The Company’s corporate headquarters is located at an owned site in Chesterfield, Missouri. In addition the Company leases office space in 51 locations throughout the world. Most of the Company’s leases have terms of three to five years; while some leases have longer terms, none exceed 15 years.
2017 reflects adjustments related to the initial adoption of U.S. Tax Reform. See Note 9 - “Income Tax” in the Notes to Consolidated Financial Statements for additional information.
This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 including, among others, statements relating to projections of the future operations, strategies, earnings, revenues, income or loss, ratios, financial performance and growth potential of the Company. Forward-looking statements often contain words and phrases such as “intend,” “expect,” “project,” “estimate,” “predict,” “anticipate,” “should,” “believe” and other similar expressions. Forward-looking statements are based on management’s current expectations and beliefs concerning future developments and their potential effects on the Company. Forward-looking statements are not a guarantee of future performance and are subject to risks and uncertainties, some of which cannot be predicted or quantified. Future events and actual results, performance, and achievements could differ materially from those set forth in, contemplated by or underlying the forward-looking statements.
Forward-looking statements should be evaluated together with the many risks and uncertainties that affect the Company’s business, including those mentioned in this document and described in the periodic reports the Company files with the SEC. These forward-looking statements speak only as of the date on which they are made. The Company does not undertake any obligation to update these forward-looking statements, even though the Company’s situation may change in the future. For a discussion of these risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements, you are advised to see Item 1A - “Risk Factors”.
operations, and it often enters new markets to support its clients as they expand internationally. Based on the compilation of information from competitors’ annual reports, the Company believes it is the second-largest global life and health reinsurer in the world based on 2018 life and health reinsurance revenues. 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. More recently, the Company has increased its investment and expenditures in client service and technology oriented initiatives to both support its clients and generate new future revenue streams.
Historically, the Company’s primary business has been traditional life reinsurance, which involves reinsuring life insurance policies that are often in force for the remaining lifetime of the underlying individuals insured, with premiums earned typically over a period of 10 to 30 years or longer. Each year, however, a portion of the business under existing treaties terminates due to, among other things, lapses or voluntary surrenders of underlying policies, deaths of insureds, and the exercise of recapture options by ceding companies. The Company has expanded its financial solutions business, including significant asset-intensive and longevity risk transactions, which allow its clients to take advantage of growth opportunities and manage their capital, longevity and investment risk.
Reinsurance business in force reflects the addition or acquisition of new life reinsurance business, offset by terminations (e.g., life and group contract terminations, lapses of underlying policies, deaths of insureds, and recapture), changes in foreign currency exchange, and any other changes in the amount of insurance in force. As a result of terminations and other changes, assumed in force amounts at risk of $225.5 billion, $374.8 billion, and $160.6 billion were released in 2019, 2018 and 2017, respectively.
Traditional Reinsurance. The percentage of new life and health business being reinsured in North America has stabilized and recently began to increase following a period of decline, due to strong recurring production coupled with in-force opportunities and an aging population, which increases the need for living benefit morbidity products. Cession rates in the Company’s international markets are expected to continue increasing as middle-class growth and wealth creation drive additional insurance growth. New products and distribution channels, from accelerated underwriting and insurtech, are expected to contribute to the growth of the insurance market globally and provide opportunities for reinsurers. In addition, changing global capital requirements are leading to additional reinsurance opportunities. The Company believes reinsurers will continue to be an integral part of the life and health insurance market due to their ability to efficiently aggregate a significant volume of life insurance in force, creating economies of scale and greater diversification of risk. As a result of having larger amounts of mortality and morbidity experience data at their disposal compared to primary life insurance companies, reinsurers tend to have more comprehensive insights into mortality and morbidity trends, creating more efficient pricing for mortality and morbidity risk.
Trends that affect all of the Company’s lines of business include the following:
International Markets. International markets continue to offer opportunities for long-term growth, and the Company intends to capitalize on these opportunities by growing its presence in select markets. Many of the markets where the Company does business, or may enter in the future, are not utilizing life reinsurance at the same levels as the North American market. Therefore, the Company believes these markets represent opportunities for increasing reinsurance penetration. In particular, markets such as Japan, Southeast Asia and South Korea are beginning to realize the benefits that reinsurers bring to the life insurance market. Markets such as China and India represent longer-term opportunities for growth as the underlying direct life insurance markets grow to meet the needs of expanding middle-class populations. Additionally, the Company believes that regulatory changes in many of its markets may cause ceding companies to reduce counterparty exposure to their existing life reinsurers and reinsure more business, creating opportunities for the Company. More recently, the Company has experienced significant growth in health related product offerings, such as critical illness, most notably in select Asian markets.
Capital Solutions. The Company provides capital solutions customized for each client, country, and product. The Company’s culture of collaboration and innovation makes it well positioned to react to regulatory and accounting changes in all of its clients’ markets, which we believe may create demand for increased product development and more capital solutions.
The Company has a history of innovation, expertise and a relentless focus on its clients. As such, the Company continues to build a diverse and experienced team while partnering with insurance companies, data and technology providers and insurtech entrepreneurs to develop and market technology and provide consulting and outsourcing solutions. While this is currently a small, but growing, part of the Company’s operations, these initiatives may lead to new revenue streams, new opportunities across the industry value chain and new business innovations that could have a transformational impact on the insurance industry and the Company.
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, 2019, the Company had $313 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:
Liabilities for future policy benefits under long-duration life insurance policies (policy reserves) are computed based upon expected investment yields, mortality and withdrawal (lapse) rates, and other assumptions, including a provision for adverse deviation from expected claim levels. Liabilities for policy claims and benefits for short-duration contracts are accounted for based on actuarial estimates of the amount of loss inherent in that period’s claims, including losses incurred for which claims have not been reported. Short-duration contract loss estimates rely on actuarial observations of ultimate loss experience for similar historical events. The Company primarily relies on its own valuation and administration systems to establish policy reserves. The policy reserves the Company establishes may differ from those established by the ceding companies due to the use of different mortality and other assumptions. However, the Company relies upon its ceding company clients to provide accurate data, including policy-level information, premiums and claims, which is the primary information used to establish reserves. The Company’s administration departments work directly with clients to help ensure information is submitted in accordance with the reinsurance contracts. Additionally, the Company performs periodic audits of the information provided by clients. The Company establishes reserves for processing backlogs with a goal of clearing all backlogs within a ninety-day period. The backlogs are usually due to data errors the Company discovers or computer file compatibility issues, since much of the data reported to the Company is in electronic format and is uploaded to its computer systems.
The Company primarily invests in fixed maturity securities, mortgage loans, short-term investments, and other invested assets. For investments reported at fair value, the Company utilizes, when available, fair values based on quoted prices in active
See “Investments” in Note 2 - “Significant Accounting Policies and Pronouncements” 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 Company provides for federal, state and foreign income taxes currently payable, as well as those deferred due to temporary differences between the tax basis of assets and liabilities and the reported amounts, and are recognized in net income or in certain cases in other comprehensive income. The Company’s accounting for income taxes represents management’s best
A discussion regarding our financial condition and results of operations for the year ended December 31, 2019, compared to the year ended December 31, 2018, is presented below. A discussion regarding our financial condition and results of operations for year ended December 31, 2018 compared to the year ended December 31, 2017, can be found under Item 7 in our Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC on February 27, 2019, which is available free of charge on the SEC’s website at www.sec.gov and our Investor Relations website at www.rgare.com. Information provided on such websites does not constitute part of this Annual Report on Form 10-K.
Consolidated net premiums increased $753 million, or 7.1% in 2019, primarily due to growth in life reinsurance in force. Consolidated assumed life insurance in force increased to $3,480.2 billion as of December 31, 2019, from $3,329.2 billion as of December 31, 2018 due to new business production and in force transactions. The Company added new business production, measured by face amount of insurance in force, of $376.5 billion, and $406.7 billion during 2019 and 2018, respectively. Foreign currency fluctuations relative to the prior year decreased net premium by $179 million in 2019 and increased net premiums by $43 million in 2018. Foreign currency fluctuations affected the increases in assumed life insurance in force favorably by $38.0 billion in 2019 and unfavorably by $101.5 billion in 2018.
The average invested assets at amortized cost, excluding spread related business, totaled $28.3 billion and $26.6 billion in 2019 and 2018, respectively. The average yield earned on investments, excluding spread related business, was 4.56% and 4.45% in 2019 and 2018, respectively. The average yield will vary from year to year depending on several variables, including the prevailing risk-fee interest rate and credit spread environment, prepayment fees and make-whole premiums, changes in the mix of the underlying investments and cash balances, and the timing of distributions on certain investments. Investment income in 2019 and 2018 benefited from higher variable investment income from joint ventures and limited partnerships, which can be highly variable from year to year. A continued low interest rate environment is expected to put downward pressure on this yield in future reporting periods. Investment income is allocated to the operating segments based upon average assets and related capital levels deemed appropriate to support segment operations.
In the fourth quarter of 2019, the Company changed the name of the Financial Reinsurance business within the U.S. and Latin America Financial Solutions segment to “Capital Solutions”. The name change better describes the product offerings for this part of the U.S. and Latin America's Financial Solutions segment. This change does not affect any previously or future reported results for the U.S. and Latin America Financial Solutions segment.
Income before income taxes increased by $126 million, or 23.5% in 2019. The increase in 2019 was due to income from asset-intensive transactions executed since the third quarter of 2018, including investment related gains recognized during portfolio reposition.
Net investment income increased $39 million, or 5.3%, in 2019, which was due to an increase in variable investment income from real estate joint ventures and limited partnerships as well as a higher invested asset base.
Interest credited expense decreased by $4 million, or 4.9%, in 2019. Interest credited in this segment relates to amounts credited on cash value products, which also have a significant mortality component. Income before income taxes is affected by the spread between the investment income and the interest credited on the underlying products.
Policy acquisition costs and other insurance expenses as a percentage of net premiums were 13.1%, and 13.3% in 2019 and 2018, respectively. Overall, these ratios are expected to remain in a predictable range and may fluctuate from period to period due to varying allowance levels within coinsurance-type arrangements. The amortization pattern of previously capitalized amounts, which are subject to the form of the reinsurance agreement and the underlying insurance policies may vary. Also, the mix of first year coinsurance business versus yearly renewable term business can cause the percentage to fluctuate from period to period. In recent years, reinsurance treaties weighted toward yearly renewable term structures have contributed to relatively stable rates.
Asset-Intensive within the U.S. and Latin America Financial Solutions segment primarily assumes investment risk within underlying annuities and other investment oriented products. Most of these agreements are coinsurance, with some on a coinsurance with funds withheld or modco. The Company recognizes profits or losses primarily from the spread between the investment income earned and amounts credited on the underlying deposit liabilities, income associated with longevity risk, and fees associated with variable annuity account values and guaranteed investment contracts.
Embedded Derivatives - Modco/Funds Withheld Treaties - Represents the change in the fair value of embedded derivatives on funds withheld at interest associated with treaties written on a modco or funds withheld basis. The fair value changes of embedded derivatives on funds withheld at interest associated with treaties written on a modco or funds withheld basis are reflected in revenues, while the related impact on deferred acquisition expenses is reflected in benefits and expenses. The Company’s utilization of a credit valuation adjustment did not have a material effect on the change in fair value of these embedded derivatives for the years ended December 31, 2019 and 2018.
The change in fair value of the embedded derivatives - modco/funds withheld treaties increased income before income taxes by $14 million in 2019. The increase in 2019 was primarily the result of repositioning in the funds withheld portfolio, partially offset by widening credit spreads.
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, 2019 and 2018.
The change in fair value of the guaranteed minimum benefits, after allowing for changes in the associated free standing derivatives, decreased income before income taxes by $2 million in 2019. The decrease in income for 2019 is primarily due to the annual update of best estimate actual policyholder assumptions, partially offset by favorable hedging results.
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 (decreased) income before income taxes by $(23) million in 2019 . The decrease in income in 2019 was primarily due to interest rate movements.
Income before income taxes and certain derivatives increased by $153 million in 2019,which was primarily due to income from new asset-intensive transactions, including investment related gains recognized during the repositioning of investment portfolios related to those new transactions.
Benefits and expenses before certain derivatives increased by $188 million in 2019. The increase in benefits and expenses in 2019 was primarily due to benefits and expenses from asset-intensive transactions executed since the third quarter of 2018.
Income before income taxes for the year ended December 31, 2019 was consistent with 2018 as the effect of a new transaction that closed in the fourth quarter of 2019 was offset by terminations earlier in the year.
Income before income taxes increased by $56 million, or 50.0%, in 2019. The increase in income for 2019 was primarily due to favorable individual mortality experience. Foreign currency exchange fluctuation in the Canadian dollar resulted in a decrease in income before income taxes of $5 million in 2019.
Loss ratios for the segment were 80.4% and 82.8% in 2019 and 2018, respectively. The decrease in the 2019 loss ratio was due to favorable individual mortality experience.
Other operating expenses increased by $4 million, or 12.1%, in 2019 primarily due to higher incentive compensation accruals. Other operating expenses as a percentage of net premiums were 3.5% and 3.2% 2019 and 2018, respectively.
Net premiums increased $46 million, or 107.0%, in 2019. The increase in net premiums in 2019 was primarily due to a new longevity transaction completed in 2019. Foreign currency exchange fluctuation in the Canadian dollar resulted in a decrease in net premiums of $2 million in 2019.
Net investment income increased by $1 million, or 50.0%, in 2019, which was primarily due to an increase in the invested asset base.
The Europe, Middle East and Africa (“EMEA”) operations includes business generated by its offices principally in France, Germany, Ireland, Italy, the Middle East, the Netherlands, Poland, South Africa, Spain and the United Kingdom (“UK”). EMEA consists of two major segments: Traditional and Financial Solutions. The Traditional segment primarily provides reinsurance through yearly renewable term and coinsurance agreements on a variety of life, health and critical illness products. Reinsurance agreements may be facultative or automatic agreements covering primarily individual risks and, in some markets, group risks. The Financial Solutions segment consists of reinsurance and other transactions associated with longevity closed blocks, payout annuities, capital management solutions and financial reinsurance.
Income before income taxes increased by $25 million, or 45.5%, in 2019. The increase in income before income taxes in 2019 was primarily due to an improvement in individual mortality and morbidity experience. Foreign currency exchange fluctuations resulted in a decrease in income before income taxes of $5 million in 2019.
Net premiums increased by $18 million, or 1.3%, in 2019, which was primarily due to increased business volumes on existing treaties partially offset by treaty terminations. The segment added new business production, measured by face amount of insurance in force, of $147.4 billion and $190.2 billion during 2019 and 2018, respectively. The face amount of reinsurance in force totaled $776.4 billion and $716.3 billion, at December 31, 2019 and 2018, respectively. Foreign currency fluctuations unfavorably affected the face amount of reinsurance in force by $19.2 billion and $41.4 billion in 2019 and 2018, respectively. Foreign currency exchange fluctuations resulted in a decrease in net premiums of $77 million in 2019. The segment’s primary currencies are the British pound, the Euro and the South African rand.
A portion of the net premiums for the segment 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 $178 million and $188 million in 2019 and 2018, respectively.
Net investment income increased by $7 million, or 10.6%, in 2019, which was primarily due to an increase in the invested asset base resulting from business growth. Foreign currency exchange fluctuations resulted in a decrease in net investment income of $4 million in 2019.
Loss ratios for this segment were 83.6% and 86.7% in 2019 and 2018, respectively. The decrease in loss ratio in 2019 was due to normal claims variability associated with individual mortality and morbidity business and changes in business mix.
Other operating expenses increased by $13 million, or 12.0%, in 2019. The increase in 2019 was in line with expected expense levels required to support the business as well as higher incentive-based compensation. Foreign currency exchange fluctuations resulted in a decrease in other operating expenses of $6 million in 2019. Other operating expenses as a percentage of net premiums totaled 8.4% and 7.5% 2019 and 2018, respectively.
Claims and other policy benefits increased $26 million, or 21.1%, in 2019, which was primarily due to business growth and a normalization of performance on the closed block longevity business compared to favorable performance in 2018.
Income before income taxes decreased by $44 million, or 25.6%, in 2019. The decrease in income before income taxes in 2019 was the result of unfavorable claims experience as compared to the prior year across the segment, partially offset by income from new business growth within the Financial Solutions business. Foreign currency exchange fluctuations resulted in an increase in income before income taxes of $4 million in 2019.
Income before income taxes decreased by $73 million, or 41.0%, in 2019. The decrease in income before income taxes in 2019 was primarily due to unfavorable claims experience as compared to prior year across the segment. Foreign currency exchange fluctuations resulted in an increase in income before income taxes of $3 million in 2019.
A portion of the net premiums for the segment 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 Traditional segment is offered primarily in South Korea, Australia, China and Hong Kong. Net premiums from this coverage totaled $1,055 million and $806 million in 2019 and 2018, respectively.
Net investment income increased $8 million, or 8.3%, in 2019. The increase in 2019 was primarily due to an increase in invested asset base, partially offset by a lower investment yield and foreign currency fluctuations. Foreign currency exchange fluctuations resulted in a decrease in net investment income of $4 million in 2019.
Loss ratios for this segment were 90.2% and 82.1% for 2019 and 2018, respectively. The increase in the loss ratio in 2019 was primarily due to unfavorable claims experience compared to the prior year across the segment.
Claims and other policy benefits increased by $117 million in 2019, which was due to new asset-intensive transactions in Asia.
Net investment related losses decreased by $113 million in 2019. The decrease in net investment related losses in 2019 was due to net gains on the sale of fixed maturity securities of $25 million compared to losses in the prior year of $55 million and an increase in the fair value of equity securities of $37 million compared to a decline in 2018 of $24 million, which were partially offset by a $3 million increase in investment impairments.
Policy acquisition costs and other insurance income increased by $8 million, or 6.5%, in 2019. Fluctuations period over period were attributable to the offset to capital charges allocated to the operating segments.
Interest expense increased by $26 million, or 17.7%, in 2019. The increase in interest expense resulted primarily from the issuance of $600 million in long-term debt in May 2019, which was partially offset by the repayment of $400 million of long-term debt in November, and the variability in tax-related interest expense.
The Company’s average investment yield, excluding spread related business, for 2019 was at 4.56%, 11 basis points above the comparable 2018 rate. However, the current interest rate environment continues to put downward pressure on the Company’s investment yield. The Company’s insurance liabilities, in particular its annuity products, are sensitive to changing market factors. Due to decreases in risk free interest rates, gross unrealized gains on fixed maturity securities available-for-sale increased from $1.9 billion at December 31, 2018 to $4.5 billion at December 31, 2019. Gross unrealized losses decreased from $748 million at December 31, 2018 to $110 million at December 31, 2019.
The Company projects its reserves to be sufficient and it would not expect to write down deferred acquisition costs or be required to take any actions to augment capital, even if interest rates remain at current levels for the next five years, assuming all other factors remain constant. While the Company has felt the pressures of sustained low interest rates and volatile equity markets and may continue to do so, its business and results of operations are not overly sensitive to these risks. Mortality and morbidity risks continue to be the most significant risk for the Company. Although management believes the Company’s current capital base is adequate to support its business at current operating levels, it continues to monitor new business opportunities and any associated new capital needs that could arise from the changing financial landscape.
RGA established an intercompany revolving credit facility where certain subsidiaries can lend to or borrow from each other and from RGA in order to manage capital and liquidity more efficiently. The intercompany revolving credit facility, which is a series of demand loans among RGA and its affiliates, is permitted under applicable insurance laws. This facility reduces overall borrowing costs by allowing RGA and its operating companies to access internal cash resources instead of incurring third-party transaction costs. The statutory borrowing and lending limit for RGA’s Missouri-domiciled insurance subsidiaries is currently 3% of the insurance company’s admitted assets as of its most recent year-end. There were borrowings of $196 million and $21 million
Undistributed earnings of the Company’s foreign subsidiaries are targeted for reinvestment outside of the U.S. As of December 31, 2019, the amount of cash and cash equivalents and short-term investments held by the Company’s subsidiaries that are taxed in a foreign jurisdiction was $720 million. The Global Intangible Low-Taxed Income (“GILTI”) and Subpart F provisions of U.S. Tax Reform generally eliminate U.S. federal income tax deferral on earnings of foreign subsidiaries, while the dividend received deduction generally allows for tax-free repatriation of any untaxed earnings. Therefore, the Company does not expect to incur any material incremental U.S. federal income tax on repatriation of these earnings. Incremental foreign withholding taxes are not expected to be material.
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, 2019, there were approximately $62 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, 2019, $1.2 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 enters into reinsurance treaties in the ordinary course of business. In some cases, if the credit rating and/or defined statutory measures of the Company declines to certain levels, the reinsurance treaty would require the Company to post collateral or additional collateral to secure the Company’s obligations under such reinsurance treaty, obtain guarantees, permit the ceding company to recapture such reinsurance treaty, or some other negotiated remedy. As of December 31, 2019, neither the Company nor its subsidiaries have been required to post additional collateral or have had a reinsurance treaty recaptured as a result of a credit downgrade or a defined statutory measure decline.
Proceeds from the notes issued by Timberlake Financial and RGA’s direct investment in Timberlake Financial were deposited into a series of trust accounts as collateral and are not available to satisfy the general obligations of the Company. As of December 31, 2019 the Company held deposits in trust and in custody of $694 million for this purpose, which is not included in the figures above. A reserve account has been established to cover interest payments on notes issued by Chesterfield Financial that are not available to satisfy the general obligations of the Company. As of December 31, 2019 the Company held deposits in trust of $15 million for this purpose, which is not included in the figures above. See “Collateral Finance and Securitization Notes and Statutory Reserve Funding” above for additional information on the Timberlake Financial and Chesterfield Financial notes.
Additional sources of liquidity to meet unexpected cash outflows in excess of operating cash inflows and current cash and equivalents on hand include selling short-term investments or fixed maturity securities and drawing funds under a revolving credit facility, under which the Company had availability of $850 million as of December 31, 2019. The Company also has $1.2 billion of funds available through collateralized borrowings from the Federal Home Loan Bank of Des Moines (“FHLB”) as of December 31, 2019. As of December 31, 2019, the Company could have borrowed these additional amounts without violating any of its existing debt covenants.
Future policy benefits are primarily related to the Company’s reinsurance of life and health insurance products. The amounts presented in the table above represent the estimated benefit obligations as they become due, and also include estimated future premiums on policies in force, 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. All estimated cash payments presented in the table above are undiscounted as to interest and gross of any reinsurance recoverable. The discounted liability amount of $28.7 billion included on the consolidated balance sheets exceeds the sum of the undiscounted estimated cash flows of $11.6 billion shown above. The difference is substantially due to net obligations including estimated future premiums exceeding estimated policy benefit payments and allowances due to the nature of certain reinsurance treaties, which generally have increasing premium rates that exceed the increasing benefit payments. In addition, differences will arise due to changes in the projection of future benefit payments compared with those developed when the reserve was established. Total payments may vary materially from prior years due to the assumption of new reinsurance treaties or as a result of changes in projections of future experience.
The Company’s liquidity position (cash and cash equivalents and short-term investments) was $1.5 billion and $2.0 billion at December 31, 2019 and 2018, respectively. Liquidity needs are determined from valuation analysis 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 had total cash and invested assets of $68.0 billion and $56.1 billion as of December 31, 2019 and 2018, respectively, as illustrated below (dollars in millions):
Investment yield increased between 2018 and 2019 due to increased income from joint ventures and limited partnerships, which is included in other invested assets on the consolidated balance sheets. Investment yield decreased between 2017 and 2018 due to the effect of a lower interest rate environment.
See “Fixed Maturity 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 these securities, and the other-than-temporary impairments in AOCI by sector as of December 31, 2019 and 2018.
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, 2019 and 2018, approximately 95.5% and 95.6%, 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 Company owns floating rate securities that represent approximately 6.3% and 6.2% of the total fixed maturity securities as of December 31, 2019 and 2018, respectively. These investments have a higher degree of income variability than the other fixed income holdings in the portfolio due to fluctuations in interest payments. The Company holds floating rate investments to match specific floating rate liabilities primarily reflected in the consolidated balance sheets as collateral finance notes, as well as to enhance asset management strategies.
The Company’s RMBS portfolio include agency-issued pass-through securities and collateralized mortgage obligations. A majority of the agency-issued pass-through securities are guaranteed or otherwise supported by the Federal Home Loan Mortgage Corporation, Federal National Mortgage Association, or the Government National Mortgage Association. The principal risks inherent in holding mortgage-backed securities are prepayment and extension risks, which will affect the timing of when cash will be received and are dependent on the level of mortgage interest rates. Prepayment risk is the unexpected increase in principal payments from the expected, primarily as a result of owner refinancing. Extension risk relates to the unexpected slowdown in principal payments from the expected. In addition, non-agency mortgage-backed securities face credit risk should the borrower be unable to pay the contractual interest or principal on their obligation. The Company monitors its mortgage-backed securities to mitigate exposure to the cash flow uncertainties associated with these risks.
The Company’s determination of whether a decline in value is other-than-temporary includes analysis of the underlying credit and the extent and duration of a decline in value. The Company’s credit analysis of an investment includes determining whether the issuer is current on its contractual payments, evaluating whether it is probable that the Company will be able to collect all amounts due according to the contractual terms of the security and analyzing the overall ability of the Company to recover the amortized cost of the investment. See “Investments - Other-than-Temporary Impairment” in Note 2 - “Significant Accounting Policies and Pronouncements” 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 2019, 2018 and 2017 (dollars in millions):
The fixed maturity impairments in 2019 and 2018 were largely related to high-yield and emerging market corporate securities. The equity impairments in 2017 were related to an equity position received as part of a debt restructuring. In addition, other impairment losses in 2019 and 2018 were primarily due to impairments on real estate joint ventures and limited partnerships.
See “Unrealized Losses for Fixed Maturity Securities Available-for-Sale” in Note 4 - “Investments” in the Notes to Consolidated Financial Statements for tables that presents information on securities where the estimated fair value had declined and remained below amortized cost as of December 31, 2019 and 2018. This includes tables that present the estimated fair values and gross unrealized losses, including other-than-temporary impairment losses reported in AOCI, for these securities by class and grade security, as well as the length of time the related market value has remained below amortized cost and where the decline is less than 20% or more than 20%.
As of December 31, 2019 and 2018, respectively, the Company classified approximately 6.1% and 5.0% of its fixed maturity securities in the Level 3 category (refer to Note 6 - “Fair Value of Assets and Liabilities” in the Notes to Consolidated Financial Statements for additional information). These securities primarily consist of private placement corporate securities, bank loans and Canadian provincial strips with inactive trading markets.
For reinsurance agreements written on a modified coinsurance basis and certain agreements written on a coinsurance basis, assets equal to the net statutory reserves are withheld and legally owned and managed by the ceding company, and are reflected as funds withheld at interest on the Company’s consolidated balance sheets. In the event of a ceding company’s insolvency, the Company would need to assert a claim on the assets supporting its reserve liabilities. However, the risk of loss to the Company is mitigated by its ability to offset amounts it owes the ceding company for claims or allowances against amounts owed by the ceding company. Interest accrues to the total funds withheld at interest assets at rates defined by the treaty terms. The Company is subject to the investment performance on the withheld assets, although it does not directly control them. These assets are primarily fixed maturity investment securities and pose risks similar to the fixed maturity securities the Company owns. To mitigate this risk, the Company helps set the investment guidelines followed by the ceding company and monitors compliance. Ceding companies with funds withheld at interest had an average financial strength rating of “A” as of December 31, 2019 and 2018. Certain ceding companies maintain segregated portfolios for the benefit of the Company.
Under these principles, the Company’s funds withheld receivable under certain reinsurance arrangements incorporate credit risk exposures that are unrelated or only partially related to the creditworthiness of the obligor and include an embedded derivative feature that is not clearly and closely related to the host contract. Therefore, the embedded derivative feature must be measured at fair value on the consolidated balance sheets and changes in fair value reported in income. See “Embedded Derivatives”
Based on data provided by ceding companies as of December 31, 2019 and 2018, funds withheld at interest totaled (dollars in millions):
Other invested assets include limited partnership interests, joint ventures (other than operating joint ventures), lifetime mortgages, derivative contracts, fair value option (“FVO”) contractholder-directed unit-linked investments and FHLB common stock. 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, 2019 and 2018.
See Note 5 - “Derivative Instruments” in the Notes to Consolidated Financial Statements for a table that presents the notional amounts and fair value of investment related derivative instruments held as of December 31, 2019 and 2018.
The Company holds beneficial interests in lifetime mortgages in the UK. Lifetime mortgages represent loans provided to individuals 55 years of age and older secured by the borrower’s residence. Lifetime mortgages are comparable to a home equity
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 dedicated risk management staff as well as 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.
Identification, assessments, and management of all known, new and emerging strategic risk exposures.
Risk appetite statement, including the ongoing alignment of the risk appetite statement with the Company’s strategy and capital plans.
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 million of catastrophic loss exposure per agreement and to retrocede up to $40 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.
Interest Rate risk is risk that changes in the level and volatility of nominal interest rates affect the profitability, value or solvency position of the Company. This includes credit spread changes and inflation but excludes credit quality deterioration. This risk arises from many of the Company’s primary activities, as the Company invests substantial funds in interest-sensitive assets, primarily fixed maturity securities, and also has certain interest-sensitive contract liabilities. A prolonged period where market yields are significantly below the book yields of the Company’s asset portfolio puts downward pressure on portfolio book yields. The Company has been proactive in its investment strategies, reinsurance structures and overall asset-liability management practices to reduce the risk of unfavorable consequences in this type of environment.
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, 2019 and 2018 (dollars in millions):
The following table presents the account values by each minimum guaranteed rate, rounded to the nearest percentage, by class of interest-sensitive product as of December 31, 2019 and 2018 (dollars in millions):
The spread profits on the Company’s fixed annuity and interest-sensitive whole life, universal life (“UL”) and fixed portion of variable universal life insurance policies are at risk if interest rates decline and remain relatively low for a period of time, which has generally been the case in recent years. Should interest rates remain at current levels, which are significantly lower than those existing prior to the declines of recent years, the average earned rate of return on the Company’s annuity and UL investment portfolios will continue to decline. Declining portfolio yields may cause the spreads between investment portfolio yields and the interest rate credited to contract holders to deteriorate as the Company’s ability to manage spreads can become limited by minimum guaranteed rates on annuity and UL policies. In 2019, minimum guaranteed rates on non-variable annuity and UL policies generally ranged from 0.10% to 6.00%, with an average guaranteed rate of approximately 3.10%. In 2018, minimum guaranteed rates on non-variable annuity and UL policies generally ranged from 0.10% to 6.00%, with an average guaranteed rate of approximately 2.86%.
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 $10.0 billion and $7.0 billion of account balances are not subject to surrender charges as of December 31, 2019 and 2018, respectively, with substantially all of these already at their minimum guaranteed rates. As such, certain management and monitoring processes are designed to minimize the effect of sudden and/or sustained changes in interest rates on fair value, cash flows, and net interest income.
Interest rate sensitivity analysis is used to measure the Company’s interest rate price risk by computing estimated changes in fair value of fixed rate assets and liabilities in the event of a hypothetical 100 basis point change (increase or decrease) in market interest rates. The Company does not have fixed rate instruments classified as trading securities. The Company’s projected net decrease in fair value of financial instruments in the event of a 100 basis point increase in market interest rates at its fiscal years ended December 31, 2019 and 2018 was $1.2 billion and $1.5 billion, respectively.
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, 2019 and 2018 was $32 million and $71 million, respectively.
Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, and should not be relied on as indicative of future results. Further, the computations do not contemplate any actions management could undertake in response to changes in interest rates. Certain shortcomings are inherent in the method of analysis presented in the computation of the estimated fair value of fixed maturity securities and the estimated cash flows of floating rate instruments, which constitute forward-looking statements. Actual values may differ materially from those projections presented due to a number of factors, including, without limitation, market conditions varying from assumptions used in the calculation of the fair value.
Equity risk is the risk that changes in the level and volatility of equity market valuations affect the profitability, value or solvency position of the Company. This risk includes variable annuity and other equity linked exposures and asset related equity exposure. The Company assumes equity risk from alternative investments, fixed indexed annuities and variable annuities. The Company uses derivatives to hedge its exposure to movements in equity markets that have a direct correlation with certain of its reinsurance products.
Generally, the Company’s insurance subsidiaries retrocede amounts in excess of their retention to certain of the Company’s insurance subsidiaries. External retrocessions are arranged through the Company’s retrocession pools for amounts in excess of its retention. As of December 31, 2019, all retrocession pool members in this excess retention pool rated by the A.M. Best Company were rated “A-” or better. A rating of “A-” is the fourth highest rating out of sixteen possible ratings. For a majority of the retrocessionaires that were not rated, letters of credit or trust assets have been given as additional security. In addition, the Company performs annual financial and in force reviews of its retrocessionaires to evaluate financial stability and performance.
The Company does not hedge the income statement risk associated with translating foreign currencies. The foreign exchange risk sensitivity of the Company’s consolidated pre-tax income is assessed using hypothetical test scenarios. Actual results may differ from the results noted below particularly due to assumptions utilized or if events occur that were not included in the methodology. For more information on this risk, see “Item 1A - Risk Factors - Risks Related to Our Business.” In general, a weaker U.S. dollar relative to foreign currencies has a favorable impact on the Company’s income before income taxes. The following tables summarize the impact on the Company’s reported income before income taxes of an immediate favorable or unfavorable change in each of the foreign exchange rates to which the Company has exposure (dollars in millions):
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 to be consistent with strategic objectives.
External environment risk relates to external competition, macro trends, and client needs. Macro characteristics that drive market opportunities, risk and growth potential, the competitive landscape and client feedback are closely monitored.
The Company is engaged in providing traditional reinsurance, which includes individual and group life and health, disability, and critical illness reinsurance. The Company also provides financial solutions, which includes longevity reinsurance, asset-intensive products, primarily annuities, financial reinsurance, capital solutions and stable value products.
Equity securities are carried at fair value and realized and unrealized gains and losses are included in investment related gains (losses), net.
Lifetime mortgages are carried at unpaid principal balances, net of any unamortized premium or discount, fees and valuation allowance. Interest income is accrued on the principal amount of the lifetime mortgage based on its contractual interest rate.
The fair value option (“FVO”) was elected for contractholder-directed investments supporting unit-linked variable annuity type liabilities that 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 related expenses.
The Company participates in a securities lending program whereby securities, reflected as investments on the Company’s consolidated balance sheets, are loaned to a third party. The Company receives securities as collateral, generally in an amount equal to a minimum of 100% to 105% of the fair value of the securities lent. The securities received as collateral are not reflected on the Company’s consolidated balance sheets.
The Company identifies fixed maturity securities that could potentially have credit impairments that are other-than-temporary by monitoring market events that could impact issuers’ credit ratings, business climates, management changes, litigation, government actions and other similar factors. The Company also monitors late payments, pricing levels, rating agency actions, key financial ratios, financial statements, revenue forecasts and cash flow projections as indicators of credit issues.
The Company reviews all securities on a case-by-case basis to determine whether an other-than-temporary decline in value exists and whether losses should be recognized. The Company considers relevant facts and circumstances in evaluating whether a credit or interest rate-related impairment of a security is other-than-temporary. Relevant facts and circumstances considered include: (1) the extent and length of time the fair value has been below cost or amortized cost; (2) the reasons for the decline in fair value; (3) the issuer’s financial position and access to capital; and (4) the Company’s intent to sell a security or whether it is more likely than not it will be required to sell the security before the recovery of its amortized cost that, in some cases, may extend to maturity. To the extent the Company determines that a security is deemed to be other-than-temporarily impaired, an impairment loss is recognized.
Impairment losses on fixed maturity securities recognized in the financial statements are dependent on the facts and circumstances related to the specific security. If the Company intends to sell a security or it is more likely than not that it would be required to sell a security before the recovery of its amortized cost, less any recorded credit loss, it recognizes an other-than-temporary impairment (“OTTI”) in investment related gains (losses), net on the consolidated statements of income for the difference between amortized cost and fair value. If neither of these two conditions exists then the recognition of the OTTI is bifurcated and the Company recognizes the credit loss portion in investment related gains (losses), net and the non-credit loss portion in AOCI.
Changes in the fair value of non-investment free-standing derivative instruments (e.g. mortality and longevity swaps), which do not receive accounting hedge treatment, are reflected in other revenues.
In a hedge of a net investment in a foreign operation, changes in the fair value of the hedging derivative that are measured as effective are reported within AOCI consistent with the translation adjustment for the hedged net investment in the foreign operation. Changes in the fair value of the hedging instrument measured as ineffective are reported within investment related gains (losses), net.
The Company tests the recoverability for each year of business at issue before establishing additional deferred acquisition costs (“DAC”). The Company also performs annual tests to establish that DAC are expected to remain recoverable, and if financial performance significantly deteriorates to the point where a deficiency exists, a cumulative charge to current operations will be recorded. No such adjustments related to DAC recoverability were made in 2019, 2018 and 2017.
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. 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, with amortization included in policy acquisition costs and other insurance expenses. Each year the Company reviews VODA and VOCRA to determine the recoverability of these balances. VODA and VOCRA totaled approximately $33 million and $41 million, including accumulated amortization of $88 million and $80 million, as of December 31, 2019 and 2018, respectively. VODA and VOCRA amortization expense for the years ended December 31, 2019, 2018 and 2017 was $8 million, $8 million and $9 million, respectively. Amortization of the VODA and VOCRA is estimated to be $8 million, $7 million, $6 million, $6 million and $6 million during 2020, 2021, 2022, 2023 and 2024, 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 property, equipment and leasehold improvements was $244 million and $249 million at December 31, 2019 and 2018, respectively. Accumulated depreciation of property, equipment and leasehold improvements was $99 million and $97 million at December 31, 2019 and 2018, respectively. Related depreciation expense was $18 million, $18 million and $17 million for the years ended December 31, 2019, 2018 and 2017, 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-duration 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.
Liabilities for future benefits on longevity business, including annuities in the payout phase, are established in an amount adequate to meet the estimated future obligations on policies in force. Liabilities for future benefits related to the longevity business, including annuities in the payout phase have been calculated using expected mortality, investment yields, 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. The mortality assumptions are based on the Company’s experience as well as industry experience and standards. A deferred profit liability is established when the gross premium exceeds the net premium.
The Company establishes future policy benefits for guaranteed minimum death benefits (“GMDB”) relating to the reinsurance of certain variable annuity contracts by estimating the expected value of death benefits in excess of the projected account balance and recognizing the excess proportionally over the accumulation period based on total expected assessments. The Company regularly evaluates estimates used and adjusts the additional liability balance, with a related charge or credit to claims and other policy benefits, if actual experience or other evidence suggests that earlier assumptions should be revised. The assumptions used in estimating the GMDB liabilities are consistent with those used for amortizing DAC, and are thus subject to the same variability and risk. The Company’s GMDB liabilities at December 31, 2019 and 2018 were not material.
Revenues for interest-sensitive and investment-type products consist of investment income, policy charges for the cost of insurance, policy administration, and surrenders that have been assessed against policy account balances during the period. Interest-sensitive contract liabilities for these products represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expenses include claims incurred in the period in excess of related policy account balances and interest credited to policy account balances. Interest is credited to policyholder account balances according to terms of the policies or contracts.
On July 27, 2017, the Financial Conduct Authority (the “FCA”) announced that it intends to stop persuading or compelling banks to submit London Interbank Offered Rates (“LIBOR”) after December 31, 2021. In addition, separate workstreams are underway in Europe and the U.S. to reform existing reference rates and provide a fall back rate upon discontinuation of LIBOR. During 2019, the Alternative Rates Committee of the Federal Reserve Board proposed the Secured Overnight Financing Rate (“SOFR”) as an alternative rate to replace U.S. Dollar LIBOR, and the European Central Bank recommended the Euro Short-term Rate (“ESTER”) as the new risk-free rate. Other jurisdictions are conducting similar exercises as well. The Company is currently assessing the effects of the discontinuation of LIBOR on existing contracts that extend beyond 2021, by analyzing contractual fallback provisions, evaluating alternative rate ramifications, and assessing the effects on current hedging strategies.
The calculation of common equivalent shares does not include the impact of options having a strike or conversion price that exceeds the average stock price for the earnings period, as the result would be antidilutive. The calculation of common equivalent shares also excludes the impact of outstanding performance contingent shares, as the conditions necessary for their issuance have not been satisfied as of the end of the reporting period. Approximately 0.2 million, 0.1 million, and 0.2 million outstanding stock options and approximately 0.3 million, 0.4 million and 0.3 million performance contingent shares were excluded from the calculation of common equivalent shares during 2019, 2018 and 2017, respectively.
The amortized cost and estimated fair value of fixed maturity securities classified as available-for-sale as of December 31, 2019 are shown by contractual maturity in the table below (dollars in millions). 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.
The tables below show the major sectors of the Company’s corporate fixed maturity holdings as of December 31, 2019 and 2018 (dollars in millions):
As discussed in Note 2 - “Significant Accounting Policies and Pronouncements,” a portion of certain OTTI on fixed maturity securities is recognized in AOCI. For these securities, the net amount recognized in the consolidated statements of income (“credit loss impairments”) represents the difference between the amortized cost of the security and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security prior to impairment. Any remaining difference between the fair value and amortized cost is recognized in AOCI. The following table sets forth the amount of pre-tax credit loss impairments on fixed maturity securities held by the Company as of the dates indicated, for which a portion of the OTTI was recognized in AOCI, and the corresponding changes in such amounts (dollars in millions):
The following table presents the total gross unrealized losses for the 1,072 and 3,109 fixed maturity securities as of December 31, 2019 and 2018, where the estimated fair value had declined and remained below amortized cost by the indicated amount (dollars in millions):
The following tables present the estimated fair values and gross unrealized losses, including OTTI reported in AOCI, for fixed maturity securities that have estimated fair values below amortized cost as of December 31, 2019 and 2018 (dollars in millions). These investments are presented by class and grade of security, as well as the length of time the related fair value has remained below amortized cost.
The OTTI on fixed maturity securities for 2019, 2018 and 2017 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.
As of December 31, 2019 and 2018, the Company held non-income producing securities with amortized costs of $47 million and $41 million, and estimated fair values of $51 million and $43 million, respectively. Generally, securities are non-income producing when principal or interest is not paid primarily as a result of bankruptcies or credit defaults, but also include securities where amortization has been discontinued.
The Company also held cash collateral for securities lending and the repurchase program/reverse repurchase programs of $1 million and $29 million as of December 31, 2019 and 2018, respectively. No cash or securities have been pledged by the Company for its securities borrowing program as of December 31, 2019 and 2018.
The following tables present information on the Company’s securities lending and repurchase transactions as of December 31, 2019 and 2018, respectively (dollars in millions). 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 distribution of mortgage loans by property type is as follows as of December 31, 2019 and 2018 (dollars in millions):
None of the payments due to the Company on its recorded investment in mortgage loans were delinquent as of December 31, 2019 and 2018.
The following table presents the recorded investment in mortgage loans, by method of measuring impairment, and the related valuation allowances, as of December 31, 2019 and 2018 (dollars in millions):
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, 2019, 2018 and 2017 (dollars in millions):
As of December 31, 2019, $3.5 billion of the funds withheld at interest balance is associated with one client. For reinsurance agreements written on a modco 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.
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, 2019, 2018 and 2017 were (dollars in millions):
Certain derivative instruments are designated as cash flow hedges when they meet the requirements of the general accounting principles for Derivatives and Hedging. The Company designates and accounts for the following as cash flows: (i) certain interest rate swaps, in which the cash flows of assets and liabilities are variable based on a benchmark rate; (ii) certain interest rate swaps, in which the cash flows of assets are denominated in different currencies, commonly referred to as cross-currency swaps; and (iii) forward bond purchase commitments.
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, 2019, 2018 and 2017 (dollars in millions):
The following table presents the effect of derivatives in cash flow hedging relationships on the consolidated statements of income and the consolidated statements of stockholders’ equity for the years ended December 31, 2019, 2018 and 2017 (dollars in millions):
For the years ended December 31, 2019, 2018 and 2017, there were no material amounts reclassified into earnings relating to instances in which the Company discontinued cash flow hedge accounting because the forecasted transaction did not occur by the anticipated date or within the additional time period permitted by the authoritative guidance for the accounting for derivatives and hedging.
The Company uses foreign currency swaps and foreign currency forwards to hedge a portion of its net investment in certain foreign operations against adverse movements in exchange rates. The following table illustrates the Company’s net investments in foreign operations (“NIFO”) hedges for the years ended December 31, 2019, 2018 and 2017 (dollars in millions):
A summary of the effect of non-hedging derivatives, including embedded derivatives, on the Company’s consolidated statements of income for the years ended December 31, 2019, 2018 and 2017 is as follows (dollars in millions):
The Company had no credit exposure related to its derivative contracts, as of December 31, 2019 and 2018, as the net amount of collateral pledged to the Company from counterparties exceeded the fair value of the derivative contracts. The Company may be exposed to credit-related losses in the event of non-performance by counterparties to derivative financial instruments with a positive fair value. Generally, the credit exposure of the Company’s derivative contracts is limited to the fair value at the reporting date plus or minus any collateral posted or held by the Company.
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.
The Company performs initial and ongoing analysis and review of the various techniques utilized in determining fair value to ensure that they are appropriate and consistently applied, and that the various assumptions are reasonable. The Company analyzes and reviews the information and prices received from third parties to ensure that the prices represent a reasonable estimate of the fair value and to monitor controls around pricing, which includes quantitative and qualitative analysis and is overseen by the Company’s investment and accounting personnel. Examples of procedures performed include, but are not limited to, review of pricing trends, comparison of a sample of executed prices of securities sold to the fair value estimates, comparison of fair value estimates to management’s knowledge of the current market, and ongoing confirmation that third party pricing services use, wherever possible, market-based parameters for valuation. In addition, the Company utilizes both internal and external cash flow models to analyze the reasonableness of fair values utilizing credit spread and other market assumptions, where appropriate. As a result of the analysis, if the Company determines there is a more appropriate fair value based upon the available market data, the price received from the third party is adjusted accordingly. The Company also determines if the inputs used in estimated fair values received from pricing services are observable by assessing whether these inputs can be corroborated by observable market data.
The inputs used in the valuation of corporate and government securities include, but are not limited to standard market observable inputs that are derived from, or corroborated by, market observable data including market yield curve, duration, call provisions, observable prices and spreads for similar publicly traded or privately placed issues that incorporate the credit quality and industry sector of the issuer. For private placements and structured securities, valuation is based primarily on matrix pricing or other similar techniques using standard market inputs including spreads for actively traded securities, spreads off benchmark yields, expected prepayment speeds and volumes, current and forecasted loss severity, rating, weighted average coupon, weighted average maturity, average delinquency rates, geographic region, debt service coverage ratios and issuance-specific information including, but not limited to: collateral type, payment terms of the underlying assets, payment priority within the tranche, structure of the security, deal performance and vintage of loans.
When observable inputs are not available, the market standard valuation techniques for determining the estimated fair value of certain types of securities that trade infrequently, and therefore have little or no price transparency, rely on inputs that are significant to the estimated fair value that are not observable in the market or cannot be derived principally from or corroborated by observable market data, such as market illiquidity. Other significant unobservable inputs used in the fair value measurement of the Company’s private debt investments include a multiple of earnings before interest, taxes, depreciation and amortization (“EBITDA”). These unobservable inputs can be based in large part on management judgment or estimation, and cannot be supported by reference to market activity. Even though unobservable, these inputs are based on assumptions deemed appropriate given the circumstances and are believed to be consistent with what other market participants would use when pricing such securities.
Equity Securities - Equity securities consist principally of exchange-traded funds and common and preferred stock of publicly and privately traded companies. The fair values of publicly traded equity securities are primarily based on quoted market prices in active markets and are classified within Level 1 in the fair value hierarchy. Non-binding broker quotes and internally developed
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, 2019 and 2018 (dollars in millions):
Assets and liabilities transferred into Level 3 are due to a lack of observable market transactions and price information. Transfers out of Level 3 are 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 2018, the Company transferred equity securities with a fair value of approximately $39 million into Level 3 as a result of the adoption of the accounting guidance for the recognition and measurement of equity securities.
The following table presents information for assets measured at an estimated fair value on a nonrecurring basis during the periods presented and still held at the reporting date (for example, when there is evidence of impairment). The estimated fair values for these assets were determined using significant unobservable inputs (Level 3).
Carrying values presented herein may differ from those in the Company’s consolidated balance sheets because certain items within the respective financial statement captions may be measured at fair value on a recurring basis.
Funds Withheld at Interest - The carrying value of funds withheld at interest approximates fair value except where the funds withheld are specifically identified in the agreement. When funds withheld are specifically identified in the agreement, the fair value is based on the fair value of the underlying assets that are held by the ceding company. Ceding companies use a variety of sources and pricing methodologies, which are not transparent to the Company and may include significant unobservable inputs, to value the securities that are held in distinct portfolios, therefore the valuation of these funds withheld assets are considered Level 3 in the fair value hierarchy.
Retrocession reinsurance treaties do not relieve the Company from its obligations to direct writing companies. Failure of retrocessionaires to honor their obligations could result in losses to the Company. The Company regularly evaluates the financial condition of the insurance and reinsurance companies from which it assumes and to which it cedes reinsurance. Consequently, allowances would be established for amounts deemed uncollectible. At December 31, 2019 and 2018, no allowances were deemed necessary.
Retrocessions are arranged through the Company’s retrocession pools for amounts in excess of the Company’s retention limit. As of December 31, 2019, all rated retrocession pool participants followed by the A.M. Best Company were rated “A- (excellent)” or better. The Company verifies retrocession pool participants’ ratings on a quarterly basis. For a majority of the retrocessionaires that were not rated, security in the form of letters of credit or trust assets has been posted. In addition, the Company performs annual financial reviews of its retrocessionaires to evaluate financial stability and performance. In addition to its third party retrocessionaires, various RGA reinsurance subsidiaries retrocede amounts in excess of their retention to affiliated subsidiaries.
The effect of reinsurance on net premiums is as follows (dollars in millions):
subsidiaries to satisfy collateral requirements for reinsurance business at December 31, 2019 and 2018, respectively. Additionally, securities with an amortized cost of $27.3 billion and $20.1 billion as of December 31, 2019 and 2018, respectively, 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 to another subsidiary, post additional collateral or make payments under a given reinsurance treaty. These conditions include change in control or ratings of the subsidiary, insolvency, nonperformance under a reinsurance treaty, or loss of license or other regulatory authorization of such subsidiary. If the Company was ever required to move reinsurance from one subsidiary to another subsidiary, the risk to the Company on a consolidated basis under the reinsurance treaties would not change; however, additional collateral may need to be posted or 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.
The effective tax rate for 2019 was higher than the U.S. Statutory rate of 21.0% primarily as a result of valuation allowance increases in various jurisdictions and tax expense related to uncertain tax positions, which were partially offset by foreign bases differences, excess tax benefit of equity compensation and tax benefit from foreign tax credits. The effective tax rate for 2018 was lower than the U.S. Statutory rate of 21% primarily as a result of the release of a valuation allowance on foreign tax credits and foreign bases differences, which was partially offset by tax expense related to GILTI and valuation allowance increases. The 2017 effective tax rate includes the tax effects of U.S. Tax Reform. See the table below for additional information.
The provision for income tax expense for the years ended December 31, 2019, 2018 and 2017 consists of the following (dollars in millions):
The Company’s effective tax rate differed from the U.S. federal income tax statutory rate of 21%, 21%, and 35% as a result of the following for the years ended December 31, 2019, 2018 and 2017 (dollars in millions):
The tax effects of temporary differences that give rise to significant portions of the deferred income tax assets and liabilities at December 31, 2019 and 2018, are presented in the following tables (dollars in millions):
As of December 31, 2018, the valuation allowance against deferred tax assets was $181 million. During 2018, a valuation allowance on the U.S. Foreign tax credit carryforwards of $65 million was released. This release partially offset a $25 million increase to the valuation allowance related to the net operating losses of RGA Australia and increases and decreases to the valuation allowance in jurisdictions where the Company does not have a history of earnings. Further decreases to the valuation allowance include foreign currency translation and reclassifications with other deferred tax assets of $13 million.
During 2019, 2018, and 2017, the Company received federal and foreign income tax refunds of approximately $22 million, $2 million, and $12 million, respectively. The Company made cash income tax payments of approximately $66 million, $144 million, and $49 million, in 2019, 2018, and 2017, respectively.
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.
As of December 31, 2019 the Company had foreign tax credit carryforwards of $28 million in Ireland for which there is a full valuation allowance.
The Company files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The Company is under continuous examination by the Internal Revenue Service and is subject to audit by taxing authorities in other foreign jurisdictions in which the Company has significant business operations. The income tax years under examination vary by jurisdiction. The Company is no longer subject to U.S. federal income tax examinations by tax authorities for years prior to 2016, Canadian tax authorities for years prior to 2015 and with a few exceptions, the Company is no longer subject to state and foreign income tax examinations by tax authorities for years prior to 2014.
The Company also provides select health care and life insurance benefits for certain retired employees. The health care benefits are provided through a self-insured welfare benefit plan. Employees become eligible for these benefits if they meet minimum age and service requirements. The retiree’s cost for health care benefits varies depending upon the credited years of service. Effective January 1, 2017, employees hired in the U.S. are not eligible for retiree health care benefits. The effect of the amendment was recorded in 2016 in AOCI and is being amortized through prior service cost. Virtually all retirees, or their beneficiaries, contribute a portion of the total cost of postretirement health benefits. Prepaid benefit costs and accrued benefit liabilities are included in other assets and other liabilities, respectively, in the Company’s consolidated balance sheets.
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, 2019 and 2018 (dollars in millions):
The components of net periodic benefit cost, included in other operating expenses on the consolidated statements of income, and other changes in plan assets and benefit obligations recognized in other comprehensive income were as follows (dollars in millions):
During 2020, the Company expects to contribute $18 million and $2 million to the pension plans and other benefit plans, respectively.
The following benefit payments, which reflect expected future service as appropriate, are expected to be paid (dollars in millions):
Weighted average assumptions used to determine the accumulated benefit obligation and net benefit cost or income were as follows:
Mutual funds were invested 27% in U.S. equity funds, 39% in U.S. fixed income funds, 18% in non-U.S. equity funds and 16% in other.
Mutual funds were invested 25% in U.S. equity funds, 42% in U.S. fixed income funds, 17% in non-U.S. equity funds and 16% in other.
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 $16 million, $15 million and $14 million in 2019, 2018 and 2017, respectively.
Reinsurance Company of Missouri (“RCM”), RGA Reinsurance and Chesterfield Reinsurance Company (“Chesterfield Re”) are subject to Missouri statutory provisions that restrict the payment of dividends. They may not pay dividends in any 12-month period in excess of the greater of the prior year’s statutory net gain from operations or 10% of statutory capital and surplus at the preceding year-end, without regulatory approval. Aurora National Life Assurance Company (“Aurora National”) is subject to California statutory provisions that are identical to those imposed by Missouri regarding the ability of Aurora National to pay dividends to RGA Reinsurance. The applicable statutory provisions only permit an insurer to pay a shareholder dividend from unassigned surplus. As of January 1, 2020, RGA Reinsurance could pay maximum dividends, without prior approval, of approximately $315 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’s commitments to fund investments as of December 31, 2019 and 2018 are presented in the following table (dollars in millions):
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, 2019, were as follows (dollars in millions):
The Company maintains six committed credit facilities, a syndicated revolving credit facility with a capacity of $850 million and five letter of credit facilities with a combined capacity of $880 million. The Company may borrow cash and obtain letters of credit in multiple currencies under its syndicated revolving credit facility. The following table provides additional information on the Company’s existing committed credit facilities as of December 31, 2019 and 2018 (dollars in millions):
In 2006, RGA’s subsidiary, Timberlake Financial L.L.C. (“Timberlake Financial”), issued $850 million of Series A Floating Rate Insured Notes, due June 2036, in a private placement. The notes were issued to fund the collateral requirements for statutory reserves required by Regulation XXX on specified term life insurance policies reinsured by RGA Reinsurance and retroceded to Timberlake Re. Proceeds from the notes, along with a $113 million direct investment by RGA, were deposited into a series of accounts that collateralize the notes and are not available to satisfy the general obligations of the Company. As of December 31, 2019 and 2018, respectively, the Company held assets in trust and in custody of $694 million and $768 million, of which $58 million and $57 million were held in a Debt Service Coverage account to cover interest payments on the notes. Interest on the notes accrues at an annual rate of 1-month LIBOR plus a base rate margin, payable monthly, and totaled $9 million, $9 million and $6 million in 2019, 2018 and 2017, respectively.
The demand note is secured by a portfolio of specified assets that have an aggregate market value at least equal to the principal amount of the demand note and a payment obligation pledged by a third party financial institution. The principal amount of the demand note is payable upon demand by the holder, which creates a corresponding payment under the note issued by RGA Americas. The note issued by RGA Americas bears interest at a rate equal to the rate on the corresponding demand note, plus an amount representing fees payable to the applicable third party financial institution. Through December 31, 2019, no principal payments have been received or are currently due on the demand note and, as a result, there was no payment obligation under the note issued by RGA Americas. Accordingly, the notes are not reflected in the Company’s consolidated balance sheet or the table below, as of that date.
In 2014, RGA’s subsidiary, Chesterfield Financial Holdings LLC, (“Chesterfield Financial”), issued $300 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 Company has geographic-based and business-based operational segments. Geographic-based operations are further segmented into traditional and financial solutions businesses.
No individual client generated 10% or more of the Company’s total gross premiums and other revenues on a consolidated basis in 2019, 2018 and 2017. For the purpose of this disclosure, companies that are within the same insurance holding company structure are combined.
The timing and amount of share repurchases are determined by management based upon market conditions and other considerations. Factors could affecting the timing and amount of any future repurchases under the share repurchase authorization, include increased capital needs of the Company due to changes in regulatory capital requirements, opportunities for growth and acquisitions, and the effect of adverse market conditions on the segments.
The following table presents the components of the Company’s other comprehensive income (loss) for the years ended December 31, 2019, 2018 and 2017 (dollars in millions):
The following table presents the amounts of AOCI reclassifications for the years ended December 31, 2019 and 2018 (dollars in millions):
or shares made available from authorized but unissued shares to support the future exercise of options or settlement of awards granted under its stock plans.
The intrinsic value of options exercised was $31 million, $26 million, and $42 million for 2019, 2018 and 2017, respectively.
During 2019, the Company issued 120,403 PCUs to key employees at a weighted average fair value per unit of $145.25. In May 2019 and May 2018, RGA’s board of directors approved a 1.35 and 1.07 share payout for each PCU granted in 2017 and 2016, resulting in the issuance of 248,789 and 170,080 shares of common stock from treasury, respectively.
As of December 31, 2019, the total compensation cost of non-vested awards not yet recognized in the financial statements was $16.6 million. It is estimated that these costs will vest over a weighted average period of 0.9 years.
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, 2019, 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, 2020 expressed an unqualified opinion on the Company's internal control over financial reporting.
We obtained an understanding and evaluated the appropriateness of the Company’s pricing sources.
Our audit procedures related to the assumptions used by management to estimate the valuation of future policy benefits and embedded derivatives and the amortization of deferred policy acquisition costs included the following, among others:
We tested the effectiveness of controls, including those related to the performance of experience studies and the setting of best estimate assumptions.
We tested the accuracy and completeness of the underlying data that served as the basis for the estimated assumptions.
Premiums receivable and other reinsurance balances - Refer to Note 1 to the financial statements
We tested management’s historical accuracy of estimation by comparing a selection of premiums received during the year to previously-reported premiums receivable.
For a selection of management’s premiums receivable estimates, we compared our independently-developed expectation to management’s estimate.