The Company believes its facilities have been generally well maintained and are in good operating condition. The Company believes the facilities are sufficient for its current requirements.
The Company’s underwriting expertise and industry knowledge has allowed it to expand into international markets and now has operations in over 25 countries including locations in Asia Pacific, Europe, the Middle East region and Africa. The
Company generally starts operations from the ground up in new markets as opposed to acquiring existing operations, and it often enters new markets to support its North American clients as they expand internationally. Based on the compilation of information from competitors’ annual reports, the Company believes it is the third-largest global life and health reinsurer in the world based on 2016 life and health reinsurance premiums. The Company conducts business with the majority of the largest U.S. and international life insurance companies. The Company has also developed its capacity and expertise in the reinsurance of longevity risks, asset-intensive products (primarily annuities and corporate-owned life insurance) and financial reinsurance.
Hong Kong, Japan, Malaysia, New Zealand, South Africa, Spain, Taiwan and the UK, and beginning in 2002, China, India and South Korea. The Company received regulatory approval to open a representative office in China in 2005 and received its branch license there in 2014; opened representative offices in Poland and Germany in 2006; opened new offices in France and Italy in 2007; opened a representative office in the Netherlands in 2009; and commenced operations in the UAE in 2011 and in Brazil in 2015. Before entering new markets, the Company evaluates several factors including:
Asset-intensive and Longevity Reinsurance and Other Products. The Company intends to continue leveraging its existing client relationships and reinsurance expertise to create customized reinsurance products and solutions. Industry trends, particularly the increased pace of consolidation and reorganization among life insurance companies and changes in products and product distribution along with new solvency requirements, are expected to enhance existing opportunities for asset-intensive and longevity reinsurance and financial solutions products. The Company began reinsuring annuities with guaranteed minimum benefits on a limited basis in 2007. To date, most of the Company’s asset-intensive reinsurance business has been written in the U.S. and the UK; however, additional opportunities outside of the U.S. continue to develop. The Company also provides longevity reinsurance in Europe and Canada, and in 2008 entered the U.S. healthcare reinsurance market with a primary focus on long-term care and Medicare supplement insurance. Additionally, the Company is experiencing growth in health related product offerings, such as critical illness, most notably in select Asian markets. In 2010, the Company expanded into the group reinsurance market in North America with the acquisition of Reliastar Life Insurance Company’s U.S. and Canada operations.
Consolidated net income increased $1.1 billion, or 159.8%, and $199.3 million, or 39.7%, in 2017 and 2016, respectively. Diluted earnings per share were $27.71 in 2017 compared to $10.79 in 2016 and $7.46 in 2015. As a result of the U.S. corporate income tax rate being reduced from 35 percent to 21 percent as part of the Tax Cuts and Jobs Act of 2017 (“U.S. Tax Reform”), a net tax benefit was recorded in 2017 of approximately $1.0 billion or $15.72 per diluted share, primarily related to the revaluation of the Company’s net deferred tax liabilities. The estimated impact of U.S. Tax Reform is based on the best information currently available and may change as a result of changes in interpretations and assumptions the Company has made.
The increases in investment related gains reflect changes in the fair value of embedded derivatives on modco or funds withheld treaties in 2017 and 2016, primarily due to changes in credit spreads. The effect of the change in fair value of these embedded derivatives on income is discussed below. Foreign currency exchange fluctuations resulted in decreases to income before income taxes of approximately $1.4 million and $28.9 million in 2017 and 2016, respectively.
hedging activity, and the primary factors that drive profitability of the underlying treaties, namely investment income, fee income, and interest credited. The individual effect on income before income taxes for these three types of embedded derivatives is as follows:
The 2016 and 2015 effective tax rates are affected by earnings of non-U.S. subsidiaries in which the Company is permanently reinvested whose statutory tax rates are less than the U.S. statutory tax rate of 35.0%, tax benefits related to the release of uncertain tax positions and differences in tax bases in foreign jurisdictions. Canada and UK statutory rates are less than the U.S. statutory rate resulting in the legal entities in these jurisdictions giving rise to the majority of the foreign rate differential. See Note 9 - “Income Tax” in the Notes to Consolidated Financial Statements for additional information on the Company’s consolidated effective tax rate.
The Company’s accounting policies are described in Note 2 - “Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements. The Company believes its most critical accounting policies include the establishment of premiums receivable; amortization of deferred acquisition costs (“DAC”); the establishment of liabilities for future policy benefits and incurred but not reported claims; the valuation of investments and investment impairments; the valuation of embedded derivatives; and accounting for income taxes. The balances of these accounts require extensive use of assumptions and estimates, particularly related to the future performance of the underlying business.
DAC related to interest-sensitive life and investment-type policies are amortized over the lives of the policies, in proportion to the actual and estimated gross profits expected to be realized from mortality, investment income less interest credited, and expense margins.
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.
See “Investments” in Note 2 - “Summary of Significant Accounting Policies” and Note 6 - “Fair Value of Assets and Liabilities” in the Notes to the Consolidated Financial Statements for additional information regarding the valuation of the Company’s investments.
The realization of deferred tax assets depends upon the existence of sufficient taxable income within the carryback or carryforward periods under the tax law in the applicable tax jurisdiction. The Company has deferred tax assets related to net operating and capital losses. The Company has projected its ability to utilize its U.S. and foreign net operating losses and has determined that all of the U.S. losses are expected to be utilized prior to their expiration and established a valuation allowance on the portion of the foreign deferred tax assets the Company believes more likely than not that deferred income tax assets will not be realized. The Company also has deferred tax assets related to foreign tax credit (“FTC”) carryforwards. The Company established a valuation allowance on the FTC carryforwards as the Company no longer expects to realize these credits.
Any such changes could significantly affect the amounts reported in the consolidated financial statements in the year these changes occur. The Company accounts for its total liability for uncertain tax positions considering the recognition and measurement thresholds established in general accounting principles for income taxes. The tax effects of a position are recognized in the consolidated statement of income only if it is more likely than not to be sustained upon examination by the appropriate taxing authority. Unrecognized tax benefits due to tax uncertainties that do not meet the more likely than not criteria are included
Income before income taxes for the U.S. and Latin America operations segment increased by $120.5 million, or 18.4%, and $210.7 million, or 47.5%, in 2017 and 2016, respectively. 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. The increase in 2016 was driven by changes in the value of the embedded derivatives associated with reinsurance treaties structured on a modco or funds withheld basis, improved claims experience in the Traditional segment, and higher investment income due to a higher invested asset base, driven largely by acquisitions of in force blocks late in 2015.
Income before income taxes for the U.S. and Latin America Traditional segment increased by $2.3 million, or 0.6%, and $135.3 million, or 57.4% in 2017 and 2016, respectively. The increase in 2017 was primarily due to higher investment income from variable investment income and a growing asset base offset somewhat by lower investment yields. Additionally, U.S. Traditional had a slightly lower underwriting margin compared to 2016. The increase in 2016 was primarily due to improved claims experience and an increase in investment income due to a higher invested asset base primarily associated with large in force block transactions executed in the fourth quarter of 2015.
Other operating expenses increased $4.5 million, or 3.5%, and $14.8 million, or 13.2% in 2017 and 2016, respectively. Contributing to the increase in 2016 was an expansion in underwriting personnel to support clients. Other operating expenses, as a percentage of net premiums, were 2.4%, 2.4% and 2.3% in 2017, 2016 and 2015, respectively. The expense ratio tends to fluctuate only slightly from period to period due to maturity and scale of this segment.
Guaranteed Minimum Benefit Riders - Represents the impact related to guaranteed minimum benefits associated with the Company’s reinsurance of variable annuities. The fair value changes of the guaranteed minimum benefits along with the changes in fair value of the free standing derivatives (interest rate swaps, financial futures and equity options), purchased by the Company to substantially hedge the liability are reflected in revenues, while the related impact on deferred acquisition expenses is reflected in benefits and expenses. The Company’s utilization of a credit valuation adjustment did not have a material effect on the change in fair value of these embedded derivatives for the years ended December 31, 2017, 2016 and 2015.
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 $14.5 million, $11.0 million and $2.7 million, in 2017, 2016 and 2015, respectively. The increase in income in in each period was primarily due to the flattening of the treasury yield curve.
Company’s reinsurance of EIAs and variable annuities and higher variable investment income. The increase in income in 2016, was primarily due to the full year impact in 2016 from the acquisition of Aurora National in the second quarter of 2015 and investment related gains (losses) associated with funds withheld and coinsurance portfolios, net of the corresponding impact to deferred acquisition costs. Funds withheld capital gains (losses) are reported through investment income while coinsurance activity is reflected in investment related gains (losses), net.
Benefits and expenses before certain derivatives increased by $152.1 million and by $36.8 million in 2017 and 2016, respectively. The increase in 2017 was primarily due to higher interest credited associated with the reinsurance of EIAs, interest credited from a new coinsurance transaction in 2017 and the corresponding impact to deferred acquisition costs from investment related gains (losses) in coinsurance and funds withheld portfolios. The increase in 2016 was primarily due to higher interest credited associated with the reinsurance of certain EIAs and the full year impact in 2016 from the acquisition of Aurora National in the second quarter of 2015. The effect on interest credited related to equity options is substantially offset by a corresponding change in investment income.
The invested asset base supporting this segment increased to $15.4 billion as of December 31, 2017 from $13.2 billion as of December 31, 2016. The increase in the asset base was due primarily to the aforementioned new coinsurance transaction in 2017. As of December 31, 2017 and 2016, $4.1 billion and $4.0 billion, respectively, 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 decreased by $14.5 million, or 10.8%, and increased by $10.5 million, or 8.5%, in 2017 and 2016, respectively. The decrease in income for 2017 was primarily due to unfavorable traditional individual life mortality experience compared to favorable experience in 2016. The increase in income before income taxes in 2016 was primarily due to a $12.0 million increase in investment related gains (losses), net, partially offset by a less favorable traditional individual life mortality experience, as compared to 2015. Foreign currency exchange fluctuation in the Canadian dollar resulted in an increase in income before income taxes of $3.2 million and a decrease of $5.8 million in 2017 and 2016, respectively.
Income before income taxes increased by $8.7 million, or 109.5%, and decreased by $6.0 million, or 42.8%, in 2017 and 2016, respectively. The increase in income before income taxes in 2017 was primarily due to favorable experience on longevity business. The decrease in income before income taxes in 2016 was primarily due to unfavorable experience on longevity business. Foreign currency exchange fluctuation in the Canadian dollar resulted in an increase in income before income taxes of $0.4 million and a decrease of $0.7 million in 2017 and 2016, respectively.
Net premiums decreased $0.5 million, or 1.2%, and increased by $0.7 million, or 1.9%, in 2017 and 2016, respectively. Foreign currency exchange fluctuation in the Canadian dollar resulted in an increase in net premiums of $0.9 million and a decrease of $1.4 million in 2017 and 2016, respectively.
Net investment income increased by $2.4 million, or 90.0%, and $1.3 million, or 87.5%, in 2017 and 2016, respectively. The increases in net investment income for both periods were primarily due to a growth in the invested asset base.
Income before income taxes increased by $25.9 million, or 15.4%, and $11.2 million, or 7.1%, in 2017 and 2016, respectively. 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. The increase in income before income taxes for 2016 was primarily due to increased business volume and favorable experience related to payout annuity and longevity business offset partly by unfavorable mortality and morbidity experience. Foreign currency exchange fluctuations contributed to a decrease in income before income taxes of $4.3 million and $20.4 million in 2017 and 2016, respectively.
Income before income taxes increased by $40.4 million, or 134.5%, and decreased by $18.4 million, or 37.9%, in 2017 and 2016, respectively. The increase in income before income taxes in 2017 was primarily due to business growth and favorable individual morbidity and mortality experience. The decrease in income before income taxes in 2016 was primarily due to unfavorable claims experience on life and critical illness business. Foreign currency exchange fluctuations contributed to an increase in income before income taxes of $1.5 million and a decrease of $1.0 million in 2017 and 2016, 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 $191.5 million, $203.4 million and $233.2 million in 2017, 2016 and 2015, respectively.
Investment related gains were level in 2017 and decreased by $8.4 million, or 99.9%, in 2016. Revenue related to unit-linked products were included in investment related gains in 2015. Beginning in 2016, revenue related to unit-linked products is included in investment income within the Financial Solutions segment.
Other revenues increased by $0.1 million, or 1.9% and decreased by $4.7 million, or 49.3%, in 2017 and 2016, respectively. These variances are primarily due to foreign currency transactions.
Loss ratios for this segment were 84.2%, 87.6% and 86.5% in 2017, 2016 and 2015, respectively. The decrease in loss ratio in 2017 was primarily due to favorable claims experience and changes in the mix of business reflecting increased volumes of new business with lower loss ratios, but with higher commissions. These higher commissions are reflected in the increase of
Other operating expenses increased by $1.0 million, or 1.0%, and $2.2 million, or 2.2%, in 2017 and 2016, respectively. The increase in 2017 was primarily due to the effect of foreign currency exchange fluctuations. The increase in 2016 was in line with expected expense levels to support business growth coupled with a higher level of incentive compensation expense. Foreign currency exchange fluctuations resulted in an increase in operating expenses of $1.6 million and a decrease of $8.1 million 2017 and 2016, respectively. Other operating expenses as a percentage of net premiums totaled 7.9%, 9.0% and 8.9% in 2017, 2016 and 2015, respectively.
Net premiums decreased by $16.6 million, or 9.2%, and increased by $8.4 million, or 4.9%, in 2017 and 2016, respectively. The decrease in 2017 in net premiums was due to a new retrocession treaty, executed for risk management purposes which cedes longevity risk to third parties, partially offset by an increase in premiums from new transactions. The increase in net premiums in 2016 was primarily due to premiums on longevity closed blocks. Foreign currency exchange fluctuations contributed to a decrease in net premiums of $7.6 million and $22.5 million in 2017 and 2016, respectively.
Net investment income decreased $2.0 million, or 1.6%, and increased by $51.9 million, or 70.6%, in 2017 and 2016, respectively. The decrease in 2017 in investment income in 2017 was primarily due to adverse foreign currency exchange fluctuations. The increase in 2016 is primarily due to an increase in the invested asset base related to a payout annuity treaty executed in the fourth quarter of 2015. Beginning in 2016, revenue related to unit-linked products was included in investment income of the Financial Solutions segment, contributing $13.1 million to the increase. The effect on investment income related to unit-linked products is substantially offset by a corresponding change in interest credited. Foreign currency exchange fluctuations resulted in a decrease in investment income of $4.8 million and $14.2 million in 2017 and 2016, respectively.
Other revenues decreased by $2.8 million, or 13.2% and $9.8 million, or 31.4%, in 2017 and 2016, respectively. The decrease in 2017 in other revenues was due to experience from a longevity swap normalizing after a particularly positive 2016. The decrease in 2016 in other revenues relate to reduced fee income associated with financial reinsurance treaties terminated at the end of 2015. 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 Asia Pacific operations include business generated by its offices principally in Australia, China, Hong Kong, India, Japan, Malaysia, New Zealand, Singapore, South Korea and Taiwan. The Traditional segment’s principal types of reinsurance include individual and group life and health, critical illness, disability and superannuation. Superannuation is the Australian government mandated compulsory retirement savings program. Superannuation funds accumulate retirement funds for employees, and, in addition, typically offer life and disability insurance coverage. The Financial Solutions segment includes financial reinsurance, asset-intensive and certain disability and life blocks. Reinsurance agreements may be facultative or automatic agreements covering primarily individual risks and in some markets, group risks.
Net premiums increased by $371.5 million, or 22.1%, and $129.9 million, or 8.4%, in 2017 and 2016, respectively. The increases in premiums for 2017 and 2016 were driven by both new and existing business written throughout the segment. The segment added new business production, measured by face amount of insurance in force, of $78.9 billion, $73.7 billion and $76.9 billion during 2017, 2016 and 2015, respectively. The face amount of reinsurance in force totaled $552.3 billion, $492.2 billion, and $462.7 billion at December 31, 2017, 2016 and 2015, respectively. Foreign currency fluctuations favorably affected the face amount of reinsurance in force by $30.6 billion and unfavorably by $4.7 billion in 2017 and 2016, respectively. Foreign currency exchange fluctuations contributed to an increase in net premiums of $22.7 million and $3.3 million in 2017 and 2016, respectively.
A portion of the net premiums for the segment, in each period presented, relates to reinsurance of critical illness coverage. This coverage provides a benefit in the event of the diagnosis of a pre-defined critical illness. Reinsurance of critical illness in the Asia Pacific operations is offered primarily in South Korea, Australia, China and Hong Kong. Net premiums from this coverage totaled $611.0 million, $398.3 million, and $312.6 million in 2017, 2016 and 2015, respectively.
Net investment income increased $8.6 million, or 10.4%, and $2.5 million, or 3.1%, in 2017 and 2016, respectively. The increases in 2017 and 2016 were primarily due to a higher invested asset base largely offset in 2016 by a lower investment yield.
Other revenues increased by $59.4 million, or 902.6%, and $0.4 million, or 5.8%, in 2017 and 2016, respectively. The increases in other revenues in 2017 was primarily due to $57.9 million in recapture fees associated with three treaties recaptured in Australia.
Loss ratios for this segment were 79.7%, 80.0% and 77.9% for 2017, 2016 and 2015, respectively. The decrease in the loss ratio in 2017 was primarily due to improved claims experience in Australia compared to the prior year. The increase in the loss ratio in 2016 was primarily due to aforementioned unfavorable individual disability claims experience in Australia and additional benefit expense associated with a large treaty in Hong Kong due to adjustments associated with delays in client reporting.
Other revenues decreased by $2.0 million, or 8.0%, and increased by $5.9 million, or 31.2%, in 2017 and 2016, respectively. The decrease in other revenues in 2017 was primarily due to run-off of the previously mentioned treaty in Japan. The increase in 2016 was primarily due to new transactions. The amount of reinsurance assumed from client companies, as measured by pre-tax statutory surplus, risk based capital and other financial reinsurance structures was $2.6 billion and $1.5 billion at December 31, 2017 and 2016, respectively. Fees earned from this business can vary significantly depending on the size of the transactions and the timing of their completion and therefore can fluctuate from period to period.
Corporate and Other revenues primarily include investment income from unallocated invested assets and investment related gains and losses. 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. Additionally, Corporate and Other includes results from certain wholly-owned subsidiaries and joint ventures that, among other activities, develop and market technology solutions for the insurance industry.
Total benefits and expenses increased by $59.9 million or 27.2%, and $32.2 million or 17.1%, in 2017 and 2016, respectively. The increase in total benefits and expenses in 2017 was primarily due to an increase in other operating expenses and interest expense offset by an increase in other insurance income, related to the offset to capital charges allocated to the operating segments. The $53.2 million increase in other operating expenses 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 $8.4 million increase in interest expense is primarily due to the issuance of $800.0 million in long-term debt in June 2016, which was partially offset by the repayment of $300.0 million of long-term debt in 2017, and a lower reduction in tax-related interest expense primarily resulting from settlement with the taxing authority.
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, 2017, the Company had $405.6 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:
As of December 31, 2017, the Company estimates that all 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.
The Company believes that cash flows from the source of funds available to it will provide sufficient cash flows for the next twelve months to satisfy the current liquidity requirements of RGA, Inc. and its subsidiaries under various scenarios that include the potential risk of early recapture of reinsurance treaties, market events and higher than expected claims. The Company performs periodic liquidity stress testing to ensure its asset portfolio includes sufficient high quality liquid assets that could be utilized to bolster its liquidity position under stress scenarios. These assets could be utilized as collateral for secured borrowing transactions with various third parties or by selling the securities in the open market if needed. The Company’s liquidity requirements have been and will continue to be funded through net cash flows from operations. However, in the event of significant unanticipated cash requirements beyond normal liquidity needs, the Company has multiple liquidity alternatives available based on market conditions and the amount and timing of the liquidity need. These alternatives include borrowings under committed credit facilities,
RGA, through wholly-owned subsidiaries, has committed to provide statutory reserve support to third-parties, in exchange for a fee, by funding loans if certain defined events occur. Such statutory reserves are required under the U.S. Valuation of Life Policies Model Regulation (commonly referred to as Regulation XXX for term life insurance policies and Regulation A-XXX for universal life secondary guarantees). The third-parties have recourse to RGA should the subsidiary fail to provide the required funding, however, as of December 31, 2017, the Company does not believe that it will be required to provide any funding under these commitments as the occurrence of the defined events is considered remote. See Note 12 - “Commitments, Contingencies and Guarantees” in the Notes to Consolidated Financial Statements for a table that presents these commitments by period and maximum obligation.
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 $3.5 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 which results in the acceleration of the maturity of indebtedness.
In June 2016, RGA issued 3.95% Senior Notes due September 15, 2026 with a face amount of $400.0 million and 5.75% Fixed-To-Floating Rate Subordinated Debentures due June 15, 2056 with a face amount of $400.0 million. These securities have been registered with the Securities and Exchange Commission. The net proceeds from these offerings were approximately $791.2 million and were used in part to repay upon maturity the Company’s $300.0 million 5.625% senior notes that matured in March 2017. The remainder will be used for general corporate purposes. Capitalized issue costs were approximately $8.8 million.
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 similar to those described in the “Debt” discussion above. At December 31, 2017, there were approximately $120.1 million of outstanding bank letters of credit in favor of third parties. Additionally, in accordance with applicable regulations, the Company utilizes letters of credit to secure statutory 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 UK. The Company believes the capital required to support the business in the affiliates reflects more realistic expectations than the original jurisdiction of the business, where capital requirements are often considered to be quite conservative. As of December 31, 2017, $1.5 billion in letters of credit from various banks were outstanding, but undrawn, backing reinsurance between the various subsidiaries of the Company. See Note 13-“Debt” in the Notes to Consolidated Financial Statements for information regarding the Company’s letter of credit facilities.
The Company has issued both collateral finance and securitization notes. The consolidated balance sheets include outstanding notes of $783.9 million and $840.7 million as of December 31, 2017 and 2016, respectively. See Note 14 - “Collateral Finance and Securitization Notes” in the Notes to Consolidated Financial Statements for additional information regarding the Company’s collateral finance and securitization notes.
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 captives subject to the new regulations as it evaluates the impact of the regulations on new captives, and how these new captives fit into the Company’s overall risk management and financing programs.
Some treaties give ceding companies the right to request that the Company place assets in trust for the benefit of the cedant to support statutory reserve credits in the event of a downgrade of the Company’s ratings to specified levels, generally non-investment grade levels, or if minimum levels of financial condition are not maintained. As of December 31, 2017, these treaties had approximately $2.9 billion 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 $2.2 billion were held in trust for the benefit of certain RGA subsidiaries to satisfy collateral requirements for reinsurance business at December 31, 2017. Additionally, securities with an amortized cost of $15.6 billion as of December 31, 2017, 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.
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 $453.8 billion of its gross assumed in force business, as of December 31, 2017, 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’s principal cash inflows from its reinsurance operations include premiums and deposit funds received from ceding companies. The primary liquidity concerns with respect to these cash flows are early recapture of the reinsurance contract by the ceding company and lapses of annuity products reinsured by the Company. The Company’s principal cash inflows from its invested assets result from investment income and the maturity and sales of invested assets. The primary liquidity concerns with respect to these cash inflows relates to the risk of default by debtors and interest rate volatility. The Company manages these risks very closely. See “Investments” and “Interest Rate Risk” below.
billion of funds available through collateralized borrowings from the Federal Home Loan Bank of Des Moines (“FHLB”) as of December 31, 2017. As of December 31, 2017, the Company could have borrowed these additional amounts without violating any of its existing debt covenants.
Cash Flows from Investments - The principal cash inflows from the Company’s investment activities come from repayments of principal on invested assets, proceeds from sales and maturities of invested assets, and settlements of freestanding derivatives. The principal cash outflows relate to purchases of investments, issuances of policy loans and settlements of freestanding derivatives. The Company typically has a net cash outflow from investing activities because cash inflows from insurance operations are reinvested in accordance with its asset/liability management discipline to fund insurance liabilities. The Company closely monitors and manages these risks through its credit risk management process. The primary liquidity concerns with respect to these cash flows are the risk of default by debtors and market disruption, which could make it difficult for the Company to sell investments.
Future policyholder benefits include liabilities related primarily to the Company’s reinsurance of life and health insurance products. Amounts presented in the table above represent the estimated obligations as they become due to ceding companies for benefits under such contracts, and also include future premiums, allowances and other amounts due to or from the ceding companies as the result of the Company’s assumptions of mortality, morbidity, policy lapse and surrender risk as appropriate to the respective product. Total payments may vary materially from prior years due to the assumption of new treaties or as a result of changes in projections of future experience. All estimated cash payments presented in the table above are undiscounted as to interest, net of estimated future premiums on policies currently in force and gross of any reinsurance recoverable. The sum of the undiscounted estimated cash flows shown for all years in the table is an obligation of $7,837.7 million compared to the discounted liability amount of $22,363.2 million included on the consolidated balance sheets, substantially all due to the effects of discounting the estimated cash flows in the balance sheet liability. The time value of money is not factored into the calculations in the table above. In addition, differences will arise due to changes in the projection of future benefit payments compared with those developed when the reserve was established. Expected premiums can exceed expected policy benefit payments and allowances due to the nature of the reinsurance treaties, which generally have increasing premium rates that exceed the increasing benefit payments.
Excluded from the table above are net deferred income tax liabilities, unrecognized tax benefits, and accrued interest related to unrecognized tax benefits of $2,319.1 million, for which the Company cannot reliably determine the timing of payment. Current income tax payable is also excluded from the table.
The net funded status of the Company’s 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, 2017, the Company had a net unfunded balance of $139.1 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’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’s liquidity position (cash and cash equivalents and short-term investments) was $1,396.8 million and $1,277.4 million at December 31, 2017 and 2016, respectively. The increase in cash and cash equivalents during 2017 is primarily related to the timing and execution of the Company’s investment strategies. Cash and cash equivalents includes cash collateral received from derivative counterparties of $185.9 million and $254.5 million as of December 31, 2017 and 2016, respectively. This unrestricted cash collateral is included in cash and cash equivalents and the obligation to return it is included in other liabilities in the Company’s consolidated balance sheets. Liquidity needs are determined from valuation analyses conducted by operational units and are driven by product portfolios. Periodic evaluations of demand liabilities and short-term liquid assets are designed to adjust specific portfolios, as well as their durations and maturities, in response to anticipated liquidity needs.
The Company is a member of the FHLB and holds $67.8 million of FHLB common stock, which is included in other invested assets on the Company’s consolidated balance sheets. Membership provides the Company access to borrowing arrangements with the FHLB (“advances”) and funding agreements, discussed below. The Company did not have advances at December 31, 2017 and 2016. The Company’s average outstanding balance of advances was $12.7 million and $28.5 million in 2017 and 2016, respectively. Interest on advances is reflected in interest expense on the Company’s consolidated statements of income.
The following table presents consolidated average invested assets at amortized cost, net investment income and investment yield, excluding spread related business. Spread related business is primarily associated with contracts on which the Company earns an interest rate spread between assets and liabilities. To varying degrees, fluctuations in the yield on other spread related business is generally subject to corresponding adjustments to the interest credited on the liabilities (dollars in thousands).
Investment yield was progressively lower each year primarily due to the effect of a lower interest rate environment notably in the U.S. and Canada.
See “Fixed Maturity and Equity Securities Available-for-Sale” in Note 4 - “Investments” in the Notes to Consolidated Financial Statements for tables that provide the amortized cost, unrealized gains and losses, estimated fair value of fixed maturity and equity securities, and the other-than-temporary impairments in AOCI by sector as of December 31, 2017 and 2016.
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”). As of December 31, 2017 and 2016, approximately 95.6% and 95.0%, respectively, of the Company’s consolidated investment portfolio of fixed maturity securities were investment grade.
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 in corporate securities, which represented approximately 60.9% of total fixed maturity securities at December 31, 2017, compared to 61.1% at December 31, 2016. 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 at December 31, 2017 and 2016.
The quality of the Company’s available-for-sale fixed maturity securities portfolio, as measured at fair value and by the percentage of fixed maturity securities invested in various ratings categories, relative to the entire available-for-sale fixed maturity security portfolio, at December 31, 2017 and 2016 was as follows (dollars in thousands):
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 RMBS 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.
Note 2 - “Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements for additional information. The table below summarizes other-than-temporary impairments and changes in the mortgage loan provision for 2017, 2016 and 2015 (dollars in thousands):
The fixed maturity impairments in 2017, 2016 and 2015 were largely related to high-yield energy and emerging market corporate securities. The equity impairments in 2017 were related to an equity position received as part of a debt restructuring. There were no impairment losses on equity securities in 2016 and 2015. In addition, other impairment losses in 2017, 2016 and 2015 are primarily due to impairments on limited partnerships.
As of December 31, 2017 and 2016, the Company’s mortgage loans, gross of unamortized deferred loan origination fees and expenses and valuation allowances, were distributed geographically as follows (dollars in thousands):
strength rating of “A” at December 31, 2017 and 2016. Certain ceding companies maintain segregated portfolios for the benefit of the Company.
Based on data provided by ceding companies at December 31, 2017 and 2016, funds withheld at interest totaled (dollars in thousands):
Based on data provided by the ceding company at December 31, 2017 and 2016, segregated portfolios contained primarily corporate, municipal, government and asset-backed securities as well as derivative securities and reverse repurchase obligations. These assets pose risks similar to the fixed maturity securities the Company directly owns. Derivatives consist primarily of S&P 500 options which are used to hedge liabilities and interest credited for EIAs reinsured by the Company. The securities held within the segregated portfolios are primarily investment-grade, with an average rating of “A.” The average maturity for investments held within the segregated portfolios of funds withheld at interest is ten years or more. Interest accrues to the total funds withheld at interest assets at rates defined by the treaty terms and the Company estimated the yields were approximately 7.78%, 5.89% and 6.10% for the years ended December 31, 2017, 2016 and 2015, respectively. Changes in these estimated yields are affected by changes in the fair value of equity options held in the funds withheld portfolio associated with EIAs. Additionally, under certain treaties the Company is subject to the investment performance on the withheld assets, although it does not directly control them. To mitigate this risk, the Company helps set the investment guidelines followed by the ceding company and monitors compliance.
Other invested assets include equity securities, limited partnership interests, joint ventures (other than operating joint ventures), derivative contracts, fair value option (“FVO”) contractholder-directed unit-linked investments, FHLB common stock and equity release mortgages. Other invested assets represented approximately 3.0% and 3.5% of the Company’s cash and invested assets as of December 31, 2017 and 2016, respectively. See “Other Invested Assets” in Note 4 - “Investments” in the Notes to Consolidated Financial Statements for a table that presents the carrying value of the Company’s other invested assets by type as of December 31, 2017 and 2016.
The Board of Directors (“the Board”) oversees enterprise risk through its standing committees. The Finance, Investments, and Risk Management (“FIRM”) Committee of the Board oversees the management of the Company’s ERM program and policies. The FIRM receives regular reports and assessments which describe the Company’s key risk exposures and include quantitative and qualitative assessments and information about breaches, exceptions, and waivers.
The Company’s Global Chief Risk Officer (“CRO”) leads the dedicated ERM function. The CRO reports to the Chief Executive Officer (“CEO”) and has direct access to the Board through the FIRM Committee with formal reporting occurring quarterly. The CRO is supported by a network of Business Unit Chief Risk Officers and Risk Management Officers throughout the business who are responsible for the analysis and management of risks within their scope. A Lead Risk Management Officer is assigned to each risk to take overall responsibility to monitor and assess the risk consistently across all markets.
Risk Limits: Risk Limits establish the maximum amount of defined risk that the Company is willing to assume to remain within the Company’s overall risk appetite. These risks have been identified by the management of the Company as relevant to manage the overall risk profile of the Company while allowing achievement of strategic objectives.
The Company seeks to limit its exposure to loss on its assumed catastrophic excess of loss reinsurance agreements by ceding a portion of its exposure to multiple retrocessionaires through retrocession line slips or directly to retrocession markets. The Company’s policy is to retain a maximum of $20.0 million of catastrophic loss exposure per agreement and to retrocede up to $30.0 million additional loss exposures to the retrocession markets. The Company limits its exposure on a country-by-country (and state-by-state in the U.S.) basis by managing its total exposure to all catastrophic excess of loss agreements bound within a given country to established maximum aggregate exposures. The maximum exposures are established and managed both on gross amounts issued prior to including retrocession and for amounts net of exposures retroceded.
The following table presents the account values, the weighted average interest-crediting rates and minimum guaranteed rate ranges for the contracts containing guaranteed rates by major class of interest-sensitive product as of December 31, 2017 and 2016 (dollars in thousands):
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 $5,343.9 million and $4,218.6 million of account balances are not subject to surrender charges as of December 31, 2017 and 2016, 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 also used to measure the Company’s interest rate cash flow risk by computing estimated changes in the expected cash flows for floating rate assets and liabilities over a one year period following an instantaneous, parallel, hypothetical 100 basis point change (increase or decrease) in market interest rates. The Company does not have variable rate instruments classified as trading securities. The Company’s projected decrease in cash flows associated with floating rate instruments in the event of an instantaneous 100 basis point decrease in market interest rates for its fiscal years ended December 31, 2017 and 2016 was $44.4 million and $33.7 million, respectively.
In order to reduce the exposure to changes in fair values from interest rate fluctuations, the Company has developed strategies to manage the net interest rate sensitivity of its assets and liabilities. In addition, from time to time, the Company has utilized the swap market to manage the sensitivity of fair values to interest rate fluctuations.
Inflation can also have direct effects on the Company’s assets and liabilities. The primary direct effect of inflation is the increase in operating expenses. A large portion of the Company’s operating expenses consists of salaries, which are subject to wage increases at least partly affected by the rate of inflation.
Long Term Care products have an inflation component linked to the future cost of such services. If health care costs increase at a much larger rate than what is prevalent in the nominal interest rates available in the markets, the Company may not earn enough investment yield to pay future claims on such products.
Real Estate risk is the risk that changes in the level and volatility of real estate market valuations may impact the profitability, value or solvency position of the Company. The Company has investments in direct real estate equity and debt instruments collateralized by real estate (“real estate loans”). Real estate equity risks include significant reduction in valuations, which could be caused by downturns in the broad economy or in specific geographic regions or sectors. In addition, real estate loan risks include defaults, borrower or tenant bankruptcy and reduced liquidity. Real estate loan risks are partially mitigated by the excess of the value of the property over the loan principle, which provides a buffer should the value of the real estate decrease. The Company manages its real estate loan risk by diversifying by property type and geography and through exposure limits.
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 swings in interest rates, unexpected contract holder behavior, and divergence between the performance of the underlying funds and hedging indices. These factors, individually or collectively, may have a material adverse effect on the Company’s net income, financial condition or liquidity. The table below provides a summary of variable annuity account values and the fair value of the guaranteed benefits as of December 31, 2017 and 2016.
Counterparty risk is the potential for the Company to incur losses due to a client, retrocessionaire, or partner becoming distressed or insolvent. This includes run-on-the-bank risk and collection risk.
Collateral risk is the risk that collateral will not be available at expected costs or in the capacity required to meet current and future needs. The Company monitors risks related to interest rate movement, collateral requirements and position and capital markets environment. Collateral demands and resources continue to be actively managed with available collateral sources being more than sufficient to cover stress level collateral demands.
Liquidity risk is the risk that the Company is unable to meet payment obligations at expected costs or in the capacity required. The Company’s traditional liquidity demands include items such as claims, expenses, debt financing and investment purchases which are largely known or can be reasonably forecasted. The Company regularly performs liquidity risk modeling, including both market and Company specific stresses, to assess the sufficiency of available resources.
Business conduct and governance is the risk related to management oversight, compliance, market conduct, and legal matters. The Company’s Compliance Risk Management Program facilitates a proactive evaluation of present and potential compliance risks associated with both local and enterprise-wide regulatory requirements as well as compliance with Company policies and procedures.
Privacy and security risk is the risk of theft, loss, or unauthorized disclosure of physical or electronic assets resulting in a loss of asset value, confidentiality, or intellectual property. The Company’s privacy and security programs, processes, and procedures are designed to prevent unauthorized physical and electronic theft and the disclosure of confidential and personal data related to its customers, insured individuals or its employees. The Company employs technology, administrative related processes and procedural controls, security measures and other preventative actions to reduce the risk of such incidents.
Business operations risk is the risk related to business processes and procedures. Business operations risk includes risk associated with the processing of transactions, data use and management, monitoring and reporting, the integrity and accuracy of models and the use of third party and advisory services.
Strategy risk is the risk related to the design and execution of the Company’s strategic plan, including risks associated with merger and acquisition activity. Strategy risks are addressed by a robust multi-year planning process, regular business unit level assessments of strategy execution and active benchmarking of key performance and risk indicators across the Company’s portfolios of businesses. The Company’s risk appetites and limits are set consistently with strategic objectives.
Key relationships risk relates to areas of important interactions with parties external to the Company. The Company’s reputation is a critical asset in successfully conducting business and therefore relationships with its primary stakeholders (including but not limited to business partners, shareholders, clients, rating agencies, and regulators) are all carefully monitored.
Political and regulatory risk relates to future law and regulation changes and the impact of political changes or instability on the Company’s ability to achieve its objectives. Regulatory and political developments and related risks that may affect the Company are identified, assessed and monitored as part of regular oversight activities.
Reinsurance Group of America, Incorporated (“RGA”) is an insurance holding company that was formed on December 31, 1992. The consolidated financial statements herein include the assets, liabilities, and results of operations of RGA and its subsidiaries, all of which are wholly owned (collectively, the “Company”).
Funds withheld at interest represent amounts contractually withheld by ceding companies in accordance with reinsurance agreements. For agreements written on a modified coinsurance basis and agreements written on a coinsurance funds withheld basis, assets which support the net statutory reserves or as defined in the treaty, are withheld and legally owned by the ceding company. Interest, recorded in investment income, net of related expenses in the consolidated statements of income, accrues to these assets at calculated rates as defined by the treaty terms. Changes in the value of the equity options held within the funds withheld portfolio associated with equity-indexed annuity treaties are reflected in investment income, net of related expenses.
In addition to derivative contracts discussed below, other invested assets include equity securities, contractholder-directed investments, limited partnership interests, joint ventures (other than operating joint ventures), equity release mortgages and structured loans. Equity securities are carried at fair value with the exception of the Company’s investment in the Federal Home Loan Bank of Des Moines (“FHLB”) common stock, which is carried at cost. The fair value option (“FVO”) was elected for contractholder-directed investments supporting unit-linked variable annuity type liabilities which do not qualify for presentation and reporting as separate accounts. Changes in estimated fair value of these securities are included in investment income, net of
Equity release mortgages are carried at unpaid principal balances, net of any unamortized premium or discount and valuation allowance. Interest income is accrued on the principal amount of the equity release mortgage based on its contractual interest rate.
flow estimates are derived from scenario-based outcomes of expected corporate restructurings or the disposition of assets using security specific facts and circumstances including timing, security interests and loss severity.
Under a fair value hedge, changes in the fair value of the hedging derivative, including amounts measured as ineffective, and changes in the fair value of the hedged item related to the designated risk being hedged, are reported within investment related gains (losses), net. The fair values of the hedging derivatives are exclusive of any accruals that are separately reported in the consolidated statement of income within interest income or interest expense to match the location of the hedged item.
Such embedded derivatives are carried on the consolidated balance sheets at fair value in the same line item as the host contract. Changes in the fair value of embedded derivatives associated with equity-indexed annuities are reflected in interest credited on the consolidated statements of income and changes in the fair value of embedded derivatives associated with variable annuity guaranteed minimum benefits are reflected in investment related gains (losses), net on the consolidated statements of income. See “Interest-Sensitive Contract Liabilities” below for additional information on embedded derivatives related to equity-indexed and variable annuities. The Company has implemented an economic hedging strategy to mitigate the volatility associated with its reinsurance of variable annuity guaranteed minimum benefits. The hedging strategy is designed such that changes in the fair value of the hedge contracts, primarily futures, swap contracts and options, move in the opposite direction of changes in the fair value of the embedded derivatives. While the Company actively manages its hedging program, the hedges that are in place may not be totally effective in offsetting the embedded derivative changes due to the many variables that must be managed and the Company may see a corresponding increase or decrease in the net liability. The Company has elected not to assess this hedging strategy for hedge accounting treatment.
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 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. Based on its review of these factors and historical experience, the Company did not believe a provision for doubtful accounts was necessary as of December 31, 2017 or 2016.
Goodwill, reported in other assets, is not amortized into results of operations, but instead is reviewed at least annually for impairment and written down only in the periods in which the recorded value of goodwill exceeds its fair value. Goodwill as of December 31, 2017 and 2016 totaled $7.0 million. The value of business acquired (“VOBA”) is amortized in proportion to the ratio of annual premium revenues to total anticipated premium revenues or in relation to the present value of estimated profits. Anticipated premium revenues have been estimated using assumptions consistent with those used in estimating reserves for future policy benefits. The carrying value is reviewed at least annually for indicators of impairment in value. The VOBA was approximately $3.3 million and $3.1 million, including accumulated amortization of $14.6 million and $14.3 million, as of December 31, 2017 and 2016, respectively. The VOBA amortization expense for the years ended December 31, 2017, 2016 and 2015 was $0.3 million, $0.5 million, and $0.4 million, respectively. These amortized balances are included in other assets on the consolidated balance sheets. Future amortization of the VOBA is not material.
Value of distribution agreements (“VODA”) is reported in other assets and represents the present value of future profits associated with the expected future business derived from the distribution agreements. Value of customer relationships acquired (“VOCRA”) is also reported in other assets and represents the present value of the expected future profits associated with the expected future business acquired through existing customers of the acquired company or business. The VODA is amortized over a useful life of 15 years and the VOCRA is also amortized over a 15 year period in proportion to expected revenues generated. Such amortization is included in policy acquisition costs and other insurance expenses for reinsurance-related acquisitions or other operating expenses for other acquisitions. Each year the Company reviews VODA and VOCRA to determine the recoverability of these balances. VODA and VOCRA totaled approximately $52.3 million and $61.2 million, including accumulated amortization of $72.1 million and $63.2 million, as of December 31, 2017 and 2016, respectively. The VODA and VOCRA amortization expense for the years ended December 31, 2017, 2016 and 2015 was $8.9 million, $9.3 million and $9.5 million, respectively. Amortization of the VODA and VOCRA is estimated to be $8.6 million, $8.3 million, $7.8 million, $6.9 million and $6.6 million during 2018, 2019, 2020, 2021 and 2022, respectively.
Property, equipment and leasehold improvements, which are included in other assets, are stated at cost, less accumulated depreciation. Depreciation is determined using the straight-line method over the estimated useful lives of the assets, as appropriate. The estimated life is generally 40 years for company occupied real estate property, from one to seven years for leasehold improvements, and from three to seven years for all other property and equipment. The cost basis of the property, equipment and leasehold improvements was $236.1 million and $221.7 million at December 31, 2017 and 2016, respectively. Accumulated depreciation of property, equipment and leasehold improvements was $79.4 million and $60.8 million at December 31, 2017 and 2016, respectively. Related depreciation expense was $17.2 million, $16.6 million and $17.1 million for the years ended December 31, 2017, 2016 and 2015, respectively. The Company had assets acquired under capital leases, included in the total above, of $136.3 million and $145.7 million, net of accumulated depreciation of $30.5 million and $21.0 million as of December 31, 2017 and 2016, respectively. Depreciation on assets under capital leases charged to expense is included in other operating expenses. Depreciation expense for the years ended December 31, 2017, 2016 and 2015 was $9.4 million, $9.6 million and $10.0 million, respectively.
Liabilities for future benefits on life policies are established in an amount adequate to meet the estimated future obligations on policies in force. Liabilities for future policy benefits under long-term life insurance policies have been computed based upon expected investment yields, mortality and withdrawal (lapse) rates, and other assumptions. These assumptions include a margin for adverse deviation and vary with the characteristics of the plan of insurance, year of issue, age of insured, and other appropriate factors. Interest rates range from 3.0% to 6.0%. The mortality and withdrawal assumptions are based on the Company’s experience as well as industry experience and standards. In establishing reserves for future policy benefits, the Company assigns policy liability assumptions to particular timeframes (eras) in such a manner as to be consistent with the underlying assumptions and economic conditions at the time the risks are assumed. The Company maintains a consistent approach to setting the provision for adverse deviation between eras.
The Company provides for federal, state and foreign income taxes currently payable, as well as those deferred due to temporary differences between the financial reporting and tax bases of assets and liabilities and are recognized in net income or in certain cases in OCI. The Company’s accounting for income taxes represents management’s best estimate of various events and transactions considering the laws enacted as of the reporting date. The Tax Cuts and Jobs Act of 2017 (“U.S. Tax Reform”) creates additional complexity due to various provisions that require management judgment and assumptions, which are subject to change.
In March 2016, the FASB updated the general accounting principal for Stock Compensation which changed how companies account for certain aspects of share-based payment awards to employees. The updated guidance requires excess tax benefits and deficiencies from share-based payment awards be recorded in income tax expense in the income statement. Previously, excess tax benefits and deficiencies were recognized in shareholders’ equity or deferred taxes on the balance sheet depending on the tax situation of the Company. In addition, the updated guidance also changes the accounting for forfeitures and statutory tax withholding requirements, as well as the classification in the statement of cash flows. The new standard generally requires a modified retrospective transition through a cumulative-effect adjustment as of the beginning of the period of adoption, with certain provisions requiring either a prospective or retrospective transition. The Company adopted the new guidance on January 1, 2017. Upon adoption, the Company recognized excess tax benefits of approximately $17.7 million in deferred tax assets that were previously not recognized in a cumulative-effect adjustment increasing retained earnings by $17.7 million. The Company also recorded excess
tax benefits of approximately $10.5 million in the provision for income taxes for the year ended December 31, 2017. The number of weighted average diluted shares outstanding were also adjusted to exclude excess tax benefits from the assumed proceeds in the diluted shares calculation resulting in an immaterial increase in the number of dilutive shares outstanding. The Company also elected to continue estimating forfeitures for purposes of recognizing share-based compensation. Other aspects of the adoption of the updated guidance did not have a material impact to the Company’s financial statements.
In February 2016, the FASB issued guidance which will replace most existing lease accounting guidance. The new standard, based on the principle that entities should recognize assets and liabilities arising from leases, does not significantly change the lessees’ recognition, measurement and presentation of expenses and cash flows from the previous accounting standard. Leases are classified as finance or operating. The new standard’s primary change is the requirement for entities to recognize a lease liability for payments and a right of use asset representing the right to use the leased asset during the term of operating lease arrangements. Lessees are permitted to make an accounting policy election to not recognize the asset and liability for leases with a term of twelve months or less. Lessors’ accounting is largely unchanged from the previous accounting standard. In addition, the new standard expands the disclosure requirements of lease arrangements. Lessees and lessors will use a modified retrospective transition approach, which includes a number of practical expedients. This guidance is effective for the Company January 1, 2019, with early adoption permitted. The Company is currently evaluating the impact of this amendment on its consolidated financial statements; however, it does not expect the adoption of the new standard to have a material impact on its results of operations or balance sheet as a result of the recognition of right-to-use assets and lease liabilities related to operating leases. Contractual obligations related to operating leases totaled approximately $38.2 million as of December 31, 2017.
different. This amendment will be applied using a modified retrospective transition method with a cumulative effect adjustment to retained earnings as of the beginning of the period of adoption. The adoption of this amendment is not expected to have a material impact on the Company’s consolidated financial statements.
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, 2017 and 2016, 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 certain third-party reinsurance treaties. The following table includes fixed maturity securities pledged and received as collateral and assets in trust held to satisfy collateral requirements under derivative transactions and certain third-party reinsurance treaties as of December 31, 2017 and 2016 (dollars in thousands):
The amortized cost and estimated fair value of fixed maturity securities available-for-sale at December 31, 2017 are shown by contractual maturity in the table below (dollars in thousands). Actual maturities can differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Asset and mortgage-backed securities are shown separately in the table below, as they are not due at a single maturity date.
Unrealized losses on below investment grade securities as of December 31, 2017 are primarily related to high-yield corporate securities. Changes in unrealized losses are primarily driven by changes in credit spreads and interest rates.
The other-than-temporary impairment losses on fixed maturity securities for 2017, 2016 and 2015 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 modified coinsurance and funds withheld treaties, as a result of changes in interest rates, driven primarily by credit spreads.
The following table includes the amount of borrowed securities, securities lent and securities collateral received as part of the securities lending program, repurchased/reverse repurchased securities pledged and received and cash received as of December 31, 2017 and 2016 (dollars in thousands):
The following tables present information on the Company’s securities lending and repurchase transactions as of December 31, 2017 and 2016, respectively (dollars in thousands). Collateral associated with certain borrowed securities is not included within the tables as the collateral pledged to each counterparty is the right to reinsurance treaty cash flows.
The Company has elected to offset amounts recognized as receivables and payables resulting from the repurchase/reverse repurchase programs. After the effect of offsetting, the net amount presented on the consolidated balance sheets was a liability of $1.1 million and $5.5 million as of December 31, 2017 and 2016, respectively. As of December 31, 2017 and 2016, the Company recognized payables resulting from cash received as collateral associated with a repurchase agreement as discussed above. Amounts owed to and due from the counterparties may be settled in cash or offset, in accordance with the agreements.
Mortgage loans represented approximately 8.5% and 8.4% of the Company’s total investments as of December 31, 2017 and 2016, respectively. As of December 31, 2017, mortgage loans were geographically dispersed throughout the U.S. with the largest concentrations in California (19.5%), Texas (8.4%) and Georgia (7.6%) and include loans secured by properties in Canada (2.3%). 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, 2017 and 2016 (dollars in thousands):
The following table presents the recorded investment in mortgage loans, by method of measuring impairment, and the related valuation allowances, as of December 31, 2017 and 2016 (dollars in thousands):
The Company’s average investment balance of impaired mortgage loans and the related interest income are reflected in the table below for the years ended December 31, 2017, 2016 and 2015 (dollars in thousands):
Policy loans comprised approximately 2.6% and 3.2% of the Company’s total investments as of December 31, 2017 and 2016, 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.
Funds withheld at interest comprised approximately 11.8% and 13.1% of the Company’s total investments as of December 31, 2017 and 2016, respectively. Of the $6.1 billion funds withheld at interest balance, net of embedded derivatives, as of December 31, 2017, $4.1 billion of the balance is associated with one client. For reinsurance agreements written on a modified coinsurance basis and certain agreements written on a coinsurance funds withheld basis, assets equal to the net statutory reserves are withheld and legally owned and managed by the ceding company and are reflected as funds withheld at interest on the Company’s consolidated balance sheets. In the event of a ceding company’s insolvency, the Company would need to assert a claim on the assets supporting its reserve liabilities. However, the risk of loss to the Company is mitigated by its ability to offset amounts it owes the ceding company for claims or allowances against amounts owed to the Company from the ceding company.
Other invested assets include equity securities, limited partnership interests, joint ventures (other than operating joint ventures), derivative contracts, and FVO contractholder-directed unit-linked investments. Other invested assets also include Federal Home
Derivatives, except for embedded derivatives and longevity and mortality swaps, are carried on the Company’s consolidated balance sheets in other invested assets or other liabilities, at fair value. Longevity and mortality swaps are included on the consolidated balance sheets in other assets or other liabilities, at fair value. Embedded derivative assets and liabilities on modified coinsurance or funds withheld arrangements are included on the consolidated balance sheets with the host contract in funds withheld at interest, at fair value. Embedded derivative liabilities on indexed annuity and variable annuity products are included on the consolidated balance sheets with the host contract in interest-sensitive contract liabilities, at fair value. The following table presents the notional amounts and gross fair value of derivative instruments prior to taking into account the netting effects of master netting agreements as of December 31, 2017 and 2016 (dollars in thousands):
The following table provides information relating to the Company’s derivative instruments as of December 31, 2017 and December 31, 2016 (dollars in thousands):
The Company does not enter into derivative instruments for speculative purposes. As discussed below under “Non-qualifying Derivatives and Derivatives for Purposes Other Than Hedging,” the Company uses various derivative instruments for risk management purposes that either do not qualify or have not been qualified for hedge accounting treatment. As of December 31, 2017 and 2016, the Company held interest rate swaps that were designated and qualified as cash flow hedges of interest rate risk, for variable rate liabilities and foreign currency assets, foreign currency swaps and foreign currency forwards that were designated and qualified as hedges of a portion of its net investment in its foreign operations, foreign currency swaps that were designated and qualified as fair value hedges of foreign currency risk, and derivative instruments that were not designated as hedging instruments. See Note 2 - “Summary of Significant Accounting Policies” for a detailed discussion of the accounting treatment for derivative instruments, including embedded derivatives. Derivative instruments are carried at fair value and generally require an insignificant amount of cash at inception of the contracts.
The Company designates and reports certain foreign currency swaps to hedge the foreign currency fair value exposure of foreign currency denominated assets as fair value hedges when they meet the requirements of the general accounting principles for Derivatives and Hedging. The gain or loss on the hedged item attributable to a change in foreign currency and the offsetting gain or loss on the related foreign currency swaps as of December 31, 2017, 2016 and 2015 were (dollars in thousands):
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, 2017, 2016 and 2015 (dollars in thousands):
As of December 31, 2017, the before-tax deferred net gains (losses) on derivative instruments recorded in AOCI that are expected to be reclassified to earnings during the next twelve months are approximately $0.7 million and $(0.8) million in investment income and interest expense, respectively.
Interest rate options, commonly referred to as swaptions, have been used by the Company primarily to hedge living benefit guarantees embedded in certain variable annuity products. A swaption, used to hedge against adverse changes in interest rates, is an option to enter into a swap with a forward starting effective date. The Company pays an upfront premium for the right to exercise this option in the future.
Mortality swaps have been used by the Company to hedge risk from changes in mortality experience associated with its reinsurance of life insurance risk. The Company agrees with another party to exchange, at specified intervals, a proportion of a notional value determined by the difference between a predefined expected and realized claim amount on a designated index of reinsured lives, for a fixed percentage (premium) each term. The mortality swaps matured in 2017 and an accrued liability for amounts owed to the counterparty is recorded in other liabilities at December 31, 2017.
The Company sells fee-based synthetic guaranteed investment contracts to retirement plans which include investment-only, stable value contracts. The assets are owned by the trustees of such plans, who invest the assets under the terms of investment guidelines to which the Company agrees. The contracts contain a guarantee of a minimum rate of return on participant balances supported by the underlying assets, and a guarantee of liquidity to meet certain participant-initiated plan cash flow requirements. These contracts are reported as derivatives and recorded at fair value.
The credit exposure of the Company’s OTC derivative transactions is represented by the contracts with a positive fair value (market value) at the reporting date. To reduce credit exposures, the Company seeks to (i) enter into OTC derivative transactions pursuant to master netting agreements that provide for a netting of payments and receipts with a single counterparty and (ii) enter into agreements that allow the use of credit support annexes, which are bilateral rating-sensitive agreements that require collateral postings at established threshold levels. Certain of the Company’s OTC derivatives are cleared derivatives, which are bilateral transactions between the Company and a counterparty where the transactions are cleared through a clearinghouse, such that each derivative counterparty is only exposed to the default of the clearinghouse. These cleared transactions require initial and daily variation margin collateral postings and include certain interest rate swaps and credit default swaps entered into on or after June 10, 2013, related to guidelines implemented under the Dodd-Frank Wall Street Reform and Consumer Protection Act. In 2017, the Company followed the Chicago Mercantile Exchange amended rulebook to legally characterize variation margin payments as settlements of the derivative’s mark-to-market exposure and not collateral. Also, the Company enters into exchange-traded futures through regulated exchanges and these transactions are settled on a daily basis, thereby reducing credit risk exposure in the event of non-performance by counterparties to such financial instruments.
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the related assets or liabilities. Level 3 assets and liabilities include those whose value is determined using market standard valuation techniques described above. When observable inputs are not available, the market standard techniques for determining the estimated fair value of certain securities that trade infrequently, and therefore have little transparency, rely on inputs that are significant to the estimated fair value and that are not observable in the market or cannot be derived principally from or corroborated by observable market data. These unobservable inputs can be based in large part on management judgment or estimation and cannot be supported by reference to market activity. Even though unobservable, management believes these inputs are based on assumptions deemed appropriate given the circumstances and consistent with what other market participants would use when pricing similar assets and liabilities. Prices are determined using valuation methodologies such as discounted cash flow models and other similar techniques that require management’s judgment or estimation in developing inputs that are consistent with those other market participants would use when pricing similar assets and liabilities. Non-binding broker quotes, which are utilized when pricing service information is not available, are reviewed for reasonableness based on the Company’s understanding of the market, and are generally considered Level 3. Under certain circumstances, based on its observations of transactions in active markets, the Company may conclude the prices received from independent third party pricing services or brokers are not reasonable or reflective of market activity. In those instances, the Company would apply internally developed valuation techniques to the related assets or liabilities.
Additionally, the Company’s embedded derivatives, all of which are associated with reinsurance treaties, and longevity and mortality swaps are classified in Level 3 since their values include significant unobservable inputs.
Assets and liabilities measured at fair value on a recurring basis as of December 31, 2017 and December 31, 2016 are summarized below (dollars in thousands):
Cash Equivalents and Short-Term Investments - Cash equivalents and short-term investments include money market instruments, commercial paper and other highly liquid debt instruments. Money market instruments are generally valued using unadjusted quoted prices in active markets that are accessible for identical assets and are primarily classified as Level 1. The fair value of certain other cash equivalents and short-term investments, such as bonds with original maturities less than twelve months, are based upon other market observable data and are typically classified as Level 2. However, certain short-term investments may incorporate significant unobservable inputs resulting in a Level 3 classification. Various time deposits, certificates of deposit and sweeps carried as cash equivalents or short-term investments are not measured at estimated fair value and therefore are excluded from the tables presented.
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, 2017 and December 31, 2016, respectively, the Company classified approximately 5.9% and 6.9% of its fixed maturity securities in the Level 3 category. These securities primarily consist of private placement corporate securities, bank loans, Canadian provincial strips, below investment grade mortgage-backed securities and subprime asset-backed securities with inactive trading markets.
The actuarial assumptions used in the fair value of embedded derivatives which include assumptions related to lapses, withdrawals, and mortality, are based on experience studies performed by the Company in combination with available industry information and are reviewed on a periodic basis, at least annually. The significant unobservable inputs used in the fair value measurement of embedded derivatives are assumptions associated with policyholder experience and selected capital market assumptions for equity-indexed and variable annuities. The selected capital market assumptions, which include long-term implied volatilities, are projections based on short-term historical information. Changes in interest rates, equity indices, equity volatility, CVA, and actuarial assumptions regarding policyholder experience may result in significant fluctuations in the value of embedded derivatives.
The following table presents quantitative information about significant unobservable inputs used in Level 3 fair value measurements that are developed internally by the Company as of December 31, 2017 and 2016 (dollars in thousands):
The Company recognizes transfers of assets and liabilities into and out of levels within the fair value hierarchy at the beginning of the quarter in which the actual event or change in circumstances that caused the transfer occurs. Transfers between Levels 1 and 2 are made to reflect changes in observability of inputs and market activity. There were no transfers between Level 1 and Level 2 for year ended December 31, 2016. The transfers from level 1 to level 2 during the year ended December 31, 2017 were due to the Company refining its process related to the observability of inputs and market activity. The following tables present the transfers between Level 1 and Level 2 during the year ended December 31, 2017 (dollars in thousands):
Assets and liabilities transferred into Level 3 are due to a lack of observable market transactions and price information. Certain transfers into Level 3 were also due to ratings downgrades on mortgage-backed securities that previously had investment-grade ratings. Assets and liabilities are transferred out of Level 3 when circumstances change such that significant inputs can be corroborated with market observable data. This may be due to a significant increase in market activity for the asset or liability, a specific event, or one or more significant input(s) becoming observable. Transfers out of Level 3 were primarily the result of the Company obtaining observable pricing information or a third party pricing quotation that appropriately reflects the fair value of those assets and liabilities. In addition, certain transfers out of Level 3 were also due to ratings upgrades on mortgage-backed securities that previously had below investment-grade ratings.
The following table presents information for assets measured at estimated fair value on a nonrecurring basis during the periods presented and still held at the reporting dates (for example, when there is evidence of impairment). The estimated fair values for these assets were determined using significant unobservable inputs.
The impaired limited partnership interests presented above were accounted for using the cost method. Impairments on these cost method investments were recognized at estimated fair value determined using the net asset values of the Company’s ownership interest as provided in the financial statements of the investees. The market for these investments has limited activity and price transparency.
The Company is required by general accounting principles for Fair Value Measurements and Disclosures to disclose the fair value of certain financial instruments including those that are not carried at fair value. The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments, which were not measured at fair value on a recurring basis, as of December 31, 2017 and December 31, 2016 (dollars in thousands).This table excludes any payables or receivables for collateral under repurchase agreements and other transactions. The estimated fair value of the excluded amount approximates carrying value as they equal the amount of cash collateral received/paid.
Cash and Cash Equivalents and Short-term Investments - The carrying values of cash and cash equivalents and short-term investments approximates fair values due to the short-term maturities of these instruments and are considered Level 1 in the fair value hierarchy.
Accrued Investment Income - The carrying value for accrued investment income approximates fair value as there are no adjustments made to the carrying value. This is considered Level 2 in the fair value hierarchy.
At December 31, 2017 and 2016, respectively, the Company provided approximately $16.2 billion and $10.8 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.
The Tax Cuts and Jobs Act of 2017 (“U.S. Tax Reform”) was signed into law on December 22, 2017. U.S. Tax Reform makes broad and complex changes to the U.S. tax code, including, but not limited to, (1) reducing the U.S. federal corporate tax rate from 35 percent to 21 percent; (2) requiring companies to pay a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries; (3) generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries; (4) eliminating the corporate alternative minimum tax (“AMT”) and changing how existing AMT credits can be realized; (5) creating the base erosion anti-abuse tax (“BEAT”), a new minimum tax; (6) establishing a new provision designed to tax global intangible low-taxed income (“GILTI”), which allows for the possibility of using foreign tax credits and a deduction of up to 50 percent to offset the income tax liability (subject to some limitations); and (7) changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017.
Because of the complexity of the new GILTI tax rules, the Company is continuing to evaluate this provision of U.S. Tax Reform and the application of Accounting Standards Codification 740 (“ASC 740”). Under U.S. GAAP, the Company is allowed to make an accounting policy choice of either (1) treating taxes due on future U.S. inclusions in taxable income related to the GILTI as a current-period expense when incurred (“the period cost method”) or (2) factoring such amounts into a Company’s measurement of its deferred taxes (“the deferred method”). The Company’s selection of an accounting policy with respect to new GILTI tax rules will depend, in part, on analyzing its global income to determine whether the Company expects to have future U.S. inclusions in taxable income related to GILTI and, if so, what the impact is expected to be. Whether the Company expects to have future U.S. inclusions in taxable income related to GILTI depends on not only its current corporate structure, its intercompany reinsurance business flows and estimated future results of global operations, but also its intent and ability to modify its structure and/or its business, the Company is not yet able to reasonably estimate the effect of this provision of U.S. Tax Reform. Therefore, the Company has not made any adjustments related to potential GILTI tax in its financial statements and has not made a policy decision regarding whether to record deferred taxes on GILTI.
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. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of U.S. Tax Reform for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of U.S. Tax Reform is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of U.S. Tax Reform.
The Company calculated a provisional estimate of the impact of U.S. Tax Reform. The actual adjustment may vary from this estimate due to a number of uncertainties and factors, including changes in interpretations and assumptions made by the Company, gathering additional information to more precisely compute the pretax deferred tax items upon which the change in rate was applied, and may change due to future further clarification of the new law regulatory and accounting guidance. The Company is still analyzing U.S. Tax Reform and refining its calculations, which could potentially impact the measurement of recorded tax balances as of December 31, 2017. This provisional amount is based on the best information currently available and may be revised and is subject to change. The provisional impact of the enactment of U.S. Tax Reform is reflected in the tables below.
The provision for income tax expense for the years ended December 31, 2017, 2016 and 2015 consists of the following (dollars in thousands):
The earnings of substantially all of the Company’s foreign subsidiaries have been permanently reinvested in foreign operations. No provision has been made for U.S. tax or foreign withholding taxes that may be applicable upon any repatriation or sale. At December 31, 2017 and 2016, the financial reporting basis in excess of the tax basis for which no deferred taxes have been recognized was approximately $1,442.9 million and $1,147.2 million, respectively. As U.S. Tax Reform generally eliminates U.S. federal income taxes on dividends from foreign subsidiaries, the Company does not expect to incur material income taxes if these funds are repatriated.
During 2017, 2016 and 2015, the Company received federal and foreign income tax refunds of approximately $11.6 million, $6.9 million and $136.8 million, respectively. The Company made cash income tax payments of approximately $48.7 million, $68.0 million and $178.4 million in 2017, 2016 and 2015, respectively. At December 31, 2017 and 2016, the Company recognized gross deferred tax assets associated with net operating losses of approximately $2,715.8 million and $1,353.6 million, respectively. The earliest expiration date for any significant net operating losses is 2029. Net operating losses of $181.2 million, $451.4 million, and $1,557.1 million would expire in 2029, 2030, and 2032, respectively if unutilized. The remaining losses where a valuation allowance has not been established that are subject to expiration are $48.0 million and would expire between 2034 and 2036. These net operating losses, other than the net operating losses for which there is a valuation allowance, are expected to be utilized in the normal course of business during the period allowed for carryforwards and in any event, are not expected to be lost, due to the application of tax planning strategies that management would utilize.
At December 31, 2017 and 2016, the Company also has foreign tax credit carryforwards of $152.0 million and $100.9 million, respectively, in the U.S. and Ireland. During 2017 the Company established a valuation allowance of $65.1 million on the U.S. foreign tax credits and the remaining U.S. foreign tax credits of $57.0 million reduced the uncertain tax liabilities. The Ireland foreign tax credit of $29.9 million has a full valuation allowance. The Company also has AMT carryforwards of $25.9 million and $21.3 million, respectively. As a result of U.S. Tax Reform, the AMT credits are fully refundable if unutilized by 2021. The Company has recorded these credits as deferred tax assets.
As of December 31, 2017, the Company’s total amount of unrecognized tax benefits was $321.2 million and the total amount of unrecognized tax benefits that would affect the effective tax rate, if recognized, was $10.9 million. Management believes there will be no material impact to the Company’s effective tax rate related to unrecognized tax benefits over the next 12 months.
A reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2017, 2016 and 2015, is as follows (dollars in thousands):
The Company recognized interest expense (benefit) associated with uncertain tax positions in 2017, 2016 and 2015 of $(5.0) million, $(8.4) million and $8.2 million, respectively. Additionally, the Company recognized penalties of $0.3 million in 2016. As of December 31, 2017 and 2016, the Company had $15.1 million and $20.4 million, respectively, of accrued interest related to unrecognized tax benefits. There are no penalties accrued as of 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. The Company recorded benefits expense of approximately $5.3 million, $6.3 million and $9.1 million in 2017, 2016 and 2015, respectively, that are related to these postretirement plans. Effective January 1, 2017, employees hired in the U. S. are not eligible for retiree health care benefits. 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.
Reflects effect of the amendment to RGA’s U.S. retiree health care benefit plan announced in 2016, effective January 1, 2017 and other administrative amendments to the pension plans. The amounts were recorded in AOCI and will be amortized through prior service cost.
The following table presents information for qualified and non-qualified pension plans with a projected benefit obligation in excess of plan assets as of December 31, 2017 and 2016 (dollars in thousands):
Equity and debt securities are exposed to various risks, such as interest rate risk, credit risk and overall market volatility. Due to the level of risk associated with certain investment securities, changes in the values of investment securities will occur and any change would affect the amounts reported in the financial statements.
The fair values of the Company’s qualified pension plan assets as of December 31, 2017 and 2016 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 $14.2 million, $9.9 million and $9.0 million in 2017, 2016 and 2015, respectively.
The licensing orders of the Company’s special purpose companies stipulate a minimum amount of capital required based on the purpose of the entity and the underlying business. These companies are subject to enhanced oversight by the regulator which includes filing detailed plans of operations before commencing operations or making material changes to existing agreements or entering into new agreements. Each of the Company’s Special Purpose Life Reinsurance Captives (“SPLRC”) exceeded the minimum capital requirements for all periods presented herein.
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 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 $158.4 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 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, 2017 are as follows (dollars in thousands):
The Company’s long-term debt consists of the following as of December 31, 2017 and 2016 (dollars in thousands):
In June 2016, RGA issued 3.95% Senior Notes due September 15, 2026 with a face amount of $400.0 million and 5.75% Fixed-To-Floating Rate Subordinated Debentures due June 15, 2056 with a face amount of $400.0 million. These securities have been registered with the Securities and Exchange Commission. The net proceeds from these offerings were approximately $791.2
million and were used in part to repay upon maturity the Company’s $300.0 million 5.625% Senior Notes that matured in March 2017. The remainder was used for general corporate purposes. Capitalized issue costs were approximately $8.8 million.
In December 2015, the interest rate on RGA’s Junior Subordinated Debentures with a face amount of $400.0 million converted from a fixed rate of 6.75% to a floating rate equal to the three-month LIBOR plus 266.5 basis points. The Company entered into an interest rate swap that commenced in December 2017, effectively fixing the interest rate on these securities at 4.82% until December 2037.
Certain of the Company’s debt agreements contain financial covenant restrictions related to, among others, liens, the issuance and disposition of stock of restricted subsidiaries, minimum requirements of consolidated net worth, maximum ratios of debt to capitalization and change of control provisions. A material ongoing covenant default could require immediate payment of the amount due, including principal, under the various agreements. Additionally, the Company’s debt agreements contain cross-default covenants, which would make outstanding borrowings immediately payable in the event of a material uncured covenant default under any of the agreements, including, but not limited to, non-payment of indebtedness when due for an amount in excess of the amounts set forth in those agreements, bankruptcy proceedings, or any other event which results in the acceleration of the maturity of indebtedness. As of December 31, 2017 and 2016, the Company had $2,808.8 million and $3,110.9 million, respectively, in outstanding borrowings under its debt agreements and was in compliance with all covenants under those agreements. As of December 31, 2017 and 2016, the average interest rate on long-term debt outstanding was 5.24% and 5.16%, respectively.
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. Future principal payments due on long-term debt, excluding discounts, as of December 31, 2017, were as follows (dollars in thousands):
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, 2017 and 2016, there were approximately $120.1 million and $189.4 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, 2017 and 2016, $1,492.2 million and $1,010.8 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.
Fees associated with the Company’s other letters of credit are not fixed for periods in excess of one year and are based on the Company’s ratings and the general availability of these instruments in the marketplace. Total fees expensed associated with the
In December 2014, RGA’s subsidiary, Chesterfield Financial Holdings LLC, (“Chesterfield Financial”), issued $300.0 million of asset-backed notes due December 2024 in a private placement. The notes were issued as part of an embedded value securitization transaction covering a closed block of policies assumed by RGA Reinsurance and retroceded to Chesterfield Re. Proceeds from the notes, along with a direct investment by the Company, were applied by Chesterfield Financial to (i) pay certain transaction-related expenses, (ii) establish a reserve account owned by Chesterfield Financial and pledged to the indenture trustee for the benefit of the holders of the notes (primarily to cover interest payments on the notes), and (iii) to fund an initial stock purchase from and capital contribution to Chesterfield Re to capitalize Chesterfield Re and to finance the payment of a ceding commission by Chesterfield Re to RGA Reinsurance under the retrocession agreement. Capitalized issuance costs were approximately $5.4 million. As of December 31, 2017 and 2016, the Company held deposits in trust of $19.4 million and $22.1 million, respectively, to cover interest payments on the notes, which are not available to satisfy the general obligations of the Company. Interest on the notes accrues at an annual rate of 4.50%, payable quarterly, and totaled $11.3 million, $13.1 million and $14.0 million in 2017, 2016 and 2015, respectively. The notes represent senior, secured indebtedness of Chesterfield Financial. Limited support is provided by RGA for temporary potential liquidity events at Chesterfield Financial and for temporary potential statutory capital and surplus events at Chesterfield Re. Otherwise, there is no legal recourse to RGA or its other subsidiaries. The notes are not insured or guaranteed by any other person or entity.
Companies in which RGA has significant influence over the operating and financing decisions but are not required to be consolidated, are reported on the equity basis of accounting. The equity in the net income of such investments is not material to the results of operations or financial position of individual segments or the Company taken as a whole. Capital expenditures of each reporting segment were immaterial in the periods noted.
No individual client generated 10% or more of the Company’s total gross premiums on a consolidated basis in 2017, 2016 and 2015. For the purpose of this disclosure, companies that are within the same insurance holding company structure are combined.
The Company uses several actuarial methods to compute incurred-but-not reported liabilities. These methods use historical claim reporting patterns to develop a triangle of reported claim amounts. The claim triangle is then used to develop the ultimate claims amount and the incurred-but-not reported liabilities. Expected claim methods use exposure data such as premiums to develop the ultimate claim amount. The final method blends the estimates from the development and the expected claim methods. The Company did not make significant changes to the methods used to compute the incurred-but-not reported liabilities in 2017.
The Company provides reinsurance on large quota share transactions. It is common industry practice for cedants to provide loss information on a bulk basis without comprehensive claim details. Additionally, a claim under aggregate stop loss coverage may be the result of thousands of claims, but the Company only pays the excess amount. Therefore, it is impractical to provide meaningful claim count detail by accident year in the tables shown below.
The reconciliation of the net incurred and paid claims development tables to the liability for claims and claim adjustment expense in the consolidated balance sheets as of December 31, 2017 and 2016, are as follows:
The following table presents the components of the Company’s other comprehensive income (loss) for the years ended December 31, 2017, 2016 and 2015 (dollars in thousands):
Includes cash flow hedges of $2,619, $(2,496) and $(29,397) as of December 31, 2017, 2016 and 2015, respectively. See Note 5 for additional information on cash flow hedges.
The intrinsic value of options exercised was $42.1 million, $41.4 million, and $26.2 million for 2017, 2016 and 2015, respectively.
During 2017, the Company issued 115,176 PCUs to key employees at a weighted average fair value per unit of $129.72. In May 2017 and May 2016, RGA’s board of directors approved a 0.75 and 0.40 share payout for each PCU granted in 2014 and 2013, resulting in the issuance of 137,083 and 94,436 shares of common stock from treasury, respectively.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2017, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2018 expressed an unqualified opinion on the Company's internal control over financial reporting.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.