RGA Reinsurance also conducts business from a total of approximately 16,000 square feet of office space in Mexico City, Madrid, Hong Kong, Tokyo, Taipei, Seoul, and Mumbai. These premises are leased through October 2005, at annual rents of approximately $859,000. GA Argentina conducts business from approximately 5,400 square feet of office space in Buenos Aires. These premises are leased through July 2005, at annual rents of approximately $19,000. RGA International conducts business from approximately 9,800 square feet of office space in Toronto. These premises are leased through August 2007, at annual rents of approximately $338,000. RGA UK conducts business from approximately 3,000 square feet of office space in London. These premises are leased through September 2009, at annual rents of approximately $290,000. RGA South Africa conducts business from approximately 10,900 square feet of office space in Cape Town and Johannesburg. These premises are leased through September 2004, at annual rents of approximately $144,000. RGA Australia conducts business from approximately 9,000 square feet of office space in Sydney. These premises are leased through July 2009, at annual rents of approximately $219,000.
Reinsurance Group of America, Incorporated ("RGA") is an insurance holding company formed December 31, 1992. On December 31, 2002, Equity Intermediary Company, a Missouri holding company, directly owned approximately 48.8% of the outstanding shares of common stock of RGA. Equity Intermediary Company is a wholly-owned subsidiary of General American Life Insurance Company ("General American"), a Missouri life insurance company, which in turn is a wholly owned subsidiary of GenAmerica Financial Corporation ("GenAmerica"), a Missouri corporation. GenAmerica was acquired and became a wholly-owned subsidiary of MetLife, a New York life insurance company, on January 6, 2000. As a result of MetLife's ownership of GenAmerica and its own direct investment in RGA, MetLife beneficially owns 59.1% of the outstanding shares of common stock of RGA at December 31, 2002.
Costs of acquiring new business, which vary with and are primarily related to the production of new business, have been deferred to the extent that such costs are deemed recoverable from future premiums or gross profits. Deferred policy acquisition costs ("DAC") reflect our expectations about the future experience of the business in force and include commissions and allowances as well as certain costs of policy issuance and underwriting. Some of the assumptions that can affect the carrying value of DAC include mortality, interest spreads and policy lapse rates. The Company performs periodic tests to determine that DAC remains recoverable, and the cumulative amortization is re-estimated and, if necessary, adjusted by a cumulative charge or credit to current operations. For the years ended December 31, 2002 and 2001, the Company reflected charges of $1.0 million and $3.1 million, respectively, for unrecoverable deferred policy acquisition costs. No such charges were reflected in 2000 results. As of December 31, 2002, the Company estimates that approximately 50 percent of its DAC balance is collateralized by surrender fees due to the Company and the reduction of policy liabilities, in excess of termination values, upon surrender or lapse of a policy.
Claims payable for incurred but not reported losses are determined using case basis estimates and lag studies of past experience. These estimates are periodically reviewed and required adjustments to such estimates are reflected in current operations.
The Company's primary business is life reinsurance, which involves reinsuring life insurance policies that are often in force for the remaining lifetime of the underlying individuals insured, with premiums earned typically over a period of 10 to 30 years. Each year, however, a portion of the business under existing treaties terminates due to, among other things, lapses or surrenders of underlying policies, deaths of policyholders, and the exercise of recapture options by the ceding companies.
Assumed insurance in force for the Company increased $142.9 billion to $758.9 billion at December 31, 2002. Assumed new business production for 2002 totaled $230.0 billion compared to $171.1 billion in 2001 and $161.1 billion in 2000.
The Company has foreign currency risk on business conducted in foreign currencies to the extent that the exchange rates of the foreign currencies are subject to adverse change over time. Additionally, the Company is exposed to the economic and political risk associated with its net investment in foreign locations. The Company's most significant foreign operations are in Canada. The exchange rate from Canadian to U.S. currency was 0.6362, 0.6277, and 0.6676 at December 31, 2002, 2001, and 2000, respectively. The Company's Latin America operations primarily conduct business in Argentine and Mexican pesos. The business generated from the Asia Pacific region is primarily denominated in U.S. dollars, Australian dollars, and Japanese yen. Additionally, the Company reinsures business in other international currencies including the Great British pound and South African rand.
Consolidated investment income increased 10.0% during 2002 and increased 4.3% during 2001. The increase in 2002 and 2001 was related to an increase in the invested asset base due to positive cash flows from operations and deposits from several new annuity reinsurance treaties, offset, in part, by a drop in the invested asset yield primarily due to a decline in prevailing interest rates. Investment income during 2001 was affected by the write-off of accrued investment income associated with the write-down of impaired securities as well as the general decline in interest rates. The cost basis of invested assets increased by $1.4 billion, or 27.5% in 2002 and increased $0.6 billion, or 13.0% in 2001. The increase in the cost basis of invested assets during 2001 was primarily a result of proceeds from the Company's capital raising efforts in December 2001, in addition to the factors previously discussed. The average yield earned on investments was 6.51% in 2002, compared with 6.79% in 2001, and 7.30% in 2000. The average yield will vary from year to year depending on a number of variables, including prevailing interest rate fluctuations, changes in the mix of asset-intensive products, and yields related to funds withheld at interest. Investment income is allocated to the segments based upon average assets and related capital levels deemed appropriate to support the segment business volumes.
The consolidated provision for income taxes for continuing operations represented approximately 33.8%, 39.7%, and 39.6% of pre-tax income for 2002, 2001, and 2000, respectively. The effective tax rate for 2002 includes the effect of a $2.0 million reduction in tax liabilities subsequent to a settlement of an IRS audit. The effective tax rate for 2001 and 2000 was affected by realized capital losses domestically and operating losses from foreign subsidiaries for which deferred tax assets cannot be fully established. The Company calculated a tax benefit of $3.1 million, $3.7 million, and $15.1 million related to the discontinued operations in 2002, 2001, and 2000, respectively. The effective tax rate on the discontinued operations was 35.1% in 2002 and 35.0% in 2001 and 2000.
Income before taxes for the U. S. operations segment totaled $177.1 million for 2002 compared to $125.7 million in 2001 and $167.2 million in 2000. Strong growth in revenue in the traditional subsegment contributed to the increase in income for 2002. Income was down in 2001 due primarily to unfavorable claims experience, higher realized net investment losses, and claims arising from the terrorist attacks of September 11, 2001.
Income before income taxes for U.S. traditional reinsurance increased 50.2% and decreased 30.9% in 2002 and 2001, respectively. The variances in income for the comparable periods are primarily due to $16.1 million in net claims
Net investment income increased 7.1% and 7.6% in 2002 and 2001, respectively. The increase in both years is due to growth in the invested asset base, primarily due to increased operating cash flows on traditional reinsurance, which was partially offset by lower yields, primarily as a result of a general decline in interest rates.
Realized investment losses of $6.1 million were reported in 2002 compared to $29.9 million and $12.2 million in 2001 and 2000, respectively.
Claims and other policy benefits, as a percentage of net premiums, were 78.2%, 80.1%, and 76.5% in 2002, 2001, and 2000, respectively. The 2001 loss ratio, when adjusted for claims of $16.1 million related to the events of September 11, 2001, is reduced to 78.8%. The lower percentage in 2000 is the result of favorable mortality experience. In 2002, liabilities established in 2001 for claims related to the terrorists attacks of September 11, 2001 were adjusted down $1.9 million as reported claims from this event are lower than originally projected. The Company's catastrophe coverage program has limited its net losses related to the terrorist attack. As of December 31, 2002, the amount recoverable from catastrophe coverage was approximately $2.9 million. Death claims are reasonably predictable over a period of many years, but are less predictable over shorter periods and are subject to significant fluctuation.
The amount of policy acquisition costs and other insurance expenses, as a percentage of net premiums, was 16.1%, 14.9%, and 14.5% in 2002, 2001, and 2000, respectively. The increase in this ratio for the comparable periods can be attributed to the proportional increase in the volume of coinsurance business written versus yearly renewable term business. These percentages will fluctuate due to variations in the mixture of business being written.
Income before income taxes increased 8.9% and 12.2% in 2002 and 2001, respectively. The increase for 2002 can be attributed to higher net fees retained as result of the continued growth in financial reinsurance. The growth in fees was somewhat offset by higher operating expenses allocated to this sub-segment in 2002. At December 31, 2002, 2001 and 2000, the amount of reinsurance assumed from client companies, as measured by pre-tax statutory surplus, was $872.7 million, $547.8 million and $498.4 million, respectively.
The Company conducts reinsurance business in Canada through RGA Canada. RGA Canada assists clients with capital management activity and mortality risk management and is primarily engaged in traditional individual life reinsurance, including preferred underwriting products, as well as creditor and non-guaranteed critical illness products. The Canadian operation is one of the leading life reinsurers in Canada. RGA Canada's reinsurance inforce totals approximately $64.5 billion and $55.8 billion at December 31, 2002 and 2001, respectively. At December 31, 2002, RGA Canada includes most of the life insurance companies in Canada as clients.
Income before income taxes decreased 25.0% in 2002 and increased 29.2% in 2001. Excluding net realized investment gains (losses), income before taxes decreased by 8.4% in 2002 and increased by 3.0% in 2001. The decrease in 2002 was the result of below-average mortality experience in the current year, primarily due to two treaties, and favorable mortality experience in the prior year. The increase in 2001 was primarily driven by favorable mortality experience.
Net investment income increased by 8.5% and 4.9% during 2002 and 2001, respectively. Investment income is allocated to the segments based upon average assets and related capital levels deemed appropriate to support business volumes. The investment income allocation to the Canadian operations was $4.0 million and $5.3 million in 2002 and 2001, respectively. Investment performance varies with the composition of investments. The increase in investment income was mainly the result of an increase in the invested asset base offset by the effects of changes in the foreign currency exchange rates. In 2002 and 2001, the invested asset base growth was due to operating cash flows on traditional reinsurance, proceeds from capital contributions and interest on an increasing amount of funds withheld at interest related to one treaty.
Policy acquisition costs and other insurance expenses as a percentage of net premiums totaled 8.9% in 2002, 8.1% in 2001, and 9.4% in 2000. The fluctuation in this ratio is primarily due to the changing mix of business. In 2002, more business was derived from coinsurance agreements than yearly renewable term agreements. The coinsurance agreements tend to have higher commission costs compared to yearly renewable term agreements. The decrease in the percentage in 2001 is the result of the mix of business which was higher in yearly renewable term agreements compared to 2000.
OTHER INTERNATIONAL OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2002 (in thousands)
The Latin America operations include traditional reinsurance, primarily from Mexico, Argentina and Chile, reinsurance of privatized pension products primarily in Argentina, which the Company ceased writing during 2001, and direct life insurance through a subsidiary in Argentina. The Company had direct and local reinsurance operations in Chile until 2000 when those operations were sold. The Latin America segment has experienced losses and decreased new business opportunity as a result of turbulent economic conditions in Argentina in the past few years. Most of the growth of the reinsurance business has been in Mexico over the last two years.
Net investment income decreased $7.9 million or 39.1% in 2002, and $6.3 million or 23.8% in 2001. The decrease during 2002 was primarily due to a decrease in allocated assets required to support the Argentine pension business as a result of the devaluation of the Argentine peso, while the sale of the Chilean operations contributed to a smaller invested asset base and less investment income for 2001. Asia Pacific reported a 79.4% increase in investment income in 2002, predominantly due to an increase in the investment assets, particularly in Australia. Investment income and realized investment gains and losses are allocated to the various operating segments based on average assets and related capital levels deemed appropriate to support the segment business volumes. Investment performance varies with the composition of investments and the relative allocation of capital to the operating segments.
During 2001, the Company ceased renewal of reinsurance treaties associated with privatized pension contracts in Argentina because of adverse experience on this business, as several aspects of the pension fund claims flow did not develop as was contemplated when the reinsurance programs were initially priced. Although premiums will continue to decline, it is estimated that claims for the privatized pension business will continue to be paid over the next several years. As the underlying reserves for the privatized pension business are in Argentine pesos, the functional currency of this segment, the devaluation of the peso during 2002 is not expected to have an impact on earnings until actual claims settlement or adjustment to the underlying peso-denominated reserves occur. Transaction gains/losses on the claims settlements are included in the claims and other policy benefits total. During 2002, the Company recorded $32.0 million in transaction gains related to claims settlements. These gains were generally offset by increases in reserves associated with the Argentine pension contracts. The impact of fluctuating exchange rates will continue to be closely monitored by the Company's management and is expected to be volatile over the near term. Claims and other policy benefits include claims paid, claims in the course of payment and establishment of additional reserves to provide for unreported claims. The level of claims may fluctuate from period to period, but exhibits less volatility over the long term. The Company monitors claims trends to evaluate the appropriateness of reserve levels and adjusts the reserve levels on a periodic basis.
Corporate revenues increased $24.7 million in 2002 and decreased $9.5 million in 2001. The increase during 2002 was largely due to an increase in investment income resulting from a larger base of invested assets. The decrease during 2001 was primarily a result of unallocated investment losses associated with the sale or impairment of investment securities. Corporate unallocated other operating expenses were less than one percent of consolidated premiums in 2002, 2001 and 2000. Corporate interest expense was $34.0 million in 2002, compared to $16.5 million in 2001 and $16.1 million in 2000. The substantial increase during 2002 was primarily a result of the addition of the Preferred Securities (See Note 16, "Issuance of Trust PIERS Units" of the Notes to Consolidated Financial Statements) and the 2001 Senior Notes, both of which were issued near the end of 2001. The Company essentially swapped variable rate debt for fixed rate debt by using the proceeds of the 2001 Senior Notes to pay down its U.S. Credit Agreement and to prepay and terminate the affiliate note. The U.S. Credit Agreement and the MetLife Note had a combined weighted average interest rate of 5.0% during 2001. As expected, interest expense during 2002 on the 2001 Senior Notes, fixed at 6.75%, exceeded the combined interest expense on the U.S. Credit Agreement and the MetLife Note during 2001. The Company views its long-term debt at its current level as an integral and
The reinsurance markets for several accident and health risks, most notably involving workers' compensation carve-out and personal accident business, have been quite volatile over the past several years. Certain programs are alleged to have been inappropriately underwritten by third party managers, and some of the reinsurers and retrocessionaires involved have alleged material misrepresentation and non-disclosures by the underwriting managers. In particular, over the past several years a number of disputes have arisen in the accident and health reinsurance markets with respect to London market personal accident excess of loss ("LMX") reinsurance programs that involved alleged "manufactured" claims spirals designed to transfer claims losses to higher-level reinsurance layers. The Company is currently a party to arbitrations that involve some of these LMX reinsurance programs. The Company and other involved reinsurers and retrocessionaires have raised substantial defenses upon which to contest these claims, including defenses based upon the failure of the ceding company to disclose the existence of manufactured claims spirals. As a result, there have been a significant number of claims for rescission, arbitration, and litigation among a number of the parties involved in these various coverages. This has had the effect of significantly slowing the reporting of claims between parties, as the various outcomes of a series of arbitrations and similar actions affects the extent to which higher level reinsurers and retrocessionaires may ultimately have exposure to claims.
RGA is a holding company whose primary uses of liquidity include, but are not limited to, the immediate capital needs of its operating companies associated with the Company's primary businesses, dividends paid by RGA to its shareholders, interest payments on its indebtedness (See Notes 15, "Long-Term Debt," and 16, "Issuance of Trust PIERS Units," of the Notes to Consolidated Financial Statements), and repurchases of RGA common stock under a board of director approved plan. The primary sources of RGA's liquidity include proceeds from its capital raising efforts, interest income on undeployed corporate investments, interest income received on surplus notes with RGA Reinsurance and RCM, and dividends from operating subsidiaries. As the Company continues its expansion efforts, RGA will continue to be dependent on these sources of liquidity.
RCM and RGA Reinsurance are subject to statutory provisions that restrict the payment of dividends. They may not pay dividends in any 12-month period in excess of the greater of the prior year's statutory operating income or 10% of capital and surplus at the preceding year-end, without regulatory approval. Pursuant to this calculation, RGA Reinsurance's allowable dividend without prior approval for 2003 would be $63.4 million. However, the applicable statutory provisions only permit an insurer to pay a shareholder dividend from unassigned surplus. As of December 31, 2002, RGA Reinsurance had unassigned surplus of $67.8 million. Any dividends paid by RGA Reinsurance would be paid to RCM, its parent company, which in turn has restrictions related to its ability to pay dividends to RGA. The assets of RCM consist primarily of its investment in RGA Reinsurance. As of January 1, 2003, RCM could pay a maximum dividend, without prior approval, to RGA equal to its unassigned surplus, approximately $28.9 million. The maximum amount available for dividends by RGA Canada to RGA under the Canadian Minimum Continuing Capital and Surplus Requirements ("MCCSR") is $33.4 million. Dividend payments from other subsidiaries and joint ventures are subject to regulations in the country of domicile. RGA Americas and RGA Barbados do not have material restrictions on their ability to pay dividends out of retained earnings.
The Company's $140.0 million U.S. credit facility expires in May 2003. No amount was outstanding under this facility as of December 31, 2002; however, the Company is currently planning on renewing this facility. The Company can give no assurances though, that it will be successful in negotiating the renewal, and if successful, that the terms, including cost, will be comparable to the current terms.
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 net worth ranging from $600.0 million
to $700.0 million, and minimum rating requirements. 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 amounts greater than $10.0 million or $25.0 million depending on the agreement, bankruptcy proceedings, and any event which results in the acceleration of the maturity of indebtedness. The facility fee and interest rate for the Company's credit facilities is based on its senior long-term debt ratings. A decrease in those ratings could result in an increase in costs for the credit facilities. As of December 31, 2002, the Company had $327.8 million in outstanding borrowings under its debt agreements and was in compliance with all covenants under those agreements. Of that amount, approximately $28.4 million is subject to immediate payment upon a downgrade of the Company's senior long-term debt rating, unless a waiver is obtained from the lenders. The ability of the Company to make debt principal and interest payments depends primarily on the earnings and surplus of subsidiaries, investment earnings on undeployed capital proceeds, and the Company's ability to raise additional funds.
In December 2001, RGA, through its wholly owned subsidiary trust, issued $225.0 million in Preferred Income Redeemable Securities ("PIERS") Units. See Notes 2, "Summary of Significant Accounting Policies," and 16, "Issuance of Trust PIERS Units," of the Notes to Consolidated Financial Statements for additional information on the terms of the PIERS units. Each PIERS unit consists of a preferred security with a face value of $50 and a stated maturity of March 18, 2051 and a warrant to purchase 1.2508 shares of RGA stock at an exercise price of $50. The warrant expires on December 15, 2050. The holders of the PIERS units have the ability to exercise their warrant for stock at any time and require RGA to payoff the preferred security. Because the exercise price of the warrant to be received from the holder is equal to the amount to be paid for the preferred security, there is no net cash required on RGA's part. If on any date after December 18, 2004, the closing price of RGA common stock exceeds and has exceeded a price per share equal to $47.97 for at least 20 trading days within the immediately preceding 30 consecutive trading days, the Company may redeem the warrants in whole for cash, RGA common stock, or a combination of cash and RGA common stock.
Consolidated interest expense increased significantly in 2002 due to the addition, in December 2001, of the $225.0 million face amount, 5.75% trust preferred securities issued by RGA Capital Trust I and the interest expense associated with its $200.0 million 6.75% Senior Notes due 2011, the proceeds of which were used to pay down a balance of $120.0 million on its U.S. revolving credit facility and to prepay and terminate the $75.0 million term loan with MetLife Credit Corp. Interest rates on the U.S. revolving credit facility and $75.0 million term loan ranged from 2.6% to 7.1% in 2001. As of December 31, 2002, the average interest rate on long-term debt outstanding, excluding the PIERS, was 6.74%.
Based on the historic cash flows and the current financial results of the Company, subject to any dividend limitations which may be imposed by various insurance regulations, management believes RGA's cash flows from operating activities, together with undeployed proceeds from its capital raising efforts, including interest and investment income on those proceeds, interest income received on surplus notes with RGA Reinsurance and RCM, and its ability to raise funds in the capital markets, will be sufficient to enable RGA to make dividend payments to its shareholders, to make interest payments on its senior indebtedness and junior subordinated notes, to repurchase RGA common stock under the board of director approved plan, and to meet its other obligations.
nonperformance under a treaty, or loss of reinsurance license of such subsidiary. RGA has issued guarantees of its subsidiaries' performance for the payment of amounts due under certain reinsurance treaties, whereby if the subsidiary fails to meet its obligations, RGA or one of its other subsidiaries will make the payment. These guarantees are granted to ceding companies in order to provide them additional security, particularly in cases where RGA's subsidiary is relatively new or not of a significant size, relative to the ceding company. Total liabilities supported by the guarantees, before consideration for any legally offsetting amounts due from the guaranteed party, totaled $126.6 million as of December 31, 2002 and are reflected on the Company's consolidated balance sheet as future policy benefits.
Additional sources of liquidity to meet unexpected cash outflows in excess of operating cash inflows include selling short-term investments or fixed maturity securities and drawing additional funds under existing credit facilities, under which the Company had availability of $155.4 million as of December 31, 2002. As previously mentioned, the Company is currently planning to renew its $140.0 million U.S. credit facility that expires in May 2003. No amount was outstanding under this facility as of December 31, 2002.
The following table displays the Company's contractual obligations, which primarily consist of the payment of outstanding debt upon maturity and leases (in millions):
The Company has obtained letters of credit in favor of various affiliated and unaffiliated insurance companies from which the Company assumes business. This allows the ceding company to take statutory reserve credits. The letters of credit issued by banks represent a guarantee of performance under the reinsurance agreements. At December 31, 2002, there were approximately $39.7 million of outstanding bank letters of credit in favor of third parties. Additionally, the Company utilizes letters of credit to secure reserve credits when it retrocedes business to its offshore subsidiaries, including RGA Americas, RGA Barbados, and Triad Re, Ltd. As of December 31, 2002, $339.4 million in letters of credit from various banks were outstanding between the various subsidiaries of the Company. Fees associated with letters of credit are not fixed and are
based on the Company's ratings and the general availability of these instruments in the marketplace. The Company has direct policies and reinsurance agreements in addition to certain investment, advisory, and administrative services contracts with affiliated entities (See Note 11, "Related Party Transactions," of the Notes to Consolidated Financial Statements).
Net cash used in investing activities was $582.5 million, $576.4 million, and $712.5 million in 2002, 2001, and 2000, respectively. Changes in cash used in investing activities primarily relate to the management of the Company's investment portfolios and the investment of excess capital generated by operating and financing activities.
Net cash provided by financing activities was $285.5 million, $487.9 million, and $565.5 million in 2002, 2001, and 2000, respectively. Changes in cash provided by financing activities primarily relate to the issuance of equity or debt securities, borrowings or payments under the Company's existing credit agreements, treasury stock activity, and excess deposits under investment type contracts.
Additionally, deferred costs related to interest-sensitive life and investment-type contracts are amortized over the lives of the contracts, in relation to the present value of estimated gross profits (EGP) from mortality, investment income, and expense margins. The EGP for asset-intensive products include the following components: (1) estimates of fees charged to policyholders to cover mortality, surrenders and maintenance costs; (2) expected interest rate spreads between income earned and amounts credited to policyholder accounts; and (3) estimated costs of administration. EGP is also reduced by our estimate of future losses due to defaults in fixed maturity securities. Deferred policy acquisition costs ("DAC") are sensitive to changes in assumptions regarding these EGP components, and any change in such an assumption could have an impact on our profitability.
In general, a change in assumption that improves our expectations regarding EGP is going to have the impact of deferring the amortization of DAC into the future, thus increasing earnings and the current DAC balance. Conversely, a change in assumption that decreases EGP will have the effect of speeding up the amortization of DAC, thus reducing earnings and lowering the DAC balance. We also adjust DAC to reflect changes in the unrealized gains and losses on available for sale fixed maturity securities since this impacts EGP. This adjustment to DAC is reflected in accumulated other comprehensive income (loss).
The Company's fixed maturity securities are invested primarily in commercial and industrial bonds, public utilities, Canadian government securities, and mortgage and asset-backed securities. As of December 31, 2002, approximately 97% of the Company's consolidated investment portfolio of fixed maturity securities was investment-grade. Important factors in the selection of investments include diversification, quality, yield, total rate of return potential, and call protection. The relative importance of these factors is determined by market conditions and the underlying product or portfolio characteristics. Cash equivalents are invested in high-grade money market instruments. The largest asset class in which fixed maturities were invested was in commercial and industrial bonds, which represented approximately 32.2% of fixed maturity securities as of December 31, 2002, an increase from 30.6% as of December 31, 2001. A majority of these securities were classified as corporate securities, with an average Standard and Poor's ("S&P") rating of A at December 31, 2002. The Company owns floating rate securities that represent approximately 2.8% of fixed maturity securities at December 31, 2002, compared to 6.1% at December 31, 2001. These investments may 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 monitors its fixed maturity securities to determine impairments in value. In conjunction with its external investment managers, the Company evaluates factors such as financial condition of the issuer, payment performance, the length of time and the extent to which the market value has been below amortized cost, compliance with covenants, general market conditions and industry sector, intent and ability to hold securities, and various other subjective factors. As of December 31, 2002, the Company held fixed maturities with a cost basis of $23.1 million and a market value of $22.9 million, or 0.7% of fixed maturities, that were non-income producing. Securities, based on management's judgment, with an other than temporary impairment in value are written down to management's estimate of net realizable value. The Company recorded other than temporary write-downs of $33.9 million, $43.4 million, and $10.1 million in 2002, 2001, and 2000, respectively. The circumstances that gave rise to these impairments were bankruptcy proceedings and deterioration in collateral value supporting certain asset-backed securities. During 2002, the Company sold fixed maturity securities with a fair value of $466.1 million at a loss of $44.4 million.
Based on data provided by the ceding companies as of December 31, 2002, the maturity distribution of the segregated portfolio portion of funds withheld at interest was approximately (in thousands):
The calculation of fair value is based on the net present value of estimated discounted cash flows expected over the life of the market risk sensitive instruments, using market prepayment assumptions and market rates of interest provided by independent broker quotations and other public sources as of December 31, 2001, with adjustments made to reflect the shift in the treasury yield curve as appropriate.
At December 31, 2002, the Company's estimated changes in fair value were within the targets outlined in the Company's investment policy.
In February 2003, the Financial Accounting Standards Board ("FASB") issued for comment Statement of Financial Accounting Standards ("SFAS") No. 133 Implementation Issue No. B36, "Embedded Derivatives: Bifurcation of a Debt Instrument That Incorporates Both Interest Rate Risk and Credit Risk Exposures That are Unrelated or Only Partially Related to the Creditworthiness of the Issuer of That Instrument" ("FASB B36"). In this tentative guidance, the FASB has concluded that funds withheld by a ceding company, for modified coinsurance and coinsurance with funds withheld contracts, may contain an embedded derivative which should be bifurcated and valued. The effective date of the implementation guidance, as currently proposed, is the first day of the first fiscal quarter beginning after June 15, 2003. As of December 31, 2002, the Company has not separately reported any potential embedded derivatives associated with these contracts, which it believes is consistent with industry practice. At this time, the Company cannot estimate the impact, if any, of the FASB B36 proposed guidance.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure, an amendment of FASB Statement No. 123." Effective January 1, 2003, the Company will prospectively adopt the fair value-based employee stock-based compensation expense recognition provisions of SFAS No. 123, as amended by SFAS No. 148. The Company currently applies the intrinsic value-based expense provisions set forth in APB Opinion No. 25, Accounting for Stock Issued to Employees, ("APB 25"). The estimated impact of the adoption of the fair value-based method on 2003 net income is estimated at approximately $1.1 million, net of tax. This amount represents estimated compensation cost associated with stock option grants expected to be issued in 2003.
Consolidation and Basis of Presentation. The consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America for stock life insurance companies. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. The most significant estimates include those used in determining deferred policy acquisition costs, premiums receivable, future policy benefits, other policy claims and benefits, including incurred but not reported claims, provision for adverse litigation, and valuation of investment impairments. In all instances, actual results could differ materially from the estimates and assumptions used by management.
carrying value. In conjunction with its external investment managers, the Company evaluates factors such as financial condition of the issuer, payment performance, the length of time and the extent to which the market value has been below amortized cost, compliance with covenants, general market conditions and industry sector, intent and ability to hold securities, and various other subjective factors. The actual value at which such financial instruments could actually be sold or settled with a willing buyer may differ from such estimated realizable values.
Funds withheld at interest represent amounts contractually withheld by ceding companies in accordance with reinsurance agreements. For agreements written on a modified coinsurance basis and certain agreements written on a coinsurance basis, assets equal to the net statutory reserves are withheld and legally owned by the ceding company. Interest accrues to these assets at rates defined by the treaty terms.
Investment income is recognized as it accrues or is legally due. Realized gains and losses on sales of investments are included in net income, as are write-downs of investments where declines in value are deemed to be other than temporary in nature. The cost of investments sold is determined based upon the specific identification method. Unrealized gains and losses on marketable equity securities and fixed maturity securities classified as available for sale, less applicable deferred income taxes as well as related adjustments to deferred acquisition costs, if applicable, are reflected as a direct charge or credit to accumulated other comprehensive income (loss) in stockholders' equity on the consolidated balance sheet.
Premiums Receivable. Premiums are accrued for when due from the ceding company, as adjusted for management estimates for lapsed premiums given historical experience, financial health of specific ceding companies, collateral value, and the legal right of offset on related amounts owed to the ceding companies.
Deferred Policy Acquisition Costs. Costs of acquiring new business, which vary with and are primarily related to the production of new business, have been deferred to the extent that such costs are deemed recoverable from future premiums or gross profits. Such costs include commissions and allowances as well as certain costs of policy issuance and underwriting. The Company performs periodic tests to determine that the cost of business acquired remains recoverable, and the cumulative amortization is re-estimated and adjusted by a cumulative charge or credit to current operations. For the years ended December 31, 2002 and 2001, the Company reflected charges of $1.0 million and $3.1 million, respectively, for unrecoverable deferred policy acquisition costs. No such charges were reflected in 2000 results.
The Company reinsures asset-intensive products, including annuities and corporate-owned life insurance. The investment portfolios for these products are segregated for management purposes within the general account of RGA Reinsurance Company ("RGA Reinsurance"). The liabilities under asset-intensive reinsurance contracts are included in interest-sensitive contract liabilities on the consolidated balance sheet.
Other Policy Claims and Benefits. Claims payable for incurred but not reported losses are determined using case basis estimates and lag studies of past experience. These estimates are periodically reviewed and required adjustments to such estimates are reflected in current operations.
Foreign Currency Translation. The functional currency is the Argentine peso for the Company's Argentine operations, the Australian dollar for the Company's Australian operations, the Canadian dollar for the Company's Canada operations, the South African Rand for the Company's South African operations and the British Pound Sterling for the Company's United Kingdom operations. The translation of the foreign currency into U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted average exchange rate during each year. Gains or losses, net of deferred income taxes, resulting from such translation are included in accumulated currency translation adjustments, net of income taxes, in accumulated other comprehensive income (loss) on the consolidated balance sheet.
Revenues for interest-sensitive and investment-type products consist of investment income, policy charges for the cost of insurance, policy administration, and surrenders that have been assessed against policy account balances during the period. Interest-sensitive contract liabilities for these products represent policy account balances before applicable surrender charges. Deferred policy acquisition costs are recognized as expenses over the term of the policies. Policy benefits and claims that are charged to expenses include claims incurred in the period in excess of related policy account balances and interest credited to policy account balances. The weighted average interest-crediting rates for interest-sensitive products were 4.2%, 6.1% and 6.7%, during 2002, 2001 and 2000, respectively. Interest crediting rates for U.S. dollar-denominated investment-type contracts ranged from 2.8% to 6.8% during 2002, 3.6% to 7.3% during 2001 and 5.3% to 7.2% during 2000. Weighted average interest crediting rates for Mexican peso-denominated investment-type contracts were 15.9%, 12.8% and 26.0% for 2002, 2001 and 2000, respectively.
Net Earnings Per Share. Basic earnings per share exclude any dilutive effects of options and warrants. Diluted earnings per share include the dilutive effects assuming outstanding stock options and warrants were exercised.
In July 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires business combinations initiated after June 30, 2001 to be reported using the purchase method of accounting, and broadens the criteria for recording intangible assets separate from goodwill. SFAS No. 142 requires the use of a non-amortization approach to account for purchased goodwill and certain intangibles. Under a non-amortization approach, goodwill and certain intangibles are not amortized into results of operations, but instead are reviewed for impairment and written down and charged to results of operations only in the periods in which the recorded value of goodwill and certain intangibles is more than its fair value. During the first quarter of 2002, the company completed the transitional impairment test of goodwill. The results of the impairment test did not have a material impact to the Company's results of operations. During 2002, there were no changes to goodwill as a result of acquisitions or disposals. Goodwill as of December 31, 2002 totaled $7.0 million and was related to the Company's purchase of RGA Financial Group L.L.C. in 2000. Goodwill amortization in the comparable prior-year periods was not material to the Company's results of operations.
Reclassification. The Company has reclassified the presentation of certain prior period information to conform to the 2002 presentation.
On September 18, 2001, the Board of Directors approved a repurchase program authorizing the Company to purchase up to $25 million of its shares of stock. Subsequent to December 31, 2001 the Board of Directors approved an additional repurchase of $25 million shares under the program, for a total of up to $50 million of its shares of stock, as conditions warrant. The Board's action allows management, in its discretion, to purchase shares on the open market. As of December 31, 2002, the Company purchased 225,500 shares of treasury stock under this program at an aggregate cost of $6.6 million. All purchases were made during 2002. The Company generally uses treasury shares to support the future exercise of options granted under its stock option plans.
RGA paid cash dividends on common shares of $0.24 per share in 2002, 2001, and 2000.
Major categories of net investment income consist of the following (in thousands):
The amortized cost, gross unrealized gains and losses, and estimated fair values of investments in fixed maturity securities at December 31, 2002 and 2001 are as follows (in thousands):
The amortized cost and estimated fair value of fixed maturity securities available for sale at December 31, 2002 are shown by contractual maturity for all securities except certain U.S. government agencies securities, which are distributed to maturity year based on the Company's estimate of the rate of future prepayments of principal over the remaining lives of the securities. These estimates are developed using prepayment rates provided in broker consensus data. Such estimates are derived from prepayment rates experienced at the interest rate levels projected for the applicable underlying collateral and can be expected
Net realized investment gains or losses consist of the following (in thousands):
Substantially all mortgage loans are performing and no valuation allowance has been established as of December 31, 2002.
The fair value of the Company's interest-sensitive contract liabilities is based on the cash surrender value of the liabilities, adjusted for recapture fees. The fair value of the Company's long-term debt and the company-obligated mandatorily redeemable preferred securities are estimated based on quoted market prices for corporations with similar credit quality.
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. As of December 31, 2002, these treaties had approximately $294.7 million in 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 $532.8 million were held in trust to satisfy collateral requirements for reinsurance business for the benefit of certain subsidiaries of the company at December 31, 2002. Additionally, securities with an amortized cost of $931.6 million, as of December 31, 2002, were held in trust to satisfy collateral requirements under certain third-party reinsurance treaties. Additionally, under certain conditions, RGA may be obligated to move reinsurance from one RGA subsidiary company to another RGA subsidiary or make payments under the treaty. These conditions generally include unusual or remote circumstances, such as change in control, insolvency, nonperformance under a treaty, or loss of reinsurance license of such subsidiary.
Some reinsurance agreements involve reimbursing the ceding company for allowances and commissions in excess of first-year premiums. These amounts represent an investment in the reinsurance agreement, and are capitalized to the extent deemed recoverable from the future premiums and amortized against future profits of the business. This type of agreement
The 2002 postretirement benefit cost assumes a 12% annual rate of increase in the per capita cost of covered health care benefits. The rate is assumed to decrease gradually to 5% for 2008 and remain at that level thereafter. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plan. A one-percentage point increase in assumed health care cost trend rates would increase the 2002 net periodic benefit cost by approximately $0.1 million and the 2002 postretirement benefit obligation by approximately $0.9 million.
General American and MetLife have historically provided certain administrative services to RGA and RGA Reinsurance. Such services have included legal, risk management and corporate travel. The cost for the years ended December 31, 2002, 2001 and 2000 was approximately $1.2 million, $1.1 million and $2.6 million respectively.
The Company also has direct policies and reinsurance agreements with MetLife and certain of its subsidiaries. As of December 31, 2002 and 2001, the Company had assets and liabilities related to these agreements totaling $78.5 million and $183.1 million, and $112.5 million and $109.0 million, respectively. Additionally, the Company reflected net premiums of approximately $172.1 million, $149.3 million, and $144.0 million in 2002, 2001, and 2000, respectively. The premiums reflect the net of business assumed from and ceded to MetLife and its subsidiaries. The pre-tax gain on this business was approximately $25.9 million, $26.1 million, and $17.8 million in 2002, 2001, and 2000, respectively.
Rent expenses amounted to approximately $6.0 million, $5.3 million, and $4.7 million for the years ended December 31, 2002, 2001, and 2000, respectively.
Note 13 FINANCIAL CONDITION AND NET INCOME ON A STATUTORY BASIS - - SIGNIFICANT SUBSIDIARIES
The Company has obtained letters of credit in favor of various affiliated and unaffiliated insurance companies from which the Company assumes business. This allows the ceding company to take statutory reserve credits. The letters of credit issued by banks represent a guarantee of performance under the reinsurance agreements. At December 31, 2002, there were approximately $39.7 million of outstanding letters of credit in favor of third-party entities. Additionally, the Company utilizes letters of credit to secure reserve credits when it retrocedes business to its offshore subsidiaries, including RGA Americas and RGA Barbados. As of December 31, 2002, $339.4 million in letters of credit from various banks were outstanding between the various subsidiaries of the Company. Fees associated with letters of credit are not fixed for periods
On December 19, 2001, RGA issued 6.75% Senior Notes with a face value of $200.0 million. These senior notes have been registered with the SEC. The net proceeds from the offering were approximately $198.5 million and were used to pay down a balance of $120 million on a revolving credit facility and to prepay and terminate a $75 million term loan with MetLife Credit Corp. Capitalized issuance costs, recorded in other assets, relate to the issuance of the 6.75% Senior Notes were $2.1 million.
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 ranging from $600 million to $700 million, and minimum rating requirements. 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 amounts greater than $10 million or $25 million depending on the agreement, bankruptcy proceedings, and any other event which results in the acceleration of the maturity of indebtedness. As of December 31, 2002, the Company had $327.8 million in outstanding borrowings under its debt agreements and was in compliance with all covenants under those agreements. Of that amount, approximately $28.4 million is subject to immediate payment upon a downgrade of the Company's senior long-term debt rating, unless a waiver is obtained from the lenders. The ability of the Company to make debt principal and interest payments depends on the earnings and surplus of subsidiaries, investment earnings on undeployed capital proceeds, and the Company's ability to raise additional funds. Interest paid on debt during 2002, 2001 and 2000 totaled $34.7 million, $18.5 million and $16.9 million, respectively.
RGA guarantees the payment of amounts outstanding under the credit facilities maintained by its subsidiary operations in the United Kingdom and Australia. The guarantees were granted to the banks providing the facilities in order to enhance their security. The total amount of debt outstanding, subject to the guarantees, as of December 31, 2002 was $28.4 million and is reflected on the Company's consolidated balance sheet under long-term debt. These lines of credit provide for additional borrowings of up to $15.4 million, which if drawn, would also be subject to the guarantees.
During 2002, two clients accounted for more than 10% of the Canada operation's gross premiums, consisting of $62.5 million and $26.5 million, or 29.7% and 12.6%, respectively. During 2002, two clients, one each in Australia and Hong Kong, generated approximately $52.9 million, or 30.2% of the total gross premiums for the Asia Pacific operations. During 2002, two clients of the Company's UK operations generated approximately $156.4 million, or 57.5% of the total gross premiums for the Europe & South Africa operations.
net income for future years. See Note 2 regarding New Accounting Pronouncements and the Company's prospective adoption of SFAS No. 148.
In January 2003, the Board approved an additional 735,655 incentive stock options at $27.29 per share under the Company's Stock Plans.
rescission, anticipated outcomes of arbitrations, and projected future premium run-off, all of which may affect the level of the claim reserve liability. Due to the significant uncertainty associated with the run-off of this business, net income in future periods could be affected positively or negatively. The consolidated statements of income for all periods presented reflect this line of business as a discontinued operation. Revenues associated with discontinued operations, which are not reported on a gross basis in the Company's consolidated statements of income, totaled $3.3 million, $3.0 million, and $23.7 million for 2002, 2001, and 2000, respectively.
We have audited the accompanying consolidated balance sheets of Reinsurance Group of America, Incorporated and subsidiaries (the "Company") as of December 31, 2002 and 2001, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2002. Our audits also included the financial statement schedules listed in the index at Item 15. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Reinsurance Group of America, Incorporated and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
The consolidated balance sheets of Reinsurance Group of America, Incorporated and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of income, cash flows and stockholders' equity for the years ended December 31, 2002, 2001 and 2000, have been prepared by management, which is responsible for their integrity and objectivity. The statements have been prepared in accordance with accounting principles generally accepted in the United States of America and include some amounts that are based upon management's best estimates and judgments. The financial information contained elsewhere in this annual report is consistent with that contained in the consolidated financial statements.
In connection with annual audits, independent certified public accountants perform an audit in accordance with auditing standards generally accepted in the United States of America, which includes the consideration of the system of internal control to the extent necessary to form an independent opinion on the consolidated financial statements prepared by management.