in fixed maturity securities reflected on the Company’s balance sheet and under funds withheld arrangements with the ceding company. Investment guidelines are established to structure the investment portfolio based upon the type, duration and behavior of products in the liability portfolio so as to achieve targeted levels of profitability. The Company manages the asset-intensive business to provide a targeted spread between the interest rate earned on investments and the interest rate credited to the underlying interest-sensitive contract liabilities. The Company periodically reviews models projecting different interest rate scenarios and their
The following table presents consolidated invested assets, net investment income and investment yield, excluding funds withheld. Funds withheld assets are primarily associated with the reinsurance of annuity contracts on which the Company earns a spread. Fluctuations in the yield on funds withheld assets are generally offset by a corresponding adjustment to the interest credited on the liabilities (dollars in thousands).
All investments held by RGA and its subsidiaries are monitored for conformance with the qualitative and quantitative limits prescribed by the applicable jurisdiction’s insurance laws and regulations. In addition, the operating companies’ boards of directors periodically review their respective investment portfolios. The Company’s investment strategy is to maintain a predominantly investment-grade, fixed maturity portfolio, to provide adequate liquidity for expected reinsurance obligations, and to maximize total return through prudent asset management. The Company’s asset/liability duration matching differs between operating segments. Based on Canadian reserve requirements, the Canadian liabilities are matched with long-duration Canadian assets. The duration of the Canadian portfolio exceeds twenty years. The average duration for all the Company’s portfolios, when consolidated, ranges between eight and ten years. See Note 4 - “Investments” in the Notes to Consolidated Financial Statements for additional information regarding the Company’s investments.
See Note 4 - “Investments” under Fixed Maturities and Equity Securities Available-for-Sale in the Notes to Consolidated Financial Statements for additional information regarding AOCI.
The Company’s fixed maturity securities are invested primarily in U.S. and foreign corporate bonds, mortgage- and asset-backed securities, and Canadian government securities. As of December 31, 2009 and 2008, approximately 94.8% and 96.7%, respectively, of the Company’s consolidated investment portfolio of fixed maturity securities was investment-grade.
The quality of the Company’s available-for-sale fixed maturity securities portfolio, as measured at fair value and by the percentage of fixed maturity securities invested in various ratings categories, relative to the entire available-for-sale fixed maturity security portfolio, at December 31, 2009 and 2008 was as follows (dollars in thousands):
Alt-A is a classification of mortgage loans where the risk profile of the borrower falls between prime and sub-prime. At December 31, 2009 and 2008, the Company’s Alt-A securities had an amortized cost of $176.6 million and $197.7 million, respectively, with an unrealized loss of $21.9 million and $39.9 million, respectively. As of December 31, 2009, 56.4% of the Alt-A securities were rated “AA−” or better. This amount includes securities directly held by the Company and securities held by ceding companies that support the Company’s funds withheld at interest investment. The Company recorded other-than-temporary impairments of $14.6 million, net of non-credit adjustments, and $16.5 million, in its Alt-A securities portfolio for the years ended December 31, 2009 and 2008, respectively, due primarily to the increased likelihood that some or all of the remaining scheduled principal and interest payments on certain securities will not be received.
The Company monitors its fixed maturity securities and equity securities to determine impairments in value and evaluates factors such as financial condition of the issuer, payment performance, the length of time and the extent to which the market value has been below amortized cost, compliance with covenants, general market conditions and industry sector, current intent and ability to hold securities and various other subjective factors. Based on management’s judgment, securities determined to have an other-than-temporary impairment in value are written down to fair value. See “Investments - Other-than-Temporary Impairment” in Note 2 - “Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements for additional information. The Company recorded $132.3 million, net of non-credit adjustments, $131.1 million and $8.5 million in other-than-temporary investment impairments in 2009, 2008 and 2007, respectively. The
The following table presents the total gross unrealized losses for 1,316 and 1,716 fixed maturity securities and equity securities at December 31, 2009 and 2008, respectively, where the estimated fair value had declined and remained below amortized cost by the indicated amount (dollars in thousands):
As of December 31, 2009 and 2008, respectively, 71.4% and 92.7% of these securities were investment grade and 43.4% and 22.9% had fair values that were less than 20% below cost. The amount of the unrealized loss on these securities was primarily attributable to a widening of credit spreads since the time the securities were purchased.
While all of these securities are monitored for potential impairment, the Company believes due to continued uncertain market conditions and liquidity concerns, and the high levels of price volatility, the extent and duration of a decline in value have become less indicative of when there has been credit deterioration with respect to an issuer. The Company’s determination of whether a decline in value is other-than-temporary includes the Company’s analysis of the underlying credit and the extent and duration of a decline in value. The Company’s credit analysis of an investment includes determining whether the issuer is current on its contractual payments, evaluating whether it is probable that the Company will be able to collect all amounts due according to the contractual terms of the security and analyzing the overall ability of the Company to recover the amortized cost of the investment. The Company continues to consider valuation declines as a potential indicator of credit deterioration.
Mortgage loans represented approximately 4.0% and 4.7% of the Company’s cash and invested assets as of December 31, 2009 and 2008, respectively. As of December 31, 2009, all mortgages were U.S. based with approximately 86.6% invested in mortgages on commercial offices, industrial properties and retail locations. The Company’s mortgage loans generally range in size up to $15.0 million, with the average mortgage loan investment as of December 31, 2009 totaling approximately $4.3 million. The mortgage loan portfolio was diversified by geographic region and property type as discussed further in Note 4 - “Investments” in the Notes to Consolidated Financial Statements.
Information regarding the portion of the Company’s mortgage loans that were impaired as of December 31, 2009 and 2008 are as follows (dollars in thousands):
The Company’s average investment in impaired loans was $3.3 million and $3.7 million as of December 31, 2009 and 2008 respectively. Interest income on impaired loans was $0.8 million and $1.3 million for the twelve months ended December 31, 2009 and 2008, respectively.
Policy loans comprised approximately 5.8% and 6.7% of the Company’s cash and invested assets as of December 31, 2009 and 2008, respectively, substantially all of which are associated with one client. These policy loans present no credit risk because the amount of the loan cannot exceed the obligation due the ceding company upon the death of the insured or surrender of the underlying policy. The provisions of the treaties in force and the underlying policies determine the policy loan interest rates. Because policy loans represent premature distributions of policy liabilities, they have the effect of reducing future disintermediation risk. In addition, the Company earns a spread between the interest rate earned on policy loans and the interest rate credited to corresponding liabilities.
The majority of the Company’s funds withheld at interest balances are associated with its reinsurance of annuity contracts. The funds withheld receivable balance totaled $4.9 billion and $4.5 billion at December 31, 2009 and 2008, respectively, of which $3.4 billion and $3.1 billion, respectively, were subject to the general accounting principles for Derivatives and Hedging related to embedded derivatives. Under these principles, the Company’s funds withheld receivable under certain reinsurance arrangements incorporate credit risk exposures that are unrelated or only partially related to the creditworthiness of the obligor and include an embedded derivative feature that is not clearly and closely related to the host contract. Therefore, the embedded derivative feature must be measured at fair value on the consolidated balance sheets and changes in fair value reported in income. See “Embedded Derivatives” in Note 2 - “Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements for further discussion.
Based on data provided by ceding companies at December 31, 2009 and 2008, funds withheld at interest were approximately (dollars in thousands):
Other invested assets represented approximately 2.6% and 3.8% of the Company’s cash and invested assets as of December 31, 2009 and 2008, respectively. Other invested assets include equity securities, non-redeemable preferred stocks, limited partnership interests, structured loans and derivative contracts.
The Company recorded $12.0 million, $17.2 million and $1.0 million in other-than-temporary impairments on other invested assets in 2009, 2008 and 2007, respectively.
The following table presents the notional amounts and fair value of investment related derivative instruments held at December 31, 2009 and 2008 (dollars in thousands):
The Company may be exposed to credit-related losses in the event of non-performance by counterparties to derivative financial instruments. Generally, the current credit exposure of the Company’s derivative contracts is limited to the net positive fair value at the reporting date less collateral held by the Company. The Company held derivative assets related to its derivative contracts with counterparties of $24.2 million and $206.3 million at December 31, 2009 and 2008, respectively. However, due to counterparty netting arrangements, the Company had no credit exposure at December 31, 2009. In addition, the derivative assets of $206.3 million held by the Company at December 31, 2008 were collateralized with $159.8 million of cash collateral from the counterparty. The decrease in derivative assets in 2009 is primarily due to the termination of the Company’s foreign currency swaps used to hedge its investment in its Canada operation, which were outstanding as of December 31, 2008.
The Company manages its credit risk related to over-the-counter derivatives by entering into transactions with creditworthy counterparties, maintaining collateral arrangements and through the use of master agreements that provide for a single net payment to be made by one counterparty to another at each due date and upon termination. Because exchange-traded futures are affected through regulated exchanges, and positions are marked to market on a daily basis, the Company has minimal exposure to credit-related losses in the event of nonperformance by counterparties to such derivative instruments. See Note 5 - “Derivative Instruments” in the Notes to Consolidated Financial Statements for more information regarding the Company’s derivative instruments.
RGA maintains a corporate risk management framework which is responsible for assessing, measuring and monitoring risks facing the enterprise. This includes development and implementation of mitigation strategies to reduce exposures to these risks to acceptable levels. Risk management is an integral part of the Company’s culture and every day activities. It includes guidelines and controls in areas such as pricing, underwriting, currency, administration, investments, asset liability management, counterparty exposure, financing, regulatory change, business continuity planning, human resources, liquidity, sovereign risks and technology development.
The corporate risk management framework is directed by the chief risk officer. Risk management officers from all areas of the Company support the chief risk officer in this effort. The chief risk officer provides quarterly risk management updates to the board of directors, executive management and the internal risk management officers.
Specific risk assessments and descriptions can be found below and in Item 1A - “Risk Factors”.
In the event that mortality or morbidity experience develops in excess of expectations, some reinsurance treaties allow for increases to future premium rates. Other treaties include experience refund provisions, which may also help reduce RGA’s mortality risk. In the normal course of business, the Company seeks to limit its exposure to loss on any single insured and to recover a portion of claims paid by ceding reinsurance to other insurance enterprises or retrocessionaires under excess coverage and coinsurance contracts. In the U.S., the Company retains a maximum of $8.0 million of coverage per individual life. In certain limited situations, due to the acquisition of in force blocks of business, the Company has retained more than $8.0 million per individual policy. In total, there are 17 such cases of over-retained policies, for amounts averaging $1.6 million over the Company’s normal retention limit. The largest amount in excess of the Company’s retention on any one life is $6.3 million. The Company enters into agreements with other reinsurers to mitigate the risk related to the over-retained policies. Additionally, due to some lower face amount reinsurance coverages provided by the Company in addition to individual life, such as group life, disability and health, under certain circumstances, the Company could potentially incur claims totaling more than $8.0 million per individual life in the U.S. For other countries, particularly those with higher risk factors or smaller books of business, the Company systematically reduces its retention. The Company has a number of retrocession arrangements whereby certain business in force is retroceded on an automatic or facultative basis.
The Company maintains a catastrophe insurance program (“Program”) that renews on September 7th of each year. The current Program began September 7, 2009, and covers events involving 10 or more insured deaths from a single occurrence. The Company retains the first $20 million in claims, the Program covers the next $80 million in claims, and the Company retains all claims in excess of $100 million. The Program covers reinsurance programs worldwide and includes losses due to acts of terrorism, including terrorism losses due to nuclear, chemical and/or biological events. The Program excludes, among other things, losses from earthquakes occurring in California, and would not cover losses from pandemics. The Program is insured by 14 insurance companies and Lloyd’s Syndicates, with only one single entity providing more than $10 million of coverage.
In the normal course of business, the Company seeks to limit its exposure to reinsurance contracts by ceding a portion of the reinsurance to other insurance companies or reinsurers. Should a counterparty not be able to fulfill its obligation to the Company under a reinsurance agreement, the impact could be material to the Company’s financial condition and results of operations.
Interest rate sensitivity analysis is also used to measure the Company’s interest rate cash flow risk by computing estimated changes in the cash flows expected in the near term attributable to floating rate assets and liabilities in the event of a range of assumed changes in market interest rates. This analysis assesses the risk of loss in cash flows in the near term in market risk sensitive floating rate instruments in the event of a hypothetical 10% change (increase or decrease) in market interest rates. The Company does not have variable rate instruments classified as trading securities. The Company’s projected decrease in cash flows in the near term associated with floating rate instruments in the event of a 10% unfavorable change in market interest rates at its fiscal years ended December 31, 2009 and 2008 was $6.8 million and $2.7 million, respectively.
requirements apply to both debt and equity securities. An impaired debt security will be considered other-than-temporarily impaired if the Company has the intent to sell or it more likely than not will be required to sell prior to recovery of the amortized cost. If the holder of a debt security does not expect recovery of the entire cost basis, even if there is no intention to sell the security, an OTTI has occurred. This amendment also changes how an entity recognizes an OTTI for a debt security by separating the loss between the amount representing the credit loss and the amount relating to other factors, if the Company does not have the intent to sell or it more likely than not will not be required to sell prior to recovery of the amortized cost less any current period credit loss. Credit losses will be recognized in net income and losses relating to other factors will be recognized in accumulated other comprehensive income (“AOCI”). If the Company has the intent to sell or it more likely than not will be required to sell before its recovery of amortized cost less any current period credit loss, the entire OTTI will be recognized in net income. This amendment is effective for interim and annual reporting periods ending after June 15, 2009. The adoption of this amendment resulted in a net after-tax increase to retained earnings and a decrease to accumulated other comprehensive income of $4.4 million, as of April 1, 2009. The required disclosures are provided in Note 4 - “Investments” in the Notes to Consolidated Financial Statements.
In January 2009, the FASB amended the general accounting principles for Investments as it relates to determining other-than-temporary impairments on purchased beneficial interests and beneficial interests that continue to be held by a transferor in securitized financial assets. The primary effect of this amendment was to remove the requirement that a holder attempt to determine the underlying cash flows on an asset-backed security based on the assumptions that a market participant would make in determining the current fair value of the instrument. Instead, the focus has been placed on determining the estimated cash flows as determined by the holder for all sources including its own comprehensive credit analysis. The provisions of this amendment were required to be applied prospectively for interim periods and fiscal years ending after December 15, 2008. The adoption of this amendment did not have a significant impact on how the Company values its structured investment securities.
In April 2009, the FASB amended the general accounting principles for Fair Value Measurements and Disclosures as it relates to determining fair value when the volume and level of activity for asset or liability have significantly decreased and identifying transactions that are not orderly. This amendment provides additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased in relation to normal market activity for the asset or liability and clarifies that the use of multiple valuation techniques may be appropriate. It also provides additional guidance on circumstances that may indicate a transaction is not orderly. Further, it requires additional disclosures about fair value measurements in annual and interim reporting periods. This amendment is effective prospectively for interim and annual reporting periods ending after June 15, 2009. The adoption of this amendment did not have a material impact on the Company’s consolidated financial statements. The required disclosures are provided in Note 6 - “Fair Value of Financial Instruments” in the Notes to Consolidated Financial Statements.
Reinsurance Group of America, Incorporated (“RGA”) is an insurance holding company that was formed on December 31, 1992. The consolidated financial statements include the assets, liabilities, and results of operations of RGA, RGA Reinsurance Company (“RGA Reinsurance”), Reinsurance Company of Missouri, Incorporated (“RCM”), RGA Reinsurance Company (Barbados) Ltd. (“RGA Barbados”), RGA Americas Reinsurance Company, Ltd. (“RGA Americas”), RGA Life Reinsurance Company of Canada (“RGA Canada”), RGA Reinsurance Company of Australia, Limited (“RGA Australia”), RGA Reinsurance UK Limited (“RGA UK”) and RGA Atlantic Reinsurance Company, Ltd. (“RGA Atlantic”) as well as other subsidiaries, subject to an ownership position of greater than fifty percent (collectively, the “Company”).
For each of its reinsurance contracts, the Company must determine if the contract provides indemnification against loss or liability relating to insurance risk, in accordance with applicable accounting standards. The Company must review all contractual features, particularly those that may limit the amount of insurance risk to which the Company is subject to or features that delay the timely reimbursement of claims. If the Company determines that a contract does not expose it to a reasonable possibility of a significant loss from insurance risk, the Company records the contract on a deposit method of accounting with the net amount payable/receivable reflected in other reinsurance assets or liabilities on the consolidated balance sheets. Fees earned on the contracts are reflected as other revenues, as opposed to premiums, on the consolidated statements of income.
Mortgage loans on real estate are carried at unpaid principal balances, net of any unamortized premium or discount and valuation allowances. A mortgage loan is considered to be impaired when, based on the current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the mortgage agreement. Valuation allowances on mortgage loans are established based upon losses expected by management to be realized in connection with future dispositions or settlement of mortgage loans, including foreclosures. The Company establishes valuation allowances for estimated impairments as of the balance sheet date. Such valuation allowances are based on the excess carrying value of the loan over the present value of expected future cash flows discounted at the loan’s original effective interest rate, the value of the loan’s collateral if the loan is in the process of foreclosure or otherwise collateral dependent, or the loan’s market value if the loan is being sold. Any subsequent adjustments to the valuation allowances will be treated as investment gains (losses), net. The Company will continue to accrue interest on loans until it is probable the Company will not receive interest or the loan is 90 days past due. Any interest accrued or received on the net carrying amount of the impaired loan will be included in investment income or applied to the principal of the loan.
Funds withheld at interest represent amounts contractually withheld by ceding companies in accordance with reinsurance agreements. For agreements written on a modified coinsurance basis and agreements written on a coinsurance funds withheld basis, assets equal to the net statutory reserves are withheld and legally owned by the ceding company. Interest accrues to these assets at rates defined by the treaty terms.
In addition to derivative contracts discussed below, other invested assets include equity securities and preferred stocks, carried at fair value, and limited partnership interests and structured loans, primarily carried at cost. Changes in fair value of equity securities and preferred stocks are recorded through AOCI.
Derivatives are financial instruments whose values are derived from interest rates, foreign currency exchange rates, or other financial indices. The Company utilizes a variety of derivative instruments including swaps, forwards and futures, primarily to manage or hedge interest rate risk, foreign currency risk and various other market risks associated with its business. The Company does not invest in derivatives for speculative purposes. It is the Company’s policy to enter into derivative contracts primarily with highly rated parties. See Note 5 - “Derivative Instruments” for additional detail on the Company’s derivative positions.
Derivatives are carried on the Company’s consolidated balance sheets in other invested assets or as liabilities within other liabilities, at fair value. Certain derivatives are subject to master netting provisions and reported as a net asset or liability. On the date a derivative contract is executed, the Company designates the derivative as (1) a fair value hedge, (2) a cash flow hedge, (3) a foreign currency hedge, (4) a net investment hedge in a foreign operation or (5) held for other risk management purposes, which primarily involve managing asset or liability risks associated with the Company’s reinsurance treaties which do not qualify for hedge accounting.
To qualify for hedge accounting, at the inception of the hedging relationship, the Company formally documents its risk management objective and strategy for undertaking the hedging transaction, as well as its designation of the hedge as either
The majority of the Company’s funds withheld at interest balances are associated with its reinsurance of annuity contracts, 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 these embedded derivatives is sensitive to the credit spread environment. The change in the fair value of these embedded derivatives increased revenues in 2009 by $78.4 million and reduced revenues in 2008 by $427.8 million. These changes in fair values of the embedded derivatives are net of a $301.7 million decrease in revenues and a $376.3 million increase in revenues for the years ended December 31, 2009 and 2008, respectively, associated with the Company’s own credit risk. The change in fair value, which is a non-cash item, also affects the amortization of deferred acquisition costs since the Company is required to include it in its expectation of gross profits. 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 income statements.
General accounting principles for Fair Value Measurements and Disclosures defines fair value, establishes a framework for measuring fair value, establishes a fair value hierarchy based on the inputs used to measure fair value and enhances disclosure requirements for fair value measurements. In compliance with these principles, the Company has categorized its financial instruments, based on the priority of the inputs to the valuation technique, into a three level hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3).
Unobservable inputs that are supported by little or no market activity and are significant to the fair value of the assets or liabilities. Unobservable inputs reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
See Note 6 - “Fair Value of Financial Instruments” for further details on the Company’s assets and liabilities recorded at fair value.
Premiums are accrued when due and in accordance with information received from the ceding company. When a ceding company fails to report information on a timely basis, the Company records accruals based on the terms of the reinsurance treaty as well as historical experience. Other management estimates include adjustments for lapsed premiums given historical experience, the financial health of specific ceding companies, collateral value and the legal right of offset on related amounts (i.e. allowances and claims) owed to the ceding company. Under the legal right of offset provisions in its reinsurance treaties, the Company can withhold payments for allowances and claims for unpaid premiums. Based on its review of these factors and historical experience, the Company did not believe a provision for doubtful accounts was necessary as of December 31, 2009 or 2008.
Goodwill and certain intangibles are not amortized into results of operations, but instead are reviewed at least annually for impairment and written down and charged to results of operations only in the periods in which the recorded value of goodwill and certain intangibles is more than its fair value. From 2007 through 2009, there were no changes to goodwill as a result of acquisitions or disposals. Goodwill as of December 31, 2009 and 2008 totaled $7.0 million including accumulated amortization of $1.0 million, and was related to the purchase by the Company’s U.S. operations of RGA Financial Group L.L.C. in 2000. The value of business acquired is amortized in proportion to the ratio of annual premium revenues to total anticipated premium revenues or in relation to the present value of estimated profits. Anticipated premium revenues have been estimated using assumptions consistent with those used in estimating reserves for future policy benefits. The carrying value is reviewed at least annually for indicators of impairment in value. The value of business acquired was approximately $1.3 million and $1.7 million, including accumulated amortization of $12.1 million and $11.7 million, as of December 31, 2009 and 2008, respectively. The value of business acquired amortization expense for the years ended December 31, 2009, 2008 and 2007 was $0.4 million, $0.4 million, and $0.6 million, respectively. These amortized balances are included in other assets on the consolidated balance sheets. Amortization of the value of business acquired is estimated to be $0.3 million, $0.2 million, $0.2 million, $0.1 million and $0.1 million during 2010, 2011, 2012, 2013 and 2014, respectively.
In addition to the goodwill and value of business acquired previously discussed, other assets primarily includes separate accounts, unamortized debt issuance costs, capitalized software, and other capitalized assets. Capitalized software is stated at cost, less accumulated amortization. Purchased software costs, as well as internal and external costs incurred to develop internal-use computer software during the application development stage, are capitalized. As of December 31, 2009 and 2008, the Company had unamortized computer software costs of approximately $13.1 million and $13.3 million, respectively. During 2009, 2008 and 2007, the Company amortized computer software costs of $3.5 million, $3.4 million, and $4.4 million, respectively. 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.
reserve is established by a charge to income, as well as a reduction in unamortized acquisition costs and, to the extent there are no unamortized acquisition costs, an increase in future policy benefits.
In establishing reserves for future policy benefits, the Company assigns policy liability assumptions to particular time frames (eras) in such a manner as to be consistent with the underlying assumptions and economic conditions at the time the risks are assumed. The Company maintains a consistent approach to setting the provision for adverse deviation between eras.
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, 2009 were not material.
Guaranteed minimum income benefits (“GMIB”) provide the contract holder, after a specified period of time determined at the time of issuance of the variable annuity contract, with a minimum level of income (annuity) payments. Under the reinsurance treaty, the Company makes a payment to the ceding company equal to the GMIB net amount-at-risk at the time of annuitization and thus these contracts meet the net settlement criteria of the general accounting principles for Derivatives and Hedging and the Company assumes no mortality risk. Accordingly, the GMIB is considered an embedded derivative, which is measured at fair value separately from the host variable annuity product.
The fair values of the GMIB, GMWB and GMAB liabilities are reflected in interest-sensitive contract liabilities on the consolidated balance sheets and are calculated based on actuarial and capital market assumptions related to the projected cash flows, including benefits and related contract charges, over the lives of the contracts, incorporating expectations concerning policyholder behavior, such as lapses, withdrawals and benefit selections. In measuring the fair value of GMIBs, GMWBs and GMABs, the Company attributes a portion of the fees collected from the policyholder equal to the present value of
expected future guaranteed minimum income, withdrawal and accumulation benefits (at inception). The changes in fair value are reported in investment related gains (losses), net. Any additional fees represent “excess” fees and are reported in other revenues on the consolidated statements of income. These variable annuity guaranteed living benefits may be more costly than expected in volatile or declining markets, causing an increase in interest-sensitive contract liabilities, negatively affecting net income.
Claims payable for incurred but not reported losses are determined using case-basis estimates and lag studies of past experience. The time lag from the date of the claim or death to when the ceding company reports the claim to the Company can vary significantly by ceding company and business segment, but generally averages around 2.9 months. The Company updates its analysis of incurred but not reported, including lag studies, on a quarterly basis and adjusts its claim liabilities accordingly.
Other liabilities primarily includes investments in transit, separate accounts, employee benefits, current federal income taxes payable, and payables related to repurchase agreements. The Company utilizes sales of investment securities with agreements to repurchase the same securities for purposes of short-term financing. The repurchase obligation is a component of other liabilities. There were no securities subject to these agreements outstanding at December 31, 2009 or 2008.
has also done extensive analysis of its capital losses and has determined that sufficient unrealized capital gains exist within its investment portfolios that should offset any capital loss realized. It is also the Company’s intention to hold all unrealized loss securities until maturity or until their market value recovers.
Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Holding Solely Junior Subordinated Debentures of the Company
The translation of the foreign currency into U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted-average exchange rate during each year. Gains or losses, net of applicable deferred income taxes, resulting from such translation are included in accumulated currency translation adjustments, in AOCI on the consolidated balance sheets until the underlying subsidiary is sold or substantially liquidated. The Company’s material functional currencies are the Canadian dollar, the British pound, the Australian dollar, the Japanese yen, the Korean won, euros and the South African rand.
Retrocessions are arranged through the Company’s retrocession pools for amounts in excess of the Company’s retention limit. As of December 31, 2009, all rated retrocession pool participants followed by the A.M. Best Company were rated “A-” or better. For a majority of the retrocessionaires that were not rated, security in the form of letters of credit or trust assets has been given as additional security in favor of RGA Reinsurance. In addition, the Company performs annual financial reviews of its retrocessionaires to evaluate financial stability and performance. In addition to its third party retrocessionaires, various RGA reinsurance subsidiaries retrocede amounts in excess of their retention to RGA Reinsurance, RGA Barbados, RGA Americas, RGA Worldwide or RGA Atlantic.
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 that 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. Minimum guaranteed rates on non-variable annuity and UL policies generally range from 2.0% to 6.0%, with an average guaranteed rate of approximately 2.9%.
In June 2009, the Financial Accounting Standards Board (“FASB”) issued “The FASB Accounting Standards Codification™ and the Hierarchy of Generally Accepted Accounting Principles”. Effective July 1, 2009, FASB Accounting Standards Codification™ (“Codification”) has become the source of authoritative U.S. accounting and reporting standards for nongovernmental entities, in addition to guidance issued by the Securities and Exchange Commission for public companies. This statement is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The Company adopted Codification on September 30, 2009 and has updated all disclosures to reference Codification herein.
In April 2009, the FASB amended the general accounting principles for Fair Value Measurements and Disclosures as it relates to determining fair value when the volume and level of activity for asset or liability have significantly decreased and identifying transactions that are not orderly. This amendment provides additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased in relation to normal market activity for the asset or liability and clarifies that the use of multiple valuation techniques may be appropriate. It also provides additional guidance on circumstances that may indicate a transaction is not orderly. Further, it requires additional disclosures about fair value measurements in annual and interim reporting periods. This amendment is effective prospectively for interim and annual reporting periods ending after June 15, 2009. The adoption of this amendment did not have a material impact on the Company’s consolidated financial statements. The required disclosures are provided in Note 6 - “Fair Value of Financial Instruments”.
In September 2006, the FASB amended the general accounting principles for Fair Value Measurements and Disclosures as it relates to defining fair value, establishing a framework for measuring fair value, establishing a fair value hierarchy based on the inputs used to measure fair value and enhanced disclosure requirements for fair value measurements. The Company adopted the amendment effective January 1, 2008. The Company’s adoption of the amendment resulted in a pre-tax gain of approximately $3.9 million, included in interest credited, related primarily to the decrease in the fair value of embedded
In January 2010, the FASB amended the general accounting principles for Equity as it relates to distributions to shareholders with components of stock and cash. This amendment clarifies that the stock portion of a distribution to shareholders, which allows them to elect to receive cash or stock with a limitation on the total amount of cash that shareholders can receive, is considered a share issuance that is reflected in earnings per share prospectively and is not a stock dividend. The amendment is effective for fiscal years and interim periods beginning after December 15, 2009. The adoption of this amendment is not expected to have an impact on the consolidated financial statements.
The Company has reclassified the presentation of certain prior period information to conform to the 2009 presentation.
On September 5, 2008, the shareholders of RGA approved a recapitalization and distribution agreement by and between RGA and MetLife, Inc. (“MetLife”). In the recapitalization, each issued and outstanding share of RGA common stock was reclassified as RGA class A common stock. The recapitalization was completed on September 12, 2008. Immediately after the recapitalization, MetLife and its subsidiaries, which held 32,243,539 shares of RGA’s outstanding stock, exchanged 29,243,539 shares of RGA class A common stock for 29,243,539 shares of RGA class B common stock, which featured enhanced voting rights. In turn, MetLife exchanged all of its RGA class B common stock to MetLife shareholders for shares of MetLife common stock.
On November 25, 2008, the shareholders of RGA approved a proposal to convert RGA class B common stock into RGA class A common stock on a one-for-one basis, with such class A common stock being automatically redesignated as “common stock”. In addition, the shareholders approved a proposal to amend and restate RGA’s articles of incorporation to eliminate provisions relating to Class B common stock and RGA’s dual-class common stock structure. As a result of the approval of the proposals, all holders of the new single class of common stock have identical voting rights in all respects.
In January 2009, the Company issued 13,096 shares of common stock from treasury and repurchased from recipients 2,280 of its common shares at $42.82 per share in settlement of income tax withholding requirements incurred by recipients of an equity incentive award. In February 2009, the Company issued 164,630 shares of common stock from treasury and repurchased from recipients 42,976 of its common shares at $35.11 per share in settlement of income tax withholding requirements incurred by recipients of an equity incentive award. Additionally, in February 2009, non-employee directors were granted a total of 7,600 shares of common stock.
All investments held by the Company are monitored for conformance with the qualitative and quantitative limits prescribed by the applicable jurisdiction’s insurance laws and regulations. In addition, the operating companies’ boards of directors periodically review their respective investment portfolios. The Company’s investment strategy is to maintain a predominantly investment-grade, fixed maturity portfolio, to provide adequate liquidity for expected reinsurance obligations, and to maximize total return through prudent asset management. The Company’s asset/liability duration matching differs between operating segments. Based on Canadian reserve requirements, the Canadian liabilities are matched with long-duration Canadian assets. The duration of the Canadian portfolio exceeds twenty years. The average duration for all the Company’s portfolios, when consolidated, ranges between eight and ten years.
In the fourth quarter of 2009, the Company wrote off its remaining interest in its direct insurance operations in Argentina, recording a $3.0 million investment-related loss. This loss was in addition to the Company’s recognition of a $10.5 million foreign currency translation loss in 2007 related to the pending sale. Investment income and a portion of investment related gains and losses are allocated to the segments based upon average assets and related capital levels deemed appropriate to support the segment business volumes.
At December 31, 2009 and 2008 the Company owned non-income producing securities with amortized costs of $29.2 million and $25.7 million, and estimated fair values of $29.3 million and $20.4 million, respectively. During 2009, 2008 and 2007 the Company sold fixed maturity securities and equity securities with fair values of $687.8 million, $536.7 million, and $1,085.2 million, which were below amortized cost, at losses of $73.0 million, $24.1 million and $31.5 million, respectively. The Company generally does not engage in short-term buying and selling of securities.
The Company has a process in place to identify fixed maturity and equity securities that could potentially have credit impairments that are other-than-temporary. This process involves monitoring market events that could impact issuers’ credit ratings, business climates, management changes, litigation and government actions and other similar factors. This process also involves monitoring late payments, pricing levels, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts and cash flow projections as indicators of credit issues.
For the nine-month period between the Date of Adoption and December 31, 2009, the Company recognized $78.4 million of credit-related losses in asset-backed and U.S. corporate securities. The Company estimates the amount of the credit loss component of a fixed maturity security impairment as the difference between amortized cost and the present value of the expected cash flows of the security. The present value is determined using the best estimate cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating rate security. The techniques and assumptions for establishing the best estimate cash flows vary depending on the type of security. The asset-backed securities’ cash flow estimates are based on security-specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity and prepayment speeds and structural support, including subordination and guarantees. The corporate fixed maturity security cash flow estimates are derived from scenario-based outcomes of expected corporate restructurings or the disposition of assets using security specific facts and circumstances including timing, security interests and loss severity.
The following table sets forth the amount of credit loss impairments on fixed maturity securities held by the Company as of the dates indicated, for which a portion of the other-than-temporary impairment loss was recognized in AOCI, and the corresponding changes in such amounts (dollars in thousands):
As mentioned above, the amended general accounting principles for Investments change how an entity recognizes an other-than-temporary impairment for a fixed maturity security by separating the other-than-temporary impairment loss between the amount representing the credit loss and the amount relating to other factors, if the Company does not have the intent to sell or it more likely than not will not be required to sell prior to recovery of the amortized cost less any current period credit loss. Credit losses are recognized in net income and losses relating to other non-credit factors are recognized in AOCI and included in unrealized losses in the 2009 table below. The following tables provide information relating to investments in fixed maturity securities and equity securities by sector as of December 31, 2009 and 2008 (dollars in thousands):
At December 31, 2009 and 2008 the Company held fixed maturity securities that were below investment grade with book values of $757.3 million and $389.6 million, and estimated fair values of $613.3 million and $274.6 million, respectively.
The amortized cost and estimated fair value of fixed maturity securities available-for-sale at December 31, 2009 are shown by contractual maturity for all securities except certain U.S. government agencies securities, which are distributed to maturity year based on the Company’s estimate of the rate of future prepayments of principal over the remaining lives of the securities. These estimates are derived from prepayment rates experienced at the interest rate levels projected for the applicable underlying collateral and can be expected to vary from actual experience. Actual maturities can differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The tables below show the major industry types and weighted average credit ratings, which comprise the U.S. and foreign corporate fixed maturity holdings at December 31, 2009 and 2008 (dollars in thousands):
At December 31, 2009 and 2008, the Company had $584.9 million and $1,416.4 million, respectively, of gross unrealized losses related to its fixed maturity and equity securities. These securities are concentrated, calculated as a percentage of gross unrealized losses, as follows:
As of December 31, 2009 and 2008, respectively, 71.4% and 92.7% of these securities were investment grade and 43.4% and 22.9% had fair values that were less than 20% below cost. The amount of the unrealized loss on these securities was primarily attributable to a widening of credit spreads since the time securities were purchased.
While all of these securities are monitored for potential impairment, the Company believes due to continued uncertain market conditions and liquidity concerns, and the high levels of price volatility, the extent and duration of a decline in value have become less indicative of when there has been credit deterioration with respect to an issuer. The Company’s determination of whether a decline in value is other-than-temporary the Company’s analysis of the underlying credit and the extent and duration of a decline in value. The Company’s credit analysis of an investment includes determining whether the issuer is current on its contractual payments, evaluating whether it is probable that the Company will be able to collect all amounts due according to the contractual terms of the security and analyzing the overall ability of the Company to recover the
amortized cost of the investment. The Company continues to consider valuation declines as a potential indicator of credit deterioration.
The following tables present the estimated fair values and gross unrealized losses, including other-than-temporary impairment losses reported in AOCI, for the 1,316 and 1,716 fixed maturity securities and equity securities that have estimated fair values below amortized cost as of December 31, 2009 and 2008, respectively. These investments are presented by class and grade of security, as well as the length of time the related market value has remained below amortized cost.
All of the Company’s mortgage loans are amortizing loans. As of December 31, 2009 and 2008, the Company’s mortgage loans were distributed throughout the United States as follows (dollars in thousands):
The maturities of the mortgage loans as of December 31, 2009 and 2008 are as follows (dollars in thousands):
Policy loans comprised approximately 5.8% and 6.7% of the Company’s cash and invested assets as of December 31, 2009 and 2008, respectively, substantially all of which are associated with one client. These policy loans present no credit risk because the amount of the loan cannot exceed the obligation due to the ceding company upon the death of the insured or surrender of the underlying policy. The provisions of the treaties in force and the underlying policies determine the policy loan interest rates. Because policy loans represent premature distributions of policy liabilities, they have the effect of reducing future disintermediation risk. In addition, the Company earns a spread between the interest rate earned on policy loans and the interest rate credited to corresponding liabilities.
Other invested assets include equity securities, non-redeemable preferred stocks, limited partnership interests, structured loans and derivative contracts. Other invested assets represented approximately 2.6% and 3.8% of the Company’s cash and invested assets as of December 31, 2009 and 2008, respectively. Carrying values of these assets as of December 31, 2009 and 2008 are as follows (dollars in thousands):
Carried on the Company’s consolidated balance sheets in other invested assets or other liabilities, at fair value.
As of December 31, 2009 and 2008, the Company held interest rate swaps that were designated and qualified as fair value hedges of interest rate risk. As of December 31, 2009, the Company held foreign currency swaps that were designated and qualified as fair value hedges of a portion of its net investment in its net investments in its Canada and Australia operations. As of December 31, 2008, the Company held foreign currency swaps that were designated and qualified as fair value hedges of a portion of its net investment in its Canada operation. The foreign currency swaps held as of December 31, 2008 were terminated in 2009 and the related unrealized gains of $50.0 million continue to be reflected in AOCI. As of December 31, 2009 and 2008, the Company also had derivative instruments that were not designated as hedging instruments. See Note 2 - “Summary of Significant Accounting Policies” for a detailed discussion of the accounting treatment for derivative instruments, including embedded derivatives. The Company does not enter into derivative instruments for speculative purposes. Derivative instruments are carried at fair value and generally require an insignificant amount of cash at inception of the contract.
The Company uses foreign currency swaps to hedge a portion of its net investment in certain foreign operations against adverse movements in exchange rates. The following tables illustrate the Company’s net investments in foreign operations (“NIFO”) hedges for the year ended December 31, 2009 (dollars in thousands):
Exchange-traded equity futures are used primarily to economically hedge liabilities embedded in certain variable annuity products assumed by the Company. With exchange-traded equity futures transactions, the Company agrees to purchase or sell a specified number of contracts, the value of which is determined by the relevant stock indices, and to post variation margin on a daily basis in an amount equal to the difference between the daily estimated fair values of those contracts. The Company enters into exchange-traded equity futures with regulated futures commission merchants that are members of the exchange.
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 inception and termination of the currency swap by each party. The Company also uses foreign currency swaps to economically hedge the foreign currency risk associated with certain of its net investments in foreign operations.
securities equal to the specified swap notional amount in exchange for the payment of cash amounts by the Company equal to the par value of the investment security surrendered.
A summary of the effect of non-hedging derivatives, including embedded derivatives, on the Company’s income statement for the year ended December 31, 2009 is as follows (dollars in thousands):
The Company manages its credit risk related to over-the-counter derivatives by entering into transactions with creditworthy counterparties, maintaining collateral arrangements and through the use of master agreements that provide for a single net payment to be made by one counterparty to another at each due date and upon termination. Because exchange-traded futures are affected through regulated exchanges, and positions are marked to market on a daily basis, the Company has minimal exposure to credit-related losses in the event of nonperformance by counterparties to such derivative instruments.
The Company enters into various collateral arrangements, which require both the posting and accepting of collateral in connection with its derivative instruments. Collateral agreements contain attachment thresholds that vary depending on the posting party’s financial strength ratings. Additionally, a decrease in the Company’s financial strength rating to a specified level results in potential settlement of the derivative positions under the Company’s agreements with its counterparties. As of
The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments at December 31, 2009 and 2008. Fair values have been determined by using available market information and the valuation techniques described below. Considerable judgment is often required in interpreting market data to develop estimates of fair value. Accordingly, the estimates presented herein may not necessarily be indicative of amounts that could be realized in a current market exchange. The use of different assumptions or valuation techniques may have a material effect on the estimated fair value amounts (dollars in thousands):
Publicly traded fixed maturity securities are valued based upon quoted market prices or estimates from independent pricing services, independent broker quotes and pricing matrices. Private placement fixed maturity securities are valued based on the credit quality and duration of marketable securities deemed comparable by the Company’s investment advisor, which may be of another issuer. The fair value of mortgage loans on real estate is estimated using discounted cash flows. Policy loans typically carry an interest rate that is adjusted annually based on a market index and therefore carrying value approximates fair value. The carrying value of funds withheld at interest approximates fair value except where the funds withheld are specifically identified in the agreement. When funds withheld are specifically identified in the agreement, the fair value is based on the fair value of the underlying assets which are held by the ceding company. The carrying values of cash and cash equivalents and short-term investments approximates fair values due to the short-term maturities of these instruments. Common and preferred equity investments and derivative financial instruments included in other invested assets are reflected at fair value on the consolidated balance sheets based primarily on quoted market prices, while limited partnership interests are carried at cost. The fair value of limited partnerships is based on net asset values. The carrying value for accrued investment income approximates fair value.
the asset or liability in an orderly transaction between market participants on the measurement date. In accordance with these principles, valuation techniques utilized by management for invested assets and embedded derivatives reported at fair value are generally categorized into three types:
The three approaches described above are consistent with generally accepted valuation techniques. While all three approaches are not applicable to all assets or liabilities reported at fair value, where appropriate and possible, one or more valuation techniques may be used. 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 regular analysis and review of the various techniques utilized in determining fair value to ensure that the valuation approaches utilized are appropriate and consistently applied, and that the various assumptions are reasonable. The Company also utilizes information from third parties, such as pricing services and brokers, to assist in determining fair values for certain assets and liabilities; however, management is ultimately responsible for all fair values presented in the Company’s financial statements. The Company performs analysis and review of the information and prices received from third parties to ensure that the prices represent a reasonable estimate of the fair value. This process involves 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, initial and ongoing review of third party pricing services and techniques, review of pricing trends and monitoring of recent trade information. 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.
For invested assets reported at fair value, when available, fair values are based on quoted prices in active markets that are regularly and readily obtainable. Generally, these are very liquid investments and the valuation does not require management judgment. When quoted prices in active markets are not available, fair value is based on the market valuation techniques described above, primarily a combination of the market approach, including matrix pricing and the income approach. The assumptions and inputs used by management in applying these techniques include, but are not limited to: interest rates, credit standing of the issuer or counterparty, industry sector of the issuer, coupon rate, call provisions, sinking fund requirements, maturity, estimated duration and assumptions regarding liquidity and future cash flows.
When observable inputs are not available, the market standard valuation techniques for determining the estimated fair value of certain types of securities that trade infrequently, and therefore have little or no price transparency, rely on inputs that are significant to the estimated fair value that are not observable in the market or cannot be derived principally from or corroborated by observable market data. These unobservable inputs can be based in large part on management judgment or estimation, and cannot be supported by reference to market activity. Even though unobservable, these inputs are based on assumptions deemed appropriate given the circumstances and are consistent with what other market participants would use when pricing such securities.
Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or market standard valuation techniques and assumptions with significant inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Such observable inputs include benchmarking prices for similar assets in active, liquid markets, quoted prices in markets that are not active and observable yields and spreads in the market. The Company’s Level 2 assets and liabilities include investment securities with quoted prices that are traded less frequently than exchange-traded instruments and derivative contracts whose values are determined using market standard valuation techniques. This category primarily includes U.S. and foreign corporate securities, Canadian and Canadian provincial government securities, and residential and commercial mortgage-backed securities, among others. Management values most of these securities using inputs that are market observable.
Assets and liabilities measured at fair value on a recurring basis as of December 31, 2009 and 2008 are summarized below (dollars in thousands).
As of December 31, 2009 and 2008, respectively, the Company classified approximately 15.3% and 17.1% of its fixed maturity securities in the Level 3 category. These securities primarily consist of private placement corporate securities with an inactive trading market. Additionally, the Company has included asset-backed securities with sub-prime exposure and mortgage backed securities that are below investment grade in the Level 3 category due to the current market uncertainty associated with these securities and the Company’s utilization of information from third parties for the valuation of these securities.
The tables below present reconciliations for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2009 and 2008 (dollars in thousands).
At December 31, 2009 and 2008, there were no reinsurance ceded receivables associated with a single reinsurer with a carrying value in excess of 5% of total assets.
At December 31, 2009 and 2008, respectively, the Company’s U.S. and Asia Pacific segments provided approximately $1.8 billion and $1.1 billion of statutory financial reinsurance, as measured by pre-tax statutory surplus, to other insurance companies under financial reinsurance transactions to assist ceding companies in meeting applicable regulatory requirements. Generally, such financial reinsurance is provided by the Company committing cash or assuming insurance liabilities, which are collateralized by future profits on the reinsured business. The Company earns a fee based on the amount of net outstanding financial reinsurance.
The tax effects of temporary differences that give rise to significant portions of the deferred income tax assets and liabilities at December 31, 2009 and 2008, are presented in the following tables (dollars in thousands):
During 2009, 2008, and 2007, the Company received federal and foreign income tax refunds of approximately $0.3 million, $31.0 million and $1.9 million, respectively. The Company made cash income tax payments of approximately $25.9 million, $54.2 million and $26.1 million in 2009, 2008 and 2007, respectively. At December 31, 2009 and 2008, the Company recognized gross deferred tax assets associated with net operating losses of approximately $957.0 million and $743.5 million, respectively, that will expire between 2023 and 2024. However, these net operating losses are expected to be utilized in the normal course of business during the period allowed for carryforwards and in any event, will not be lost, due to the application of tax planning strategies that management would utilize.
As of December 31, 2009, the Company’s total amount of unrecognized tax benefits was $221.0 million and the total amount
of unrecognized tax benefits that would affect the effective tax rate, if recognized, was $17.3 million. It is not anticipated that the Company’s liability for unrecognized tax benefits will change significantly over the next 12 months due to the fact that most of the Company’s unrecognized tax benefits are timing in nature and even if recognized, would be offset by the addition of uncertain tax benefits that the Company does not consider effectively settled. Management believes there will be no material impact to the Company’s effective tax rate related to unrecognized tax benefits over the next 12 months.
The Company recognized a benefit in interest expense of $2.1 million in 2009 and interest expense of $2.5 million and $3.9 million in 2008 and 2007, respectively. As of December 31, 2009 and 2008, the Company had $34.1 million and $36.2 million, respectively, of accrued interest related to unrecognized tax benefits. The net decrease of $2.1 million from December 31, 2008 was related to accrued interest on effectively settled positions offset by reductions in accrued interest on uncertain tax positions.
The Company also provides certain health care and life insurance benefits for retired employees. The health care benefits are provided through a self-insured welfare benefit plan. Employees become eligible for these benefits if they meet minimum age and service requirements. The retiree’s cost for health care benefits varies depending upon the credited years of service. The Company recorded benefits expense of approximately $1.3 million, $1.4 million, and $1.4 million in 2009, 2008 and 2007, respectively that are related to these postretirement plans. Virtually all retirees, or their beneficiaries, contribute a portion of the total cost of postretirement health benefits.
Funded status includes the impact of obligations associated with various non-qualified executive deferred savings plans for which there are no required funding levels. The Company’s qualified defined benefit pension plan was under-funded by $4.9 million and $8.9 million, respectively, as of December 31, 2009 and 2008.
The following table presents additional year-end information for pension plans based on the excess or shortfall of plan assets as compared to the accumulated benefit obligation (“ABO”) as of December 31, 2009 and 2008 (dollars in thousands):
Weighted average assumptions used to determine the accumulated benefit obligation and net benefit cost or income for the year ended December 31:
Equity and debt securities are exposed to various risks, such as interest rate risk, credit risk, and overall market volatility. Due to the level of risk associated with certain investment securities, it is reasonably possible that changes in the values of investment securities will occur and that such change could affect the amounts reported in the financial statements.
RGA Reinsurance also has a product license and service agreement with MetLife. Under this agreement, RGA has licensed the use of its electronic underwriting product to MetLife and provides internet hosting services, installation and modification services for the product. The Company recorded revenue under the agreement for the years ended December 31, 2008 and 2007 of approximately $0.6 million (through the Divestiture Date) and $0.6 million, respectively.
The Company also had arms-length direct policies and reinsurance agreements with MetLife and certain of its subsidiaries. These direct policies and reinsurance agreements with MetLife and certain of its subsidiaries continue to be in place after the Divestiture Date. The Company reflected net premiums from these agreements of approximately $163.5 million (through the Divestiture Date) and $250.9 million in 2008 and 2007, respectively. The premiums reflect the net of business assumed from and ceded to MetLife and its subsidiaries. The pre-tax income, excluding investment income allocated to support the business, was approximately $15.8 million (through the Divestiture Date) and $16.0 million in 2008 and 2007, respectively.
The following table presents selected statutory financial information for the Company’s primary life reinsurance legal entities, as of or for the years ended December 31, 2009, 2008, and 2007 (dollars in thousands):
The Company is subject to litigation in the normal course of its business. The Company currently has no material litigation. A legal reserve is established when the Company is notified of an arbitration demand or litigation or is notified that an arbitration demand or litigation is imminent, it is probable that the Company will incur a loss as a result and the amount of the probable loss is reasonably capable of being estimated. However, if such material litigation did arise, it is possible that an adverse outcome on any particular arbitration or litigation situation could have a material adverse effect on the Company’s consolidated financial position and/or net income in a particular reporting period.
RGA has issued guarantees to third parties on behalf of its subsidiaries for the payment of amounts due under certain credit facilities, reinsurance treaties and office lease obligations, whereby if a subsidiary fails to meet an obligation, RGA or one of its other subsidiaries will make a payment to fulfill the obligation. In limited circumstances, treaty guarantees are granted to ceding companies in order to provide them additional security, particularly in cases where RGA’s subsidiary is relatively new, unrated, or not of a significant size, relative to the ceding company. Liabilities supported by the treaty guarantees, before consideration for any legally offsetting amounts due from the guaranteed party, totaled $330.3 million and $273.6 million as of December 31, 2009 and 2008, respectively, and are reflected on the Company’s consolidated balance sheets in
Certain of the Company’s debt agreements contain financial covenant restrictions related to, among others, liens, the issuance and disposition of stock of restricted subsidiaries, minimum requirements of consolidated net worth, maximum ratios of debt to capitalization and change of control provisions. A material ongoing covenant default could require immediate payment of the amount due, including principal, under the various agreements. Additionally, the Company’s debt agreements contain cross-default covenants, which would make outstanding borrowings immediately payable in the event of a material uncured covenant default under any of the agreements, including, but not limited to, non-payment of indebtedness when due for an amount in excess of $100.0 million, bankruptcy proceedings, or any other event which results in the acceleration of the
In accordance with the general accounting principles for Consolidation, Timberlake Financial is considered to be a variable interest entity and the Company is deemed to hold the primary beneficial interest. As a result, Timberlake Financial has been consolidated in the Company’s financial statements. The Company’s consolidated balance sheets include the assets of Timberlake Financial recorded as fixed maturity investments and other invested assets, which consists of restricted cash and cash equivalents, with the liability for the notes recorded as collateral finance facility. The Company’s consolidated statements of income include the investment return of Timberlake Financial as investment income and the cost of the facility is reflected in collateral finance facility expense.
The Company’s reportable segments are strategic business units that are primarily segregated by geographic region. Information related to revenues, income (loss) before income taxes, interest expense, depreciation and amortization, and assets of the Company’s continuing operations are summarized below (dollars in thousands).
The table above includes amortization of deferred acquisition costs, including the effect from investment related gains and losses.
Equity-based compensation expense of $10.7 million, $10.7 million, and $18.3 million related to grants or awards under the Stock Plans was recognized in 2009, 2008 and 2007, respectively. Equity-based compensation expense is principally related to the issuance of stock options, performance contingent restricted units, and restricted stock.
The intrinsic value of options exercised was $4.7 million, $1.7 million, and $10.3 million for 2009, 2008 and 2007, respectively.
The following table presents the components of the Company’s other comprehensive income (loss) for the years ended December 31, 2009, 2008 and 2007 (dollars in thousands):
Effective January 1, 2010, the Company completed its acquisition of ReliaStar Life Insurance Company’s U.S. and Canadian group life, accident and health reinsurance business. ReliaStar is a subsidiary of ING Groep N.V. The acquisition was structured as an indemnity coinsurance agreement and the Company expects this business to generate returns of between 15 and 19 percent, beginning in 2010. The acquisition is expected to enhance the Company’s expertise and product offerings in the North American market, but is expected to contribute less than five percent to the Company’s consolidated assets, liabilities and income in 2010.
We have audited the accompanying consolidated balance sheets of Reinsurance Group of America, Incorporated and subsidiaries (the “Company”) as of December 31, 2009 and 2008, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009. Our audits also included the financial statement schedules listed in the Index at Item 15. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.