The following table sets forth selected information concerning assumed life reinsurance business in force and assumed new business volume by segment for the periods indicated. The terms “in force” and “new business” refer to insurance policy face amounts or net amounts at risk.
Capital Management. Changing regulatory environments, rating agencies and competitive business pressures are causing life insurers to evaluate reinsurance as a means to:
Automatic Reinsurance. The Company intends to maintain its presence in the North American automatic reinsurance market by leveraging its mortality expertise and breadth of products and services to gain additional market share.
In Force Block Reinsurance. Increasingly, there are occasions to grow the business by reinsuring in force blocks, as insurers and reinsurers seek to exit various non-core businesses and increase financial flexibility in order to, among
other things, redeploy capital and pursue merger and acquisition activity. The Company continually seeks these types of opportunities.
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 markets such as Japan, Southeast Asia and South Korea are beginning to realize the benefits that reinsurers bring to the life insurance market. Markets such as China and India represent longer-term opportunities for growth as the underlying direct life insurance markets grow to meet the needs of growing middle-class populations. Additionally, the Company believes that regulatory changes (e.g., Solvency II) in European markets may cause ceding companies to reduce counterparty exposure to their existing life reinsurers and reinsure more business, creating opportunities for the Company.
The average invested assets at amortized cost, excluding spread related business, totaled $26.6 billion, $25.2 billion and $23.2 billion in 2018, 2017 and 2016, respectively. The average yield earned on investments, excluding spread related business, was 4.45%, 4.55% and 4.57% in 2018, 2017 and 2016, respectively. The average yield will vary from year to year depending on several variables, including the prevailing interest rate and credit spread environment, prepayment fees and make-whole premiums, changes in the mix of the underlying investments and cash balances, and the timing of dividends and distributions on certain investments. Investment income in 2018 and 2017 benefited from distributions from joint ventures and limited partnerships, which can be highly variable from year to year. A continued low interest rate environment is expected to put downward pressure on this yield in future reporting periods.
Total investment related gains (losses), net, decreased by $337.8 million or 201.3% in 2018 and increased by $73.7 million, or 78.2%, in 2017. Fluctuations in investment related gains (losses), net are primarily due to unfavorable and favorable changes in the value of embedded derivatives related to reinsurance treaties written on a modco or funds withheld basis of $157.3 million and $90.6 million in 2018 and 2017, respectively. In addition, 2018 reflects net realized losses on investment sales compared to net realized gains in 2017. Net realized losses in 2018 are primarily related to repositioning of fixed maturity securities in a rising interest rate environment. Investment impairments on fixed maturity securities decreased by $14.1 million in 2018 and increased by $3.8 million in 2017, compared to the prior years. See Note 4 - “Investments” and Note 5 - “Derivative Instruments” in the Notes to Consolidated Financial Statements for additional information on investment related gains (losses), net, and derivatives. Investment income is allocated to the operating segments based upon average assets and related capital levels deemed appropriate to support segment operations.
The effective tax rate on a consolidated basis was 15.4%, (59.4)%, and 32.8% for 2018, 2017, and 2016, respectively. The 2018 effective tax rate was lower than the U.S. Statutory rate of 21% primarily as a result of the release of a valuation allowance on foreign tax credits, which was partially offset by tax expense related to global intangible low-taxed income (“GILTI”) and valuation allowance increases. The 2017 effective tax rate includes the tax effects of the U.S. Tax Reform. The Company recorded an estimated net tax benefit of approximately $1.0 billion resulting in a reduction to the effective tax rate. See Note 9 - “Income Tax” in the Notes to Consolidated Financial Statements for additional information on the Company’s consolidated effective tax rate.
Premiums are accrued when due and in accordance with information received from the ceding company. When the Company enters into a new reinsurance agreement, it records accruals based on the terms of the reinsurance treaty. Similarly, when a ceding company fails to report information on a timely basis, the Company records accruals based on the terms of the reinsurance treaty as well as historical experience. Other management estimates include adjustments for increased insurance in force on existing treaties, 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 from unpaid premiums.
DAC is sensitive to changes in assumptions regarding these EGP components, and any change in such assumptions could have an effect on the Company’s profitability.
The Company periodically reviews the EGP valuation model and assumptions so that the assumptions reflect best estimates of future experience. Two assumptions are considered to be most significant: (1) estimated interest spread, and (2) estimated future policy lapses. As of December 31, 2018, the Company had $420.2 million of DAC related to asset-intensive products, all within the U.S. and Latin America Financial Solutions segment. The following table reflects the possible change that would occur in a given year if assumptions, as a percentage of current DAC related to asset-intensive products, are changed as illustrated:
The Company periodically reviews actual historical experience and relative anticipated experience compared to the assumptions used to establish aggregate policy reserves. Further, the Company establishes premium deficiency reserves if actual and anticipated experience indicates that existing aggregate policy reserves, together with the present value of future gross premiums, are not sufficient to cover the present value of future benefits, settlement and maintenance costs and to recover
unamortized acquisition costs. The premium deficiency reserve is established through a charge to income, as well as a reduction to unamortized acquisition costs and, to the extent there are no unamortized acquisition costs, an increase to future policy benefits. Because of the many assumptions and estimates used in establishing reserves and the long-term nature of the Company’s reinsurance contracts, the reserving process, while based on actuarial science, is inherently uncertain. If the Company’s assumptions, particularly on mortality, are inaccurate, its reserves may be inadequate to pay claims and there could be a material adverse effect on its results of operations and financial condition.
In addition, investments are subject to impairment reviews to identify when a decline in value is other-than-temporary. Other-than-temporary impairment losses related to non-credit factors are recognized in AOCI whereas the credit loss portion is recognized in investment related gains (losses), net. See “Other-than-Temporary Impairment” in Note 2 - “Significant Accounting Policies and Pronouncements” in the Notes to the Consolidated Financial Statements for a discussion of the policies regarding other-than-temporary impairments.
See Note 9 - “Income Tax” for further discussion including the impact of the December 22, 2017 enactment of U.S. Tax Reform.
Income before income taxes decreased by $238.1 million, or 30.7%, and increased by $120.5 million, or 18.4%, in 2018 and 2017, respectively. The decrease in 2018 was primarily due to unfavorable claims experience in the group disability and healthcare excess lines of business. Additionally, the individual life line of business experienced higher claims, partially related to a severe influenza season in 2018. Also contributing to the year over year decline in income were lower investment related gains and changes in the value of the embedded derivatives associated with reinsurance treaties structured on a modco or funds withheld basis. The increase in 2017 was the result of several factors, including changes in the value of the embedded derivatives associated with reinsurance treaties structured on a modco or funds withheld, an increase in investment related capital gains and additional variable investment income.
Net investment income increased $1.7 million, or 0.2%, and $28.2 million, or 4.0%, in 2018 and 2017, respectively. The increase in 2018 was due to a higher asset base largely offset by lower investment yields with variable investment income relatively consistent for both periods. The increase in 2017 was primarily due to strong variable investment income associated with a higher level of bond make-whole premiums and distributions from joint ventures and limited partnerships, and an increase in the average invested asset base partially offset by a lower investment yield.
Other operating expenses increased $9.0 million, or 6.8%, and $4.5 million, or 3.5% in 2018 and 2017, respectively. In addition to reflecting normal growth in employee related costs, the increase in operating expenses for 2018 reflects expense growth associated with key business line initiatives focused on enhancing the services and reinsurance options for clients. Other operating expenses, as a percentage of net premiums, were 2.5%, 2.4% and 2.4% in 2018, 2017 and 2016, respectively. The expense ratio tends to fluctuate only slightly from period to period due to maturity and scale of this segment.
Asset-Intensive within the U.S. and Latin America Financial Solutions segment primarily assumes investment risk within underlying annuities and corporate-owned life insurance policies. Most of these agreements are coinsurance, coinsurance with funds withheld or modco. The Company recognizes profits or losses primarily from the spread between the investment income earned and the interest credited on the underlying deposit liabilities, income associated with longevity risk, and fees associated with variable annuity account values and guaranteed investment contracts.
Embedded Derivatives - Modco/Funds Withheld Treaties - Represents the change in the fair value of embedded derivatives on funds withheld at interest associated with treaties written on a modco or funds withheld basis. The fair value changes of embedded derivatives on funds withheld at interest associated with treaties written on a modco or funds withheld basis are reflected in revenues, while the related impact on deferred acquisition expenses is reflected in benefits and expenses. The Company’s utilization of a credit valuation adjustment did not have a material effect on the change in fair value of these embedded derivatives for the years ended December 31, 2018, 2017 and 2016.
The change in fair value of the guaranteed minimum benefits, after allowing for changes in the associated free standing derivatives, decreased income before income taxes by $5.1 million, $13.3 million and $28.8 million in 2018, 2017 and 2016, respectively. The decrease in income for 2018 is primarily associated with unfavorable policyholder termination experience. The decrease in income for 2017 and 2016 was primarily due to the annual update of best estimate actuarial assumptions to account for lower policyholder termination experience.
Equity-Indexed Annuities - Represents changes in the liability for equity-indexed annuities in excess of changes in account value, after adjustments for related deferred acquisition expenses. The change in fair value of embedded derivative liabilities associated with equity-indexed annuities increased income before income taxes by $6.4 million, $14.5 million and $11.0 million, in 2018, 2017 and 2016, respectively. The increase in income in 2018 was primarily due to lower policyholder lapses and withdrawals. The increase in income in 2017 and 2016 was primarily due to declining long-term interest rates and the flattening of the treasury yield curve.
The invested asset base supporting this segment increased to $20.1 billion as of December 31, 2018 from $15.4 billion as of December 31, 2017. The increase in the asset base was due primarily to new coinsurance transactions in the second half of 2018. As of December 31, 2018 and 2017, $3.8 billion and $4.1 billion, respectively, of the invested assets were funds withheld at interest, of which greater than 90% is associated with one client.
Financial Reinsurance within the U.S. Financial Solutions segment income before income taxes consists primarily of net fees earned on financial reinsurance transactions. Additionally, a portion of the business is brokered business in which the Company
does not participate in the assumption of risk. The fees earned from financial reinsurance contracts and brokered business are reflected in other revenues, and the fees paid to retrocessionaires are reflected in policy acquisition costs and other insurance expenses.
Income before income taxes increased by $1.8 million, or 2.2%, and $21.6 million, or 36.5%, in 2018 and 2017, respectively. The increases in 2018 and 2017 were primarily related to the growth from new transactions.
At December 31, 2018, 2017 and 2016, the amount of reinsurance assumed from client companies, as measured by pre-tax statutory surplus, risk based capital and other financial reinsurance structures, was $14.2 billion, $13.1 billion and $8.8 billion, respectively. The increases in both 2018 and 2017 can primarily be attributed to an increase in the number of new transactions executed each year and is consistent with the increase in related income. Fees earned from this business can vary significantly depending on the size of the transactions and the timing of their completion and, therefore, can fluctuate from period to period.
The Company conducts reinsurance business in Canada primarily through RGA Canada, which assists clients with capital management activity and mortality and morbidity risk management. The Canada operations are primarily engaged in Traditional reinsurance, which consists mainly of traditional individual life reinsurance, and to a lesser extent creditor, group life and health, critical illness and disability 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 individual life insurance. The Canada Financial Solutions segment consists of longevity and financial reinsurance.
Income before income taxes decreased by $7.9 million, or 6.6%, and $14.5 million, or 10.8%, in 2018 and 2017, respectively. The decrease in income for 2018 was primarily due to unfavorable traditional individual life mortality experience. The decrease in income for 2017 was primarily due to unfavorable traditional individual life mortality experience compared to favorable experience in 2016. Foreign currency exchange fluctuation in the Canadian dollar resulted in a decrease in income before income taxes of $1.2 million and an increase of $3.2 million in 2018 and 2017, respectively.
Net premiums increased by $122.0 million, or 13.5%, and decreased by $26.7 million, or 2.9%, in 2018 and 2017, respectively. The increase in 2018 was primarily due to new in force block transactions completed during 2018. The decrease in 2017 was primarily due to a decrease in creditor premiums of $80.4 million partially offset by an increase in traditional individual life business premiums from annually increasing premium rates on yearly renewable term treaties and favorable foreign currency exchange fluctuation. Foreign currency exchange fluctuation in the Canadian dollar had a negligible effect on net premiums in 2018 and resulted in an increase of $18.5 million in 2017. The segment added new business production, measured by face amount of insurance in force, of $43.1 billion, $35.6 billion and $34.9 billion during 2018, 2017 and 2016, respectively.
pattern of previously capitalized amounts, which are subject to the form of the reinsurance agreement and the underlying insurance policies, may vary.
Other operating expenses decreased by $0.2 million, or 0.6%, and $4.4 million, or 11.7%, in 2018 and 2017, respectively. Foreign currency exchange fluctuation in the Canadian dollar had a negligible effect on other operating expenses for 2018 and resulted in an increase in other operating expenses of $0.7 million in 2017, respectively. The decrease in other operating expenses in 2017 is primarily due to decrease in allocated expense from corporate operations. Other operating expenses as a percentage of net premiums were 3.2%, 3.7% and 4.1% in 2018, 2017 and 2016, respectively.
Income before income taxes decreased by $7.1 million, or 42.5%, and increased by $8.7 million, or 109.5%, in 2018 and 2017, respectively. The decrease in income before income taxes in 2018 was primarily a result of favorable experience on the longevity block of business in 2017 and a decrease in investment income. The increase in income before income taxes in 2017 was primarily due to favorable experience on longevity business. Foreign currency exchange fluctuation in the Canadian dollar resulted in an increase in income before income taxes of $0.2 million and a decrease of $0.4 million in 2018 and 2017, respectively.
Net premiums increased $5.1 million, or 13.5%, and decreased by $0.5 million, or 1.2%, in 2018 and 2017, respectively. The increase in net premiums in 2018 was primarily due to longevity business, where the premium structure generally increases over time. Foreign currency exchange fluctuation in the Canadian dollar resulted in an increase in net premiums of $0.1 million and $0.9 million in 2018 and 2017, respectively.
Net investment income decreased by $3.8 million, or 73.9%, and increased by $2.4 million, or 90.0%, in 2018 and 2017, respectively. The decrease in net investment income in 2018 was primarily due to a decrease in the invested asset base. The increase in net investment income for 2017 was primarily due to a growth in the invested asset base.
Claims and other policy benefits increased by $7.2 million, or 24.2%, and decreased by $6.6 million, or 18.3%, in 2018 and 2017, respectively. The increase in 2018 and the decrease in 2017 reflect favorable experience on the longevity block of business in 2017. The effect of changes in the Canadian dollar exchange rates resulted in a decrease in claims and other policy benefits of $0.2 million and an increase of $0.6 million in 2018 and 2017, respectively.
Income before income taxes increased by $57.5 million, or 29.6%, and $25.9 million, or 15.4%, in 2018 and 2017, respectively. The increase in income before income taxes for 2018 was primarily due to favorable performance in the closed block longevity and payout annuity business partially offset by unfavorable individual mortality and morbidity experience. The increase in income before income taxes for 2017 was primarily due to favorable individual mortality, morbidity and longevity experience, partly offset by lower payout annuity performance. Foreign currency exchange fluctuations resulted in an increase in income before income taxes of $7.4 million and a decrease of $4.3 million in 2018 and 2017, respectively.
A portion of the net premiums for the segment, in each period presented, relates to reinsurance of critical illness coverage, primarily in the UK. This coverage provides a benefit in the event of the diagnosis of a pre-defined critical illness. Net premiums earned from this coverage totaled $187.6 million, $191.5 million and $203.4 million in 2018, 2017 and 2016, respectively.
Net investment income increased by $10.7 million, or 19.3%, and $5.2 million, or 10.4%, in 2018 and 2017, respectively. The increase in 2018 was primarily due to an increase in the invested asset base and increased invested asset yield. The increase in 2017 was primarily due to an increase in the invested asset base related to increased business volumes. Foreign currency exchange fluctuations resulted in an increase in net investment income of $1.8 million and $0.1 million in 2018 and 2017, respectively.
Policy acquisition costs and other insurance expenses as a percentage of net premiums were 7.0%, 7.1% and 5.6% for 2018, 2017 and 2016, respectively. The increase in policy acquisition cost ratio in 2017 was due primarily to changes in the mix of business reflecting increased volumes of new business with higher commissions.
Other operating expenses increased by $3.8 million, or 3.7%, and $1.0 million, or 1.0%, in 2018 and 2017, respectively. The increases in 2018 and 2017 were primarily due to the effects of foreign currency exchange fluctuations. Foreign currency exchange fluctuations resulted in an increase in operating expenses of $2.6 million and $1.6 million 2018 and 2017, respectively. Other operating expenses as a percentage of net premiums totaled 7.5%, 7.9% and 9.0% in 2018, 2017 and 2016, respectively.
Income before income taxes increased by $72.9 million, or 59.0%, and decreased by $14.5 million, or 10.5%, in 2018 and 2017, respectively. The increase in 2018 was primarily due to favorable performance in the closed block longevity and payout annuity businesses. The decrease in 2017 in income before income taxes was primarily due to payout annuity experience normalizing after a particularly positive 2016, partly offset by favorable longevity business results. Foreign currency exchange fluctuations resulted in an increase in income before income taxes of $5.8 million and a decrease of $5.8 million in 2018 and 2017, respectively.
Net premiums increased by $31.6 million, or 19.3%, and decreased by $16.6 million, or 9.2%, in 2018 and 2017, respectively. The increase in 2018 in net premiums was due to increased volumes of closed block longevity business. The decrease in 2017 in net premiums was due to a new retrocession treaty, executed for risk management purposes that cedes longevity risk to third parties, partially offset by an increase in premiums from new transactions. Foreign currency exchange fluctuations resulted in an increase in net premiums of $6.5 million and a decrease of $7.6 million in 2018 and 2017, respectively.
Net investment income increased $10.6 million, or 8.6%, and decreased by $2.0 million, or 1.6%, in 2018 and 2017, respectively. The increase in investment income in 2018 was due to an increased invested asset base resulting from business growth. The decrease in investment income in 2017 was primarily due to adverse foreign currency exchange fluctuations. Foreign currency exchange fluctuations resulted in an increase in investment income of $4.8 million and a decrease of $4.8 million in 2018 and 2017, respectively.
Other revenues increased by $1.5 million, or 8.3% and decreased by $2.8 million, or 13.2%, in 2018 and 2017, respectively. The increase in 2018 in other revenues was due to increased volumes of fee income business. The decrease in 2017 in other revenues was due to experience from a longevity swap normalizing after a particularly positive 2016. Fees earned from this business can vary significantly depending on the size of the transactions and the timing of their completion and, therefore, can fluctuate from period to period.
Claims and other policy benefits decreased $19.6 million, or 13.8%, and $22.1 million, or 13.4%, in 2018 and 2017, respectively. The decrease in 2018 was primarily due to higher terminations in closed block longevity business. The decrease in 2017 was primarily due to the aforementioned new longevity retrocession treaty that cedes longevity risk to third parties, net of an increase in claims and other policy benefits from new transactions.
Income before income taxes increased by $9.6 million, or 5.9%, and $43.9 million, or 37.2%, in 2018 and 2017, respectively. The increase in income before income taxes in 2018 was primarily due to business growth across the region and net favorable claims experience in Asia, partially offset by adverse claims experience in Australia. Also offsetting the increase in income before income taxes were losses on sales of investment securities and unfavorable changes in the fair value of derivatives in 2018 compared with gains on security sales and favorable changes in the fair value of derivatives in 2017. The increase in income before income taxes in 2017 was primarily due to higher income from offices in Asia driven by business growth, most notably in Hong Kong and Southeast Asia. Foreign currency exchange fluctuations resulted in an increase in income before income taxes of $3.1 million and a decrease of $1.1 million in 2018 and 2017, respectively.
Income before income taxes increased by $28.7 million, or 19.3%, and $34.9 million, or 30.6%, in 2018 and 2017, respectively. The increase in income before income taxes in 2018 was primarily due to business growth across the region and favorable claims experience in Asia partially offset by adverse claims experience in Australia. The increase in income before income taxes in 2017 was primarily due to higher income from offices in Asia driven by business growth. Foreign currency exchange fluctuations resulted in an increase in income before income taxes of $2.8 million and a decrease of $1.4 million in 2018 and 2017, respectively.
Policy acquisition costs and other insurance expenses as a percentage of net premiums were 8.5%, 13.5% and 9.7% for 2018, 2017 and 2016, respectively. The ratio of policy acquisition costs and other insurance expenses as a percentage of net premiums increased in 2017, primarily due to the acceleration of policy acquisition costs related to the aforementioned recaptured treaties in Australia. The ratio of policy acquisition costs and other insurance expenses as a percentage of net premiums should generally decline as the business matures; however, the percentage does fluctuate periodically due to variations in the mixture of business and client-related actions.
Income before income taxes decreased by $19.1 million, or 145.4%, and increased by $9.1 million, or 223.2%, in 2018 and 2017, respectively. The decrease in income before income taxes in 2018 was primarily due to investment related losses and a decrease in the fair value of derivatives in 2018 compared to investment related gains and an increase in the fair value of derivatives in 2017. The increase in income before income taxes in 2017 was primarily due to favorable lapse experience on a closed treaty in Japan as compared to 2016. Foreign currency exchange fluctuations resulted in an increase in income before income taxes of $0.4 million and $0.3 million in 2018 and 2017, respectively.
Net premiums decreased by $1.6 million, or 64.2%, and $3.0 million, or 55.4%, in 2018 and 2017, respectively. The decreases were primarily due to policy lapses on a closed treaty in Japan.
Other operating expenses increased by $2.2 million, or 14.5%, and decreased by $0.2 million, or 1.3%, in 2018 and 2017, respectively. The timing of premium flows and the level of costs associated with the entrance into and development of new markets in the Asia Pacific segment causes other operating expenses to fluctuate over periods of time.
Corporate and Other revenues primarily include investment income from unallocated invested assets, investment related gains and losses and service fees. Corporate and Other expenses consist of the offset to capital charges allocated to the operating segments within the policy acquisition costs and other insurance income line item, unallocated overhead and executive costs, interest expense related to debt, and the investment income and expense associated with the Company’s collateral finance and securitization transactions and service business expenses. Additionally, Corporate and Other includes results from certain wholly-owned subsidiaries, such as RGAx, and joint ventures that, among other activities, develop and market technology, and provide consulting and outsourcing solutions for the insurance and reinsurance industries. In the past two years, the Company has increased its investment and expenditures in this area in an effort to both support its clients and generate new future revenue streams.
Net investment income increased by $16.1 million, or 10.8%, and $31.9 million, or 27.3%, in 2018 and 2017, respectively. The increase in 2018 was related to an increase in unallocated invested assets and higher variable investment income. The increase in 2017 was related to an increase in unallocated invested assets and higher investment yields.
Other revenues increased by $18.2 million, or 165.4%, and decreased by $1.3 million, or 10.7%, in 2018 and 2017, respectively. The increase in 2018 was mainly due to the Company’s January 2018 acquisition of LOGiQ3 Inc., a group of companies providing technology, consulting and outsourcing solutions primarily to the North American life insurance and reinsurance industry, which contributed $20.5 million to other revenues in 2018.
Policy acquisition costs and other insurance income decreased by $15.5 million, or 14.3%, and $8.4 million, or 8.4%, in 2018 and 2017, respectively. Fluctuations period over period were attributable to the offset to capital charges allocated to the operating segments.
Other operating expenses increased by $47.6 million, or 22.9%, and $53.2 million, or 34.4%, in 2018 and 2017, respectively. The increase in other operating expenses during 2018 was due to increased compliance costs, strategic initiatives, acquisitions and increased incentive-based compensation. In addition, the aforementioned acquisition of LOGiQ3 Inc. contributed $29.3 million of other operating expenses in 2018. The $53.2 million increase in other operating expenses in 2017 was primarily related to a $22.5 million capital project write-off, in addition to a $13.7 million increase in compensation expense, mainly due to increased incentive-based compensation and pension benefits, and a $10.0 million increase in consulting expenses due to various corporate initiatives.
The current interest rate environment in select markets, primarily the U.S. and Canada, continues to put downward pressure on the Company’s investment yield. The Company’s average investment yield, excluding spread related business, for 2018 was at 4.45%, 10 basis points below the comparable 2017 rate. The Company’s insurance liabilities, in particular its annuity products, are sensitive to changing market factors. Due to increases in risk free interest rates, gross unrealized gains on fixed maturity securities available-for-sale decreased from $2,982.8 million at December 31, 2017 to $1,858.7 million at December 31, 2018. Gross unrealized losses increased from $113.3 million at December 31, 2017 to $748.5 million at December 31, 2018.
The Company continues to be in a position to hold any investment security showing an unrealized loss until recovery, provided it remains comfortable with the credit of the issuer. As indicated above, gross unrealized gains on investment securities of $1,858.7 million remain well in excess of gross unrealized losses of $748.5 million as of December 31, 2018. Historically low interest rates continued to put pressure on the Company’s investment yield. The Company does not rely on short-term funding or commercial paper and to date it has experienced no liquidity pressure, nor does it anticipate such pressure in the foreseeable future.
RGA established an intercompany revolving credit facility where certain subsidiaries can lend to or borrow from each other and from RGA in order to manage capital and liquidity more efficiently. The intercompany revolving credit facility, which is a series of demand loans among RGA and its affiliates, is permitted under applicable insurance laws. This facility reduces overall borrowing costs by allowing RGA and its operating companies to access internal cash resources instead of incurring third-party transaction costs. The statutory borrowing and lending limit for RGA’s Missouri-domiciled insurance subsidiaries is currently 3% of the insurance company’s admitted assets as of its most recent year-end. There were $20.9 million and no borrowings outstanding under the intercompany revolving credit facility as of December 31, 2018 and 2017, respectively. In addition to loans associated
Dividend payments from non-U.S. operations are subject to similar restrictions established by local regulators. The non-U.S. regulatory regimes also commonly limit the dividend payments to the parent to a portion of the prior year’s statutory income, as determined by the local accounting principles. The regulators of the Company’s non-U.S. operations may also limit or prohibit profit repatriations or other transfers of funds to the U.S. if such transfers are deemed to be detrimental to the solvency or financial strength of the non-U.S. operations, or for other reasons. Most of the non-U.S. operating subsidiaries are second tier subsidiaries that are owned by various non-U.S. holding companies. The capital and rating considerations applicable to the first tier subsidiaries may also impact the dividend flow to RGA.
Certain of the Company’s debt agreements contain financial covenant restrictions related to, among others, liens, the issuance and disposition of stock of restricted subsidiaries, minimum requirements of consolidated net worth, maximum ratios of debt to capitalization and change of control provisions. The Company is required to maintain a minimum consolidated net worth, as defined in the debt agreements, of $5.3 billion, calculated as of the last day of each fiscal quarter. Also, consolidated indebtedness, calculated as of the last day of each fiscal quarter, cannot exceed 35% of the sum of the Company’s consolidated indebtedness plus adjusted consolidated stockholders’ equity. A material ongoing covenant default could require immediate payment of the amount due, including principal, under the various agreements. Additionally, the Company’s debt agreements contain cross-default covenants, which would make outstanding borrowings immediately payable in the event of a material uncured covenant default under any of the agreements, including, but not limited to, non-payment of indebtedness when due for an amount in excess of the amounts set forth in those agreements, bankruptcy proceedings, or any other event that results in the acceleration of the maturity of indebtedness.
The Company may borrow up to $850.0 million in cash and obtain letters of credit in multiple currencies on its revolving credit facility that matures in August 2023. As of December 31, 2018, the Company had no cash borrowings outstanding and $18.2 million in issued, but undrawn, letters of credit under this facility.
Affiliated captives are commonly used in the insurance industry to help manage statutory reserve and collateral requirements. The NAIC has analyzed the insurance industry’s use of affiliated captive reinsurers to satisfy certain reserve requirements and has adopted measures to promote uniformity in both the approval and supervision of such reinsurers. New standards to address the use of captive reinsurers were implemented, allowing current captives to continue in accordance with their currently approved plans. State insurance regulators that regulate the Company’s domestic insurance companies have placed additional restrictions on the use of newly established captive reinsurers, which may increase costs and add complexity. As a result, the Company may need to alter the type and volume of business it reinsures, increase prices on those products, raise additional capital to support higher regulatory reserves or implement higher cost strategies, all of which could adversely affect the Company’s competitive position and its results of operations. It is also possible that the NAIC could place limits on the recognition of capital held in related party captives when adopting its group capital calculation. Doing so would adversely impact the amount of capital that the group would otherwise be able to recognize and report as capital resident in the group.
In the U.S., the introduction of the certified reinsurer has provided an alternative way to manage collateral requirements. In 2014, RGA Americas was designated as a certified reinsurer by the MDOI. This designation allows the Company to retrocede business to RGA Americas in lieu of using captives for collateral requirements. Effective in 2017, principles-based reserves are permitted in the U.S. During 2016, the NAIC amended the standard valuation law to adopt life principles-based reserving that was effective January 1, 2017, allowing a three-year adoption period. The Company has chosen not to establish new captives while it evaluates the impact of principles-based reserving upon its overall risk management and financing programs, but continues to evaluate the effectiveness of the certified reinsurer option for financing its reserve growth compared to the option of establishing captives under the U.S. post-2014 regulations.
securities with an amortized cost of $20.1 billion as of December 31, 2018, were held in trust to satisfy collateral requirements under certain third-party reinsurance treaties. Under certain conditions, the Company may be obligated to move reinsurance from one subsidiary of RGA to another subsidiary or make payments under a given treaty. These conditions include change in control or ratings of the subsidiary, insolvency, nonperformance under a treaty, or loss of reinsurance license of such subsidiary. If the Company was ever required to perform under these obligations, the risk to the Company on a consolidated basis under the reinsurance treaties would not change; however, additional capital may be required due to the change in jurisdiction of the subsidiary reinsuring the business, which could lead to a strain on liquidity.
Proceeds from the notes issued by Timberlake Financial and RGA’s direct investment in Timberlake Financial were deposited into a series of trust accounts as collateral and are not available to satisfy the general obligations of the Company. As of December 31, 2018 the Company held deposits in trust and in custody of $767.9 million for this purpose, which is not included in the figures above. A reserve account has been established to cover interest payments on notes issued by Chesterfield Financial that are not available to satisfy the general obligations of the Company. As of December 31, 2018 the Company held deposits in trust of $13.5 million for this purpose, which is not included in the figures above. See “Collateral Finance and Securitization Notes and Statutory Reserve Funding” above for additional information on the Timberlake Financial and Chesterfield Financial notes.
Reinsurance agreements, whether facultative or automatic, generally provide recapture provisions. Most U.S.-based reinsurance treaties include a recapture right for ceding companies, generally after 10 years. Outside of the U.S., treaties primarily include a mutually agreed-upon recapture provision. Recapture rights permit the ceding company to reassume all or a portion of the risk formerly ceded to the reinsurer. In some situations, the Company has the right to place assets in trust for the benefit of the ceding party in lieu of recapture. Additionally, certain treaties may grant recapture rights to ceding companies in the event of a significant decrease in RGA Reinsurance’s NAIC risk based capital ratio or financial strength rating. The RBC ratio trigger varies by treaty, with the majority between 125% and 225% of the NAIC’s company action level. Financial strength rating triggers vary by treaty with the majority of the triggers reached if RGA Reinsurance’s financial strength rating falls five notches from its current rating of “AA-” to the “BBB” level on the S&P scale. Recapture of business previously ceded does not affect premiums ceded prior to the recapture of such business, but would reduce premiums in subsequent periods. Upon recapture, the Company would reflect a net gain or loss on the settlement of the assets and liabilities associated with the treaty. In some cases, the ceding company is required to pay the Company a recapture fee. The Company estimates approximately $544.9 billion of its gross assumed in force business, as of December 31, 2018, was subject to treaties where the ceding company could recapture in the event minimum levels of financial condition or ratings were not maintained.
The Company has commitments to fund investments in limited partnerships, joint ventures, commercial mortgage loans, private placement investments and bank loans, including revolving credit agreements. See Note 12 - “Commitments, Contingencies and Guarantees” in the Notes to Consolidated Financial Statements for additional information on the Company’s commitments to fund investments and other off-balance sheet arrangements.
Additional sources of liquidity to meet unexpected cash outflows in excess of operating cash inflows and current cash and equivalents on hand include selling short-term investments or fixed maturity securities and drawing funds under a revolving credit facility, under which the Company had availability of $831.8 million as of December 31, 2018. The Company also has $684.0 million of funds available through collateralized borrowings from the Federal Home Loan Bank of Des Moines (“FHLB”) as of December 31, 2018. As of December 31, 2018, the Company could have borrowed these additional amounts without violating any of its existing debt covenants.
The net funded status of the Company’s qualified and nonqualified pension and other postretirement liabilities included within other liabilities has been excluded from the amounts presented in the table above. As of December 31, 2018, the Company had a net unfunded balance of $143.4 million related to qualified and nonqualified 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 actively manages its cash and 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-
The Company’s asset-intensive products are primarily supported by investments in fixed maturity securities reflected on the Company’s consolidated balance sheets 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 effect on profitability. Certain of these asset-intensive agreements, primarily in the U.S. and Latin America Financial Solutions operating segment, are generally funded by fixed maturity securities that are withheld by the ceding company.
The Company is a member of the FHLB and holds $83.2 million of FHLB common stock, which is included in other invested assets on the Company’s consolidated balance sheets. The Company has entered into funding agreements with the FHLB under guaranteed investment contracts whereby the Company has issued the funding agreements in exchange for cash and for which the FHLB has been granted a blanket lien on the Company’s commercial and residential mortgage-backed securities and commercial mortgage loans used to collateralize the Company’s obligations under the funding agreements. The Company maintains control over these pledged assets, and may use, commingle, encumber or dispose of any portion of the collateral as long as there is no event of default and the remaining qualified collateral is sufficient to satisfy the collateral maintenance level. The funding agreements and the related security agreements represented by this blanket lien provide that upon any event of default by the Company, the FHLB’s recovery is limited to the amount of the Company’s liability under the outstanding funding agreements. The amount of the Company’s liability for the funding agreements with the FHLB under guaranteed investment contracts was $1.7 billion and $1.4 billion at December 31, 2018 and 2017, respectively, which is included in interest sensitive contract liabilities on the Company’s consolidated balance sheets. The advances on these agreements are collateralized primarily by commercial and residential mortgage-backed securities, commercial mortgage loans, and U.S. Treasury and government agency securities. The amount of collateral exceeds the liability and is dependent on the type of assets collateralizing the guaranteed investment contracts.
Important factors in the selection of investments include diversification, quality, yield, call protection and total rate of return potential. The relative importance of these factors is determined by market conditions and the underlying reinsurance liability and existing portfolio characteristics. The largest asset class in which fixed maturity securities were invested was corporate securities, which represented approximately 59.9% of total fixed maturity securities as of December 31, 2018, compared to 60.9% as of December 31, 2017. See “Corporate Fixed Maturity Securities” in Note 4 - “Investments” in the Notes to Consolidated Financial Statements for tables showing the major industry types, which comprise the corporate fixed maturity holdings as of December 31, 2018 and 2017.
The Company references rating agency designations in some of its investments disclosures. These designations are based on the ratings from nationally recognized statistical rating organizations, primarily Moody’s, S&P and Fitch. Structured
The Company’s RMBS include agency-issued pass-through securities and collateralized mortgage obligations. A majority of the agency-issued pass-through securities are guaranteed or otherwise supported by the Federal Home Loan Mortgage Corporation, Federal National Mortgage Association, or the Government National Mortgage Association. The principal risks inherent in holding mortgage-backed securities are prepayment and extension risks, which will affect the timing of when cash will be received and are dependent on the level of mortgage interest rates. Prepayment risk is the unexpected increase in principal payments from the expected, primarily as a result of owner refinancing. Extension risk relates to the unexpected slowdown in principal payments from the expected. In addition, non-agency mortgage-backed securities face credit risk should the borrower be unable to pay the contractual interest or principal on their obligation. The Company monitors its mortgage-backed securities to mitigate exposure to the cash flow uncertainties associated with these risks.
The Company’s ABS include credit card receivables, railcar leasing, student loans, single-family rentals, home equity loans and collateralized debt obligations (primarily collateralized loan obligations). The Company owns floating rate securities that represent approximately 16.0% and 13.8% of the total fixed maturity securities as of December 31, 2018 and 2017, respectively. These investments have a higher degree of income variability than the other fixed income holdings in the portfolio due to the floating rate nature of the interest payments. The Company holds these investments to match specific floating rate liabilities primarily reflected in the consolidated balance sheets as collateral finance notes, as well as to enhance asset management strategies. In addition to the risks associated with floating rate securities, principal risks in holding asset-backed securities are structural, credit and capital market risks. Structural risks include the securities’ cash flow priority in the capital structure and the inherent prepayment sensitivity of the underlying collateral. Credit risks include the adequacy and ability to realize proceeds from the collateral. Credit risks are mitigated by credit enhancements that include excess spread, over-collateralization and subordination. Capital market risks include general level of interest rates and the liquidity for these securities in the marketplace.
See “Unrealized Losses for Fixed Maturity and Equity Securities Available-for-Sale” in Note 4 - “Investments” in the Notes to Consolidated Financial Statements for a table that presents the total gross unrealized losses for these securities as of December 31, 2018 and 2017, respectively, where the estimated fair value had declined and remained below amortized cost by 20% or more or less than 20%.
See “Unrealized Losses for Fixed Maturity and Equity Securities Available-for-Sale” in Note 4 - “Investments” in the Notes to Consolidated Financial Statements for tables that present the estimated fair values and gross unrealized losses, including other-than-temporary impairment losses reported in AOCI, for these securities that have estimated fair values below amortized cost, by class and grade security, as well as the length of time the related market value has remained below amortized cost as of December 31, 2018 and 2017.
As of December 31, 2018 and 2017, respectively, the Company classified approximately 5.0% and 5.9% of its fixed maturity securities in the Level 3 category (refer to Note 6 - “Fair Value of Assets and Liabilities” in the Notes to Consolidated
Mortgage loans represented approximately 8.8% and 8.3% of the Company’s cash and invested assets as of December 31, 2018 and 2017, respectively. The Company’s mortgage loan portfolio consists of U.S., Canada and United Kingdom based investments primarily in commercial offices, light industrial properties and retail locations. The mortgage loan portfolio is diversified by geographic region and property type. Most of the mortgage loans in the Company’s portfolio range in size up to $30.0 million, with the average mortgage loan investment as of December 31, 2018 totaling approximately $9.6 million. The mortgage loan portfolio was diversified by geographic region and property type as discussed further under “Mortgage Loans on Real Estate” in Note 4 - “Investments” in the Notes to Consolidated Financial Statements.
Policy loans comprised approximately 2.4% and 2.6% of the Company’s cash and invested assets as of December 31, 2018 and 2017, respectively, the majority of which are associated with one client. These policy loans present no credit risk because the amount of the loan cannot exceed the obligation due the ceding company upon the death of the insured or surrender of the underlying policy. The provisions of the treaties in force and the underlying policies determine the policy loan interest rates. The Company earns a spread between the interest rate earned on policy loans and the interest rate credited to corresponding liabilities.
Funds withheld at interest comprised approximately 10.3% and 11.5% of the Company’s cash and invested assets as of December 31, 2018 and 2017, respectively. For reinsurance agreements written on a modified coinsurance basis and certain agreements written on a coinsurance basis, assets equal to the net statutory reserves are withheld and legally owned and managed by the ceding company, and are reflected as funds withheld at interest on the Company’s consolidated balance sheets. In the event of a ceding company’s insolvency, the Company would need to assert a claim on the assets supporting its reserve liabilities. However, the risk of loss to the Company is mitigated by its ability to offset amounts it owes the ceding company for claims or
allowances against amounts owed by the ceding company. Interest accrues to the total funds withheld at interest assets at rates defined by the treaty terms. The Company is subject to the investment performance on the withheld assets, although it does not directly control them. These assets are primarily fixed maturity investment securities and pose risks similar to the fixed maturity securities the Company owns. To mitigate this risk, the Company helps set the investment guidelines followed by the ceding company and monitors compliance. Ceding companies with funds withheld at interest had an average financial strength rating of “A” as of December 31, 2018 and 2017. Certain ceding companies maintain segregated portfolios for the benefit of the Company.
Based on data provided by ceding companies as of December 31, 2018 and 2017, funds withheld at interest totaled (dollars in thousands):
The Company utilizes derivative financial instruments to protect the Company against possible changes in the fair value of its investment portfolio as a result of interest rate changes, to hedge against risk of changes in the purchase price of securities, to hedge liabilities associated with the reinsurance of variable annuities with guaranteed living benefits and to manage the portfolio’s effective yield, maturity and duration. In addition, the Company utilizes derivative financial instruments to reduce the risk associated with fluctuations in foreign currency exchange rates. The Company uses both exchange-traded, centrally cleared, and customized over-the-counter derivative financial instruments.
The Company may be exposed to credit-related losses in the event of non-performance by counterparties to derivative financial instruments. Generally, the credit exposure of the Company’s derivative contracts is limited to the fair value at the reporting date plus or minus any collateral posted or held by the Company. The Company had no credit exposure related to its derivative contracts, excluding futures and mortality swaps, as of December 31, 2018 and 2017, as the net amount of collateral pledged to the Company from counterparties exceeded the fair value of the derivative contracts.
The Company holds beneficial interests in equity release mortgages in the UK. Equity release mortgages represent loans provided to individuals 55 years of age and older secured by the borrower’s residence. Equity release mortgages are comparable to a home equity loan by allowing the borrower to utilize the equity in their home as collateral. The amount of the loan is dependent on the appraised value of the home at the time of origination, the borrower's age and interest rate. Unlike a home equity loan, no payment of principal or interest is required until the death of the borrower or sale of the home. Equity release mortgages may also be either fully funded at origination, or the borrower can request periodic funding similar to a line of credit. Equity release mortgages are subject to risks, including market, credit, interest rate, liquidity, operational, reputational and legal risks.
Other invested assets includes $475.9 million and $219.9 million of equity release mortgages as of December 31, 2018 and 2017, respectively. Investment income includes $17.9 million, $8.3 million and $2.6 million in interest income earned on equity release mortgages for the years ended December 31, 2018, 2017 and 2016, respectively.
The Insurance, Market and Credit, Capital, and Operational risk committees have direct oversight accountability for their respective risks areas including the identification, assessments, and management of known, new and emerging risk exposures and the review and approval of RGA group-level risk limits
To ensure appropriate oversight of enterprise-wide risk management issues without unnecessary duplication, as well as to foster cross-committee communication and coordination regarding risk issues, risk committee chairs attend RMSC meetings.
In addition to the risk committees, their sub-committees and working groups, some RGA operating entities have risk management committees that oversee relevant risks related to segment-level risk limits.
The Company has developed extensive expertise in assessing insurance risks that ultimately forms an integral part of ensuring that it is compensated commensurately for the risks it assumes and that it does not overpay for the risks it transfers to third parties. This expertise includes a vast array of market and product knowledge supported by a large information database of historical experience that is closely monitored. Analysis and experience studies derived from this database help form the basis for the Company’s pricing assumptions that are used in developing rates for new risks. If actual mortality or morbidity experience is materially adverse, some reinsurance treaties allow for increases to future premium rates.
The Company accesses the markets each year for annual catastrophic coverages and reviews current coverage and pricing of current and alternate designs. The coverage may vary from year to year based on the Company’s perceived value of such protection. The current policy covers events involving 5 or more insured deaths from a single occurrence and covers $100.0 million of claims in excess of the Company’s $25.0 million deductible.
The spread profits on the Company’s fixed annuity and interest-sensitive whole life, universal life (“UL”) and fixed portion of variable universal life (“VUL”) insurance policies are at risk if interest rates decline and remain relatively low for a period of time, which has generally been the case in recent years. Should interest rates remain at current levels, which are significantly lower than those existing prior to the declines of recent years, the average earned rate of return on the Company’s annuity and UL investment portfolios will continue to decline. Declining portfolio yields may cause the spreads between investment portfolio yields and the interest rate credited to contract holders to deteriorate as the Company’s ability to manage spreads can become limited by minimum guaranteed rates on annuity and UL policies. In 2018, minimum guaranteed rates on non-variable annuity and UL policies generally ranged from 0.10% to 6.00%, with an average guaranteed rate of approximately 2.86%. In 2017, minimum guaranteed rates on non-variable annuity and UL policies generally ranged from 0.50% to 6.00%, with an average guaranteed rate of approximately 2.74%.
Interest rate spreads are managed for near term income through a combination of crediting rate actions and portfolio management. Certain annuity products contain crediting rates that reset annually, of which $7,003.9 million and $5,343.9 million of account balances are not subject to surrender charges as of December 31, 2018 and 2017, respectively, with substantially all of these already at their minimum guaranteed rates. As such, certain management and monitoring processes are designed to minimize the effect of sudden and/or sustained changes in interest rates on fair value, cash flows, and net interest income.
Interest rate sensitivity analysis is used to measure the Company’s interest rate price risk by computing estimated changes in fair value of fixed rate assets and liabilities in the event of a hypothetical 100 basis point change (increase or decrease) in market interest rates. The Company does not have fixed rate instruments classified as trading securities. The Company’s projected net decrease in fair value of financial instruments in the event of a 100 basis point increase in market interest rates at its fiscal years ended December 31, 2018 and 2017 was $1,493.1 million and $966.7 million, respectively.
The Company reinsures variable annuities including those with guaranteed minimum death benefits (“GMDB”), guaranteed minimum income benefits (“GMIB”), guaranteed minimum accumulation benefits (“GMAB”) and guaranteed minimum withdrawal benefits (“GMWB”). Strong equity markets, increases in interest rates and decreases in equity market volatility will generally decrease the fair value of the liabilities underlying the benefits. Conversely, a decrease in the equity markets along with a decrease in interest rates and an increase in equity market volatility will generally result in an increase in the fair value of the liabilities underlying the benefits, which has the effect of increasing reserves and lowering earnings. The Company maintains a customized dynamic hedging program that is designed to substantially mitigate the risks associated with income volatility around the change in reserves on guaranteed benefits, ignoring the Company’s own credit risk assessment. However, the hedge positions may not fully offset the changes in the carrying value of the guarantees due to, among other things, time lags, high levels of volatility in the equity and derivative markets, extreme changes in interest rates, unexpected contract holder behavior, and divergence between the performance of the underlying funds and hedging indices. These factors, individually or collectively, may have a material adverse effect on the Company’s net income, financial condition or liquidity. The table below provides a summary of variable annuity account values and the fair value of the guaranteed benefits as of December 31, 2018 and 2017.
Credit risk, which includes default risk, is risk of loss due to credit quality deterioration of an individual financial asset, derivative or non-derivative contract or instrument. Credit quality deterioration may or may not be accompanied by a ratings downgrade. Generally, the credit exposure for an asset is limited to the fair value, net of any collateral received, at the reporting date.
The Company manages counterparty risk by limiting the total exposure to a single counterparty and by only initiating contracts with creditworthy counterparties. In addition, some of the counterparties have set up trusts and letters of credit, reducing the Company’s exposure to these counterparties.
Generally, RGA’s insurance subsidiaries retrocede amounts in excess of their retention to certain other RGA insurance subsidiaries. External retrocessions are arranged through the Company’s retrocession pools for amounts in excess of its retention. As of December 31, 2018, all retrocession pool members in this excess retention pool rated by the A.M. Best Company were rated “A-” or better except one pool member that was rated “B+.” A rating of “A-” is the fourth highest rating out of sixteen possible ratings. For a majority of the retrocessionaires that were not rated, letters of credit or trust assets have been given as additional security. In addition, the Company performs annual financial and in force reviews of its retrocessionaires to evaluate financial stability and performance.
Foreign currency risk is the risk of changes in level and volatility of currency exchange rates affect the profitability, value or solvency position of the Company. The Company manages its exposure to currency principally by currency matching invested assets with the underlying liabilities to the extent practical. The Company has in place net investment hedges for a portion of its investments in its Canadian operations to reduce excess exposure to these currencies. Translation differences resulting from translating foreign subsidiary balances to U.S. dollars are reflected in stockholders’ equity on the consolidated balance sheets.
Reinsurance is an arrangement under which an insurance company, the reinsurer, agrees to indemnify another insurance company, the ceding company, for all or a portion of the insurance risks underwritten by the ceding company. Reinsurance is designed to (i) reduce the net amount at risk on individual risks, thereby enabling the ceding company to increase the volume of business it can underwrite, as well as increase the maximum risk it can underwrite on a single risk; (ii) enhance the ceding company’s financial strength and surplus position; (iii) stabilize operating results by leveling fluctuations in the ceding company’s loss experience; and (iv) assist the ceding company in meeting applicable regulatory requirements.
There were no subsequent events, other than as disclosed in Note 19 - “Subsequent Event,” that would require disclosure or adjustments to the accompanying consolidated financial statements through the date the consolidated financial statements were issued.
The Company participates in securities borrowing programs whereby securities, which are not reflected on the Company’s consolidated balance sheets, are borrowed from third parties. The borrowed securities are used to provide collateral under affiliated reinsurance transactions. The Company is required to maintain a minimum of 100% of the fair value, or par value under certain programs, of the borrowed securities as collateral. The collateral consists of rights to reinsurance treaty cash flows. If cash flows from the reinsurance treaties are insufficient to maintain the minimum collateral requirement, the Company may substitute cash or securities to meet the requirement.
The Company participates in repurchase/reverse repurchase programs in which securities, reflected as investments on the Company’s consolidated balance sheets, are pledged to third parties. In return, the Company receives securities from the third parties with an estimated fair value equal to a minimum of 100% of the securities pledged. The securities received are not reflected on the Company’s consolidated balance sheets.
Impairment losses on fixed maturity securities recognized in the financial statements are dependent on the facts and circumstances related to the specific security. If the Company intends to sell a security or it is more likely than not that it would be required to sell a security before the recovery of its amortized cost, less any recorded credit loss, it recognizes an other-than-temporary impairment in investment related gains (losses), net on the consolidated statements of income for the difference between amortized cost and fair value. If neither of these two conditions exists then the recognition of the other-than-temporary impairment is bifurcated and the Company recognizes the credit loss portion in investment related gains (losses), net and the non-credit loss portion in AOCI.
In periods after an other-than-temporary impairment loss is recognized on a fixed maturity security, the Company will report the impaired security as if it had been purchased on the date it was impaired and will continue to estimate the present value of the estimated cash flows of the security. Accordingly, the discount (or reduced premium) based on the new cost basis is accreted into net investment income over the remaining term of the fixed maturity security in a prospective manner based on the amount and timing of estimated future cash flows.
in income). The fair value of the embedded derivatives is included in the funds withheld at interest line item on the consolidated balance sheets. The change in the fair value of the embedded derivatives is recorded in investment related gains (losses), net on the consolidated statements of income.
The Company tests the recoverability for each year of business at issue before establishing additional deferred acquisition costs (“DAC”). The Company also performs annual tests to establish that DAC are expected to remain recoverable, and if financial performance significantly deteriorates to the point where a deficiency exists, a cumulative charge to current operations will be recorded. No such adjustments related to DAC recoverability were made in 2018, 2017 and 2016.
Other acquired intangibles are also reported in other assets and primarily represent intangibles and licenses acquired through the Company’s acquisition of service and technology oriented companies in an effort to both support its clients and generate new future revenue streams. Other acquired intangible assets are amortized using the straight-line method over the estimated useful life of 10 years, with amortization included in other operating expenses. Each year the Company reviews other acquired intangibles to determine the recoverability of these balances. Other acquired intangibles totaled approximately $37.4 million and $3.1 million, including accumulated amortization of $4.4 million and $0.6 million, as of December 31, 2018 and 2017, respectively. Other acquired intangibles amortization expense for the years ended December 31, 2018, 2017 and 2016 was $3.8 million, $0.3 million and $0.2 million, respectively. Amortization of other acquired intangibles is estimated to be $4.2 million, $4.2 million, $4.1 million, $4.1 million and $4.1 million during 2019, 2020, 2021, 2022 and 2023, respectively.
The Company establishes future policy benefits for guaranteed minimum death benefits (“GMDB”) relating to the reinsurance of certain variable annuity contracts by estimating the expected value of death benefits in excess of the projected account balance and recognizing the excess proportionally over the accumulation period based on total expected assessments. The Company regularly evaluates estimates used and adjusts the additional liability balance, with a related charge or credit to claims and other policy benefits, if actual experience or other evidence suggests that earlier assumptions should be revised. The assumptions used in estimating the GMDB liabilities are consistent with those used for amortizing DAC, and are thus subject to the same variability and risk. The Company’s GMDB liabilities at December 31, 2018 and 2017 were not material.
Liabilities for future benefits on interest-sensitive life and investment-type contract liabilities are carried at the accumulated contract holder values without reduction for potential surrender or withdrawal charges. The Company reinsures asset-intensive products, including annuities and corporate-owned life insurance. The investment portfolios for these products are segregated for management purposes within the general account of the respective legal entity. The liabilities under asset-intensive insurance contracts or reinsurance contracts reinsured on a coinsurance basis are included in interest-sensitive contract liabilities on the consolidated balance sheets. Asset-intensive contracts principally include individual fixed annuities in the accumulation phase, single premium immediate annuities, equity-indexed annuities, individual variable annuities, corporate-owned life and interest-sensitive whole life insurance contracts. Interest-sensitive contract liabilities are equal to (i) policy account values, which consist of an accumulation of gross premium payments; (ii) credited interest less expenses, mortality charges, and withdrawals; and (iii) fair value adjustments relating to business combinations. Liabilities for immediate annuities are calculated as the present value of the expected cash flows, with the locked-in discount rate determined such that there is no gain or loss at inception. Additionally, certain annuity contracts the Company reinsures contain terms, such as guaranteed minimum benefits and equity participation options, which are deemed to be embedded derivatives and are accounted for based on the general accounting principles for Derivatives and Hedging.
The Company reinsures equity-indexed annuity contracts. These contracts allow the contract holder to elect an interest rate return or an equity market component where interest credited is based on the performance of common stock market indices, such as the S&P 500 Index®, the Dow Jones Industrial Average, or the NASDAQ. The equity market option is considered an embedded derivative, similar to a call option, which is reflected at fair value on the consolidated balance sheets in interest-sensitive contract
liabilities. The fair value of embedded derivatives is computed based on a projection of future equity option costs using a budget methodology, discounted back to the balance sheet date using current market indicators of volatility and interest rates. Changes in the fair value of the embedded derivatives are included as a component of interest credited on the consolidated statements of 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, business segment and product type, but generally averages around 3.8 months. Incurred but not reported claims are estimates on an undiscounted basis, using actuarial estimates of historical claims expense, adjusted for current trends and conditions. These estimates are continually reviewed and the ultimate liability may vary significantly from the amount recognized, which are reflected in claims and other policy benefits in the consolidated statements of income in the period in which they are determined.
Assets, liabilities and results of foreign operations are recorded based on the functional currency of each foreign operation. The determination of the functional currency is based on economic facts and circumstances pertaining to each foreign operation. The Company’s material functional currencies are the U.S. dollar, Canadian dollar, British pound, Australian dollar, Japanese yen, Korean won, Euro and South African rand. The translation of the functional 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 weighted-average exchange rates 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 functional currency operation is sold or substantially liquidated.
Basic earnings per share exclude any dilutive effects of any outstanding options. Diluted earnings per share include the dilutive effects assuming outstanding stock options were exercised.
not been satisfied as of the end of the reporting period. Approximately 0.1 million and 0.2 million outstanding stock options were not included in the calculation of common equivalent shares during 2018 and 2017, respectively. During 2016, all outstanding options were included in the calculation of common equivalent shares. Approximately 0.4 million, 0.3 million and 0.4 million performance contingent shares were excluded from the calculation of common equivalent shares during 2018, 2017 and 2016, respectively.
The Company holds various types of fixed maturity securities available-for-sale and classifies them as corporate securities (“Corporate”), Canadian and Canadian provincial government securities (“Canadian government”), residential mortgage-backed securities (“RMBS”), asset-backed securities (“ABS”), commercial mortgage-backed securities (“CMBS”), U.S. government and agencies (“U.S. government”), state and political subdivisions, and other foreign government, supranational and foreign government-sponsored enterprises (“Other foreign government”).
The following table provides information relating to investments in fixed maturity securities by sector as of December 31, 2018 (dollars in thousands):
The Company enters into various collateral arrangements with counterparties that require both the pledging and acceptance of fixed maturity securities as collateral. Pledged fixed maturity securities are included in fixed maturity securities, available-for-sale in the consolidated balance sheets. Fixed maturity securities received as collateral are held in separate custodial accounts and are not recorded on the Company’s consolidated balance sheets. Subject to certain constraints, the Company is permitted by contract to sell or repledge collateral it receives; however, as of December 31, 2018 and 2017, none of the collateral received had been sold or repledged. The Company also holds assets in trust to satisfy collateral requirements under derivative transactions and
The Company monitors its concentrations of financial instruments on an ongoing basis and mitigates credit risk by maintaining a diversified investment portfolio that limits exposure to any one issuer. The Company’s exposure to concentrations of credit risk from single issuers greater than 10% of the Company’s stockholders’ equity included securities of the U.S. government and its agencies, as well as the securities disclosed below, as of December 31, 2018 and 2017 (dollars in thousands):
security prior to impairment. Any remaining difference between the fair value and amortized cost is recognized in AOCI. The following table sets forth the amount of pre-tax credit loss impairments on fixed maturity securities held by the Company as of the dates indicated, for which a portion of the OTTI loss was recognized in AOCI, and the corresponding changes in such amounts (dollars in thousands):
The following table presents the total gross unrealized losses for the 3,109 fixed maturity securities as of December 31, 2018, where the estimated fair value had declined and remained below amortized cost by the indicated amount (dollars in thousands):
The following table presents the total gross unrealized losses for the 1,116 fixed maturity and equity securities as of December 31, 2017, where the estimated fair value had declined and remained below amortized cost by the indicated amount (dollars in thousands):
The Company’s determination of whether a decline in value is other-than-temporary includes an analysis of the underlying credit and the extent and duration of a decline in value. The Company’s credit analysis of an investment includes determining whether the issuer is current on its contractual payments, evaluating whether it is probable that the Company will be able to collect all amounts due according to the contractual terms of the security and analyzing the overall ability of the Company to recover the amortized cost of the investment. In the Company’s impairment review process, the duration and severity of an unrealized loss position for equity securities are given greater weight and consideration given the lack of contractual cash flows or deferability features.
The following table presents the estimated fair values and gross unrealized losses, including other-than-temporary impairment losses reported in AOCI, for 3,109 fixed maturity securities that have estimated fair values below amortized cost as of December 31, 2018 (dollars in thousands). These investments are presented by class and grade of security, as well as the length of time the related fair value has remained below amortized cost.
The Company has no intention to sell, nor does it expect to be required to sell, the securities outlined in the table above, as of the dates indicated. However, unforeseen facts and circumstances may cause the Company to sell fixed maturity securities in the
Major categories of investment income, net of related expenses, consist of the following (dollars in thousands):
The other-than-temporary impairment losses on fixed maturity securities for 2018, 2017 and 2016 are primarily due to emerging market and high-yield debt exposures. The fluctuations in investment related gains (losses) for derivatives and other are primarily due to changes in the fair value of embedded derivatives related to modco and funds withheld treaties, as a result of changes in interest rates, driven primarily by credit spreads. These fluctuations were partially offset by changes in the fair value of free-standing derivatives as a result of changes in value of underlying stock indices, movements in credit and inflation spreads, and changes in interest rates.
Mortgage loans represented approximately 9.1% and 8.5% of the Company’s total investments as of December 31, 2018 and 2017, respectively. As of December 31, 2018, mortgage loans were geographically dispersed throughout the U.S. with the largest concentrations in California (18.7%), Texas (10.9%) and Washington (7.4%) and include loans secured by properties in Canada (2.7%) and United Kingdom (0.1%). The recorded investment in mortgage loans on real estate presented below is gross of unamortized deferred loan origination fees and expenses, and valuation allowances.
The distribution of mortgage loans by property type is as follows as of December 31, 2018 and 2017 (dollars in thousands):
The following tables set forth certain key credit quality indicators of the Company’s recorded investment in mortgage loans as of December 31, 2018 and 2017 (dollars in thousands):
The age analysis of the Company’s past due recorded investments in mortgage loans as of December 31, 2018 and 2017 (dollars in thousands):
Average recorded investment represents the average loan balances as of the beginning of period and all subsequent quarterly end of period balances.
Policy loans comprised approximately 2.5% and 2.6% of the Company’s total investments as of December 31, 2018 and 2017, respectively, the majority 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. The Company earns a spread between the interest rate earned on policy loans and the interest rate credited to corresponding liabilities.
assets also include Federal Home Loan Bank of Des Moines (“FHLB”) common stock, which is included in Other in the table below. Other invested assets represented approximately 3.5% and 2.9% of the Company’s total investments as of December 31, 2018 and 2017, respectively. Carrying values of these assets as of December 31, 2018 and 2017 are as follows (dollars in thousands):
See Note 2 - “Significant Accounting Policies and Pronouncements” for a detailed discussion of the accounting treatment for derivative instruments, including embedded derivatives and Note 6 - “Fair Value of Assets and Liabilities” for additional disclosures related to the fair value hierarchy for derivative instruments, including embedded derivatives.
Equity index options are used by the Company primarily to hedge minimum guarantees embedded in certain variable annuity products. To hedge against adverse changes in equity indices volatility, the Company buys put options. The contracts are net settled in cash based on differentials in the indices at the time of exercise and the strike price. Equity warrants have also been used by the Company to economically hedge the variability in anticipated cash flows for the acquisition of investment securities.
The net amount represents the ineffective portion of the fair value hedges.
The following table presents the components of AOCI, before income tax, and the consolidated income statement classification where the gain or loss is recognized related to cash flow hedges for the years ended December 31, 2018, 2017 and 2016 (dollars in thousands):
The following table presents the effective portion of derivatives in cash flow hedging relationships on the consolidated statements of income and the consolidated statements of stockholders’ equity for the years ended December 31, 2018, 2017 and 2016 (dollars in thousands):
anticipated date or within the additional time period permitted by the authoritative guidance for the accounting for derivatives and hedging.
The cumulative foreign currency translation gain recorded in AOCI related to these hedges was $201.0 million and $113.7 million as of December 31, 2018 and 2017, respectively. If a hedged foreign operation was sold or substantially liquidated, the amounts in AOCI would be reclassified to the consolidated statements of income. A pro rata portion would be reclassified upon partial sale of a hedged foreign operation.
The Company has elected to include all derivatives, except embedded derivatives, in the tables below, irrespective of whether they are subject to an enforceable master netting arrangement or a similar agreement. See Note 4 - “Investments” for information regarding the Company’s securities borrowing, lending, repurchase and repurchase/reverse repurchase programs. See “Embedded Derivatives” above for information regarding the Company’s bifurcated embedded derivatives.
The Company may be exposed to credit-related losses in the event of non-performance by counterparties to derivative financial instruments with a positive fair value. Generally, the credit exposure of the Company’s derivative contracts is limited to the fair value at the reporting date plus or minus any collateral posted or held by the Company. The Company had no credit exposure related to its derivative contracts, as of December 31, 2018 and 2017, as the net amount of collateral pledged to the Company from counterparties exceeded the fair value of the derivative contracts.
the use of master netting agreements that provide for a single net payment to be made by one counterparty to another at each due date and upon termination. The Company is only exposed to the default of the central clearing counterparties for OTC cleared derivatives, and these transactions require initial and daily variation margin collateral postings. Exchange-traded derivatives are settled on a daily basis, thereby reducing the credit risk exposure in the event of non-performance by counterparties to such financial instruments.
Assets and liabilities measured at fair value on a recurring basis as of December 31, 2018 and 2017 are summarized below (dollars in thousands):
The Company performs initial and ongoing analysis and review of the various techniques utilized in determining fair value to ensure that they are appropriate and consistently applied, and that the various assumptions are reasonable. The Company analyzes and reviews the information and prices received from third parties to ensure that the prices represent a reasonable estimate of the fair value and to monitor controls around pricing, which includes quantitative and qualitative analysis and is overseen by the Company’s investment and accounting personnel. Examples of procedures performed include, but are not limited to, review of pricing trends, comparison of a sample of executed prices of securities sold to the fair value estimates, comparison of fair value estimates to management’s knowledge of the current market, and ongoing confirmation that third party pricing services use, wherever possible, market-based parameters for valuation. In addition, the Company utilizes both internal and external cash flow
Derivative Assets and Derivative Liabilities - All of the derivative instruments utilized by the Company, except for longevity and mortality swaps, are classified within Level 2 on the fair value hierarchy. These derivatives are principally valued using an income approach. Valuations of interest rate contracts are based on present value techniques, which utilize significant inputs that may include the swap yield curve, London Interbank Offered Rate (“LIBOR”) basis curves, and repurchase rates. Valuations of foreign currency contracts are based on present value techniques, which utilize significant inputs that may include the swap yield curve, LIBOR basis curves, currency spot rates, and cross currency basis curves. Valuations of credit contracts, are based on present value techniques, which utilize significant inputs that may include the swap yield curve, credit curves, and recovery rates. Valuations of equity market contracts, are based on present value techniques, which utilize significant inputs that may include the swap yield curve, spot equity index levels, and dividend yield curves. Valuations of equity market contracts, option-based, are based on option pricing models, which utilize significant inputs that may include the swap yield curve, spot equity index levels, dividend yield curves, and equity volatility.
Longevity and Mortality Swaps - The Company utilizes a discounted cash flow model to estimate the fair value of longevity and mortality swaps. The fair value of these swaps includes an accrual for premiums payable and receivable. Some inputs to the valuation model are generally observable, such as interest rates and actual population mortality experience. The valuation also requires significant inputs that are generally not observable and, accordingly, the valuation is considered Level 3 in the fair value hierarchy.
As of December 31, 2018 and 2017, respectively, the Company classified approximately 5.0% and 5.9% of its fixed maturity securities in the Level 3 category. These securities primarily consist of private placement corporate securities, bank loans and Canadian provincial strips with inactive trading markets.
Other significant unobservable inputs used in the fair value measurement of the Company’s private debt and equity investments include a multiple of earnings before interest, taxes, depreciation and amortization (“EBITDA”). An increase (decrease) in the EBITDA multiple would result in a higher (lower) fair value measurement.
The following table presents information for financial instruments measured at an estimated fair value on a nonrecurring basis during the periods presented and still held at the reporting date (for example, when there is evidence of impairment). The estimated fair values for these financial instruments were determined using significant unobservable inputs (Level 3).
Other Invested Assets - This primarily includes limited partnership interests accounted for using the cost method, FHLB common stock, cash collateral and equity release mortgages. The fair value of limited partnership interests and other investments accounted for using the cost method is determined using the NAV of the Company’s ownership interest as provided in the financial statements of the investees. The fair value of the Company’s common stock investment in the FHLB is considered to be the carrying value and it is considered Level 2 in the fair value hierarchy. The fair value of the Company’s cash collateral is considered to be the carrying value and considered to be Level 1 in the fair value hierarchy. The fair value of the Company’s equity release mortgage loan portfolio, considered Level 3 in the fair value hierarchy, is estimated by discounting cash flows, both principal and interest, using a risk-free rate plus an illiquidity premium. The cash flow analysis considers future expenses, changes in property prices, and actuarial analysis of borrower behavior, mortality and morbidity.
The following table presents information for the Company’s ceded reinsurance receivable assets, including the respective amount and A.M. Best rating for each reinsurer representing in excess of five percent of the total as of December 31, 2018 or 2017 (dollars in thousands):
Included in the total ceded reinsurance receivables balance were $242.8 million and $243.8 million of claims recoverable, of which $17.4 million and $1.9 million were in excess of 90 days past due, as of December 31, 2018 and 2017, respectively.
At December 31, 2018 and 2017, respectively, the Company provided approximately $18.1 billion and $16.2 billion of financial reinsurance, as measured by pre-tax statutory surplus, risk based capital and other financial reinsurance structures, 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.
Reinsurance agreements, whether facultative or automatic, may provide for recapture rights on the part of the ceding company. Recapture rights permit the ceding company to reassume all or a portion of the risk formerly ceded to the reinsurer after an agreed-upon period of time, generally 10 years, or in some cases due to changes in the financial condition or ratings of the reinsurer. Recapture of business previously ceded does not affect premiums ceded prior to the recapture of such business, but would reduce premiums in subsequent periods. Additionally, some treaties give the ceding company the right to request the Company to place assets in trust for their benefit to support their reserve credits, in the event of a downgrade of the Company’s ratings to specified levels, generally non-investment grade levels, or if minimum levels of financial condition are not maintained. As of December 31, 2018 and 2017, these treaties had approximately $3,421.0 million and $2,901.1 million, respectively, in statutory reserves. Assets placed in trust continue to be owned by the Company, but their use is restricted based on the terms of the trust agreement. Securities with an amortized cost of $2,910.2 million and $2,214.1 million were held in trust to satisfy collateral requirements for reinsurance business for the benefit of certain RGA subsidiaries at December 31, 2018 and 2017, respectively. In addition, the Company’s collateral financing operations have asset in trust requirements. See Note 14 - “Collateral Finance and Securitization Notes” for additional information. Securities with an amortized cost of $20,072.7 million and $15,584.3 million, as of December 31, 2018 and 2017, respectively, were held in trust to satisfy collateral requirements under certain third-party reinsurance treaties. Under
The SEC issued Staff Accounting Bulletin 118 (“SAB 118”), which provides guidance on accounting for the tax effects of U.S. Tax Reform. SAB 118 provides a measurement period that should not extend beyond one year from U.S. Tax Reform enactment date for companies to complete the accounting under ASC 740. The Company completed its accounting for the effects of U.S. Tax Reform within the measurement period during the fourth quarter of 2018.
The Company’s refinement of the provisional estimates for the impact of U.S. Tax Reform resulted in the aforementioned valuation allowance adjustment and other immaterial adjustments to the amounts originally estimated. Upon review of the Proposed Treasury Regulations issued during the year and completion of the accumulated and current earnings and profits calculations of the Company’s foreign subsidiaries, no adjustment to the provisional estimate of the transition tax on unrepatriated earnings was necessary.
The valuation allowance established with U.S. Tax Reform was released in 2018. The Company recognized an uncertain tax position due to the expiration of the statute of limitations. Concurrent with this recognition of a prior year tax position, the Company established a new uncertain tax liability. The foreign tax credits were used to offset the new uncertain tax liability, hence a valuation allowance was no longer necessary.
For the year ended December 31, 2018, the Company is not subject to the BEAT. The Company continues to monitor guidance as it is issued; however, it does not expect changes in guidance to result in a BEAT liability.
Pre-tax income for the years ended December 31, 2018, 2017 and 2016 consists of the following (dollars in thousands):
The provision for income tax expense for the years ended December 31, 2018, 2017 and 2016 consists of the following (dollars in thousands):
Total income taxes for the years ended December 31, 2018, 2017 and 2016 were as follows (dollars in thousands):
As of December 31, 2018, the valuation allowance against deferred tax assets was $181.1 million. During 2018, a valuation allowance on the U.S. Foreign tax credit carryforwards of $65.1 million was released. This release partially offset a $24.5 million increase to the valuation allowance related to the net operating losses of RGA Reinsurance Company of Australia Limited (“RGA Australia”) and increases and decreases to the valuation allowance in jurisdictions where the Company does not have a history of earnings. Further movement in the valuation allowance includes foreign currency translation and reclassifications with other deferred tax assets of ($12.8) million.
As of December 31, 2017, the valuation allowance against deferred tax assets was approximately $226.9 million. During 2017 a valuation allowance was established on the U.S. Foreign tax credit carryforwards of $65.1 million, RGA Australia net operating losses of $20.1 million, as well as on the deferred tax assets of other jurisdictions of $3.3 million. Further movement in the valuation allowance includes foreign currency translation and reclassifications with other deferred tax assets of $10.6 million and ($5.6) million, respectively. The other significant components of the valuation allowance relate to a partial valuation allowance on the net operating loss carryforwards in RGA Australia and the foreign tax credit carryforwards in RGA International Reinsurance Company dac (“RGA International”). A valuation allowance also exists against the deferred tax assets of other branches and legal entities most of which there is no history of earnings in recent years.
During 2018, 2017 and 2016, the Company received federal and foreign income tax refunds of approximately $2.4 million, $11.6 million and $6.9 million, respectively. The Company made cash income tax payments of approximately $144.1 million, $48.7 million and $68.0 million in 2018, 2017 and 2016, respectively.
The following table presents consolidated net operating losses (“NOL”) as of December 31, 2018 (dollars in millions):
The Company recognized a benefit in interest expense associated with uncertain tax positions in 2018, 2017 and 2016 of $3.3 million, $5.0 million and $8.4 million, respectively. Additionally, the Company recognized penalties of $0.3 million in 2016. As of December 31, 2018 and 2017, the Company had $11.6 million and $15.1 million, respectively, of accrued interest related to unrecognized tax benefits. There are no penalties accrued as of December 31, 2018 or December 31, 2017.
The Company also provides select health care and life insurance benefits for certain 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. Effective January 1, 2017, employees hired in the U. S. are not eligible for retiree health care benefits. The effect of the amendment was recorded in 2016 in AOCI and is being amortized through prior service cost. Virtually all retirees, or their beneficiaries, contribute
a portion of the total cost of postretirement health benefits. Prepaid benefit costs and accrued benefit liabilities are included in other assets and other liabilities, respectively, in the Company’s consolidated balance sheets.
A December 31 measurement date is used for all of the defined benefit and postretirement plans. The status of these plans as of December 31, 2018 and 2017 is summarized below (dollars in thousands):
The following table presents information for pension plans with an accumulated benefit obligation in excess of plan assets as of December 31, 2018 and 2017 (dollars in thousands):
The components of net periodic benefit cost, included in other operating expenses on the consolidated statements of income, and other changes in plan assets and benefit obligations recognized in other comprehensive income were as follows (dollars in thousands):
The fair values of the Company’s qualified pension plan assets as of December 31, 2018 and 2017 are summarized below (dollars in thousands):
Certain subsidiaries of RGA also sponsor savings and investment plans under which a portion of employee contributions are matched. Subsidiary contributions to these plans were $15.3 million, $14.2 million and $9.9 million in 2018, 2017 and 2016, respectively.
The Company’s foreign insurance subsidiaries prepare financial statements in accordance with local regulatory requirements. The regulatory authorities in these foreign jurisdictions establish some form of minimum regulatory capital and surplus requirements. All of the Company’s foreign insurance subsidiaries have regulatory capital and surplus that exceed the local minimum requirements. These requirements do not represent a significant constraint for the payment of dividends by the Company’s foreign insurance companies.
The state of domicile of certain of the Company’s SPLRCs follow prescribed accounting practices differing from NAIC statutory accounting practices (“NAIC SAP”) applicable to their statutory financial statements. Specifically, these prescribed practices require that surplus note interest accrued but not approved for payment be reported as a direct reduction of surplus and an addition to the surplus note balance. Under NAIC SAP, surplus note interest is not to be reported until approved for payment and is reported as a reduction of net investment income in the Summary of Operations. In addition, these prescribed practices allow the SPLRC
Reinsurance Company of Missouri (“RCM”), RGA Reinsurance and Chesterfield Reinsurance Company (“Chesterfield Re”) are subject to Missouri statutory provisions that restrict the payment of dividends. They may not pay dividends in any 12-month period in excess of the greater of the prior year’s statutory net gain from operations or 10% of statutory capital and surplus at the preceding year-end, without regulatory approval. Aurora National Life Assurance Company (“Aurora National”) is subject to California statutory provisions that are identical to those imposed by Missouri regarding the ability of Aurora National to pay dividends to RGA Reinsurance. The applicable statutory provisions only permit an insurer to pay a shareholder dividend from unassigned surplus. As of January 1, 2018, RGA Reinsurance could pay maximum dividends, without prior approval, of approximately $653.9 million. Any dividends paid by RGA Reinsurance would be paid to RCM, its parent company, which in turn has restrictions related to its ability to pay dividends to RGA.
Chesterfield Re would pay dividends to its immediate parent Chesterfield Financial Holdings LLC, (“Chesterfield Financial”), which would in turn pay dividends to RCM, subject to the terms of the indenture for the embedded value securitization transaction, in which Chesterfield Financial cannot declare or pay any dividends so long as any private placement notes are outstanding. The Missouri Department of Insurance, Financial Institution and Professional Registration, allows RCM to pay a dividend to RGA to the extent RCM received the dividend from its subsidiaries, without limitation related to the level of unassigned surplus. Dividend payments from other subsidiaries are subject to regulations in the jurisdiction of domicile, which are generally based on their earnings and/or capital level.
The Company’s commitments to fund investments as of December 31, 2018 and 2017 are presented in the following table (dollars in thousands):
The Company leases office space and furniture and equipment under non-cancelable operating lease agreements, which expire at various dates. Future minimum office space annual rentals under non-cancelable operating leases at December 31, 2018 are as follows (dollars in thousands):
The Company indemnifies its directors and officers as provided in its charters and by-laws. Since this indemnity generally is not subject to limitation with respect to duration or amount, the Company does not believe that it is possible to determine the maximum potential amount due under this indemnity in the future.
The Company has obtained bank letters of credit in favor of various affiliated and unaffiliated insurance companies from which the Company assumes business. These letters of credit represent guarantees of performance under the reinsurance agreements and allow ceding companies to take statutory reserve credits. Certain of these letters of credit contain financial covenant restrictions. At December 31, 2018 and 2017, there were approximately $105.6 million and $120.1 million, respectively, of undrawn outstanding bank letters of credit in favor of third parties. Additionally, the Company utilizes letters of credit primarily to secure reserve credits when it retrocedes business to its affiliated subsidiaries. The Company cedes business to its affiliates to help reduce the amount of regulatory capital required in certain jurisdictions such as the U.S. and the United Kingdom. As of December 31, 2018 and 2017, $1,356.9 million and $1,492.2 million, respectively, in undrawn letters of credit from various banks were outstanding, primarily backing reinsurance between the various subsidiaries of the Company. The banks providing letters of credit to the Company are included on the NAIC list of approved banks.
In 2015, RGA’s subsidiary, RGA Reinsurance Company (Barbados) Ltd. (“RGA Barbados”) obtained CAD$200.0 million of collateral financing from a third party through 2020, enabling RGA Barbados to support collateral requirements for Canadian reinsurance transactions. The obligation is reflected on the consolidated balance sheets in collateral finance and securitization notes. Interest on the collateral financing is payable quarterly and accrues at 3-month Canadian Dealer Offered Rate plus a margin and totaled $5.1 million, $4.2 million and $4.0 million in 2018, 2017 and 2016, respectively.
The demand note is secured by a portfolio of specified assets that have an aggregate market value at least equal to the principal amount of the demand note and a payment obligation pledged by a third party financial institution. The principal amount of the demand note is payable upon demand by the holder, which creates a corresponding payment under the note issued by RGA Americas. The note issued by RGA Americas bears interest at a rate equal to the rate on the corresponding demand note, plus an amount representing fees payable to the applicable third party financial institution. Through December 31, 2018, no principal payments have been received or are currently due on the demand note and, as a result, there was no payment obligation under the note issued by RGA Americas. Accordingly, the notes are not reflected in the Company’s consolidated balance sheet or the table below, as of that date.
The Company’s collateral finance and securitization notes consist of the following as of December 31, 2018 and 2017 (dollars in thousands):
Information related to revenues, income (loss) before income taxes, interest expense, depreciation and amortization, and assets of the Company’s operations are summarized below (dollars in thousands):
No individual client generated 10% or more of the Company’s total gross premiums on a consolidated basis in 2018, 2017 and 2016. For the purpose of this disclosure, companies that are within the same insurance holding company structure are combined.
Incurred claims related to prior years reflected in the table above, resulted in part from developed claims for prior years being different than were anticipated when the liabilities for unpaid claims were originally estimated. These trends have been considered in establishing the current year liability for unpaid claims.
The changes in number of common stock shares, issued, held in treasury and outstanding are as follows for the periods indicated:
During 2016, RGA’s board of directors authorized and amended a share repurchase program, with no expiration date, to repurchase up to $400.0 million of RGA’s outstanding common stock. During 2016, RGA repurchased 1,356,892 shares of common stock under this program for $116.5 million.
On January 24, 2019, RGA’s board of directors authorized a share repurchase program for up to $400.0 million of RGA’s outstanding common stock. The authorization was effective immediately and does not have an expiration date. In connection with this new authorization, the board of directors terminated the stock repurchase authority granted in 2017.
The following table presents the components of the Company’s other comprehensive income (loss) for the years ended December 31, 2018, 2017 and 2016 (dollars in thousands):
Includes cash flow hedges of $8,788, $2,619 and $(2,496) as of December 31, 2018, 2017 and 2016, respectively. See Note 5 for additional information on cash flow hedges.
The Company adopted the RGA Flexible Stock Plan (the “Plan”) in February 1993, as amended, and the Flexible Stock Plan for Directors (the “Directors Plan”) in January 1997, as amended, (collectively, the “Stock Plans”). The Stock Plans provide for the award of benefits (collectively “Benefits”) of various types, including stock options, stock appreciation rights (“SARs”), restricted stock, performance shares, cash awards, and other stock-based awards, to key employees, officers, directors and others performing significant services for the benefit of the Company or its subsidiaries. As of December 31, 2018, shares authorized for the granting of Benefits under the Plan and the Directors Plan totaled 14,960,077 and 412,500 respectively. The Company uses treasury shares or shares made available from authorized but unissued shares to support the future exercise of options or settlement of awards granted under its stock plans.
The intrinsic value of options exercised was $25.6 million, $42.1 million, and $41.4 million for 2018, 2017 and 2016, respectively.
The following table presents the weighted average assumptions used to determine the fair value of stock options issued:
During 2018, the Company issued 110,042 PCUs to key employees at a weighted average fair value per unit of $150.87. In May 2018 and May 2017, RGA’s board of directors approved a 1.07 and 0.75 share payout for each PCU granted in 2016 and 2015, resulting in the issuance of 170,080 and 137,083 shares of common stock from treasury, respectively.
We have audited the accompanying consolidated balance sheets of Reinsurance Group of America, Incorporated and subsidiaries (the "Company") as of December 31, 2018 and 2017, and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2018, and the related notes, and the schedules listed in the Index at Item 15 (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.