Additionally, merger and acquisition transactions within the life insurance industry continue to occur. The Company believes that reorganizations and consolidations of life insurers will continue. As reinsurance services are used to facilitate these transactions and manage risk, the Company expects demand for its products to continue.
Asset-intensive and Longevity Reinsurance and Other Products and Services. In recent years, the Company has experienced growth in asset-intensive and longevity reinsurance. The Company intends to continue leveraging its existing client relationships and reinsurance expertise to create customized reinsurance products and solutions. Industry trends, particularly the increased pace of consolidation and reorganization among life insurance companies and changes in products and product distribution along with new solvency requirements, are expected to enhance existing opportunities for asset-intensive and longevity reinsurance and financial solutions products. The Company began reinsuring annuities with guaranteed minimum benefits on a limited basis in 2007. To date, most of the Company’s asset-intensive reinsurance business has been written in the U.S. and the UK; however, additional opportunities outside of the U.S. continue to develop. The Company also provides longevity reinsurance in Europe and Canada, and in 2008 entered the U.S. healthcare reinsurance market with a primary focus on long-term care and Medicare supplement insurance. Additionally, the Company is experiencing growth in health related product offerings, such as critical illness, most notably in select Asian markets. In 2010, the Company expanded into the group reinsurance market in North America with the acquisition of Reliastar Life Insurance Company’s U.S. and Canada operations. The Company has more recently increased its investment and expenditures in client service and technology oriented initiatives to both support its clients and generate new future revenue streams.
Consolidated net premiums increased $702.6 million, or 7.1%, and $592.3 million, or 6.4%, in 2018 and 2017, respectively. The increases in 2018 and 2017 are primarily due to growth in life reinsurance in force. Foreign currency fluctuations relative to the prior year affected net premiums favorably by approximately $43.0 million and $25.9 million in 2018 and 2017, respectively. Consolidated assumed life insurance in force was $3,329.2 billion, $3,297.3 billion and $3,062.5 billion as of December 31, 2018, 2017 and 2016, respectively. Foreign currency fluctuations affected the increases in assumed life insurance in force unfavorably by $101.5 billion in 2018 and favorably by $121.1 billion in 2017. The Company added new business production, measured by face amount of insurance in force, of $406.7 billion, $395.4 billion and $404.8 billion during 2018, 2017 and 2016, respectively.
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, 2018, 2017 and 2016.
Revenue before certain derivatives decreased by $96.2 million and increased by $172.5 million in 2018 and 2017, respectively. The decrease in 2018 was primarily due to the change in fair value of equity options associated with the reinsurance of EIAs and lower investment related gains (losses) associated with coinsurance portfolios, partially offset by revenues from new transactions. The increase in 2017 was primarily due to the change in fair value of equity options associated with the reinsurance of EIAs, investment income from a new coinsurance transaction in 2017, and higher investment related gains (losses) associated with coinsurance and funds withheld portfolios. The effect on investment income related to equity options is substantially offset by a corresponding change in interest credited.
Other operating expenses increased by $1.2 million, or 3.7%, and $7.4 million, or 30.0%, in 2018 and 2017, respectively. The increase in other operating expenses of 2018 was primarily due to an increase in foreign currency exchange fluctuations. The increase in 2017 was primarily due to increased administration costs related to longevity transactions, costs related to a potential
acquisition and by the effect of foreign currency exchange fluctuations. Foreign currency exchange fluctuations resulted in an increase in operating expenses of $1.2 million and a decrease of $0.4 million 2018 and 2017, respectively.
The Company holds various types of fixed maturity securities available-for-sale and classifies them as corporate securities (“Corporate”), Canadian and Canadian provincial government securities (“Canadian government”), residential mortgage-backed securities (“RMBS”), asset-backed securities (“ABS”), commercial mortgage-backed securities (“CMBS”), U.S. government and agencies (“U.S. government”), state and political subdivisions, and other foreign government, supranational and foreign government-sponsored enterprises (“Other foreign government”). As of both December 31, 2018 and 2017, approximately 95.6% of the Company’s consolidated investment portfolio of fixed maturity securities were investment grade.
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, 2018 and 2017.
In addition to leading the ERM function, the CRO also chairs the Company’s Risk Management Steering Committee (“RMSC”), which is made up of senior management executives, including the CEO, the Chief Financial Officer (“CFO”), and the Chief Operating Officer, among others. The RMSC provides oversight for the Insurance, Market and Credit, Capital, and Operational risk committees and retains direct risk oversight responsibilities for the following:
The Company seeks to limit its exposure to loss on its assumed catastrophic excess of loss reinsurance agreements by ceding a portion of its exposure to multiple retrocessionaires through retrocession line slips or directly to retrocession markets. The Company’s policy is to retain a maximum of $20.0 million of catastrophic loss exposure per agreement and to retrocede up to $40.0 million additional loss exposures to the retrocession markets. The Company limits its exposure on a country-by-country (and state-by-state in the U.S.) basis by managing its total exposure to all catastrophic excess of loss agreements bound within a given country to established maximum aggregate exposures. The maximum exposures are established and managed both on gross amounts issued prior to including retrocession and for amounts net of exposures retroceded.
All counterparty exposures are calculated on a quarterly basis, reviewed by management and monitored by the ERM function.
Premiums are accrued when due and in accordance with information received from the ceding company. When the Company enters into a new reinsurance agreement, it records accruals based on the terms of the reinsurance treaty. Similarly, when a ceding company fails to report information on a timely basis, the Company records accruals based on the terms of the reinsurance treaty as well as historical experience. Other management estimates include adjustments for increased in force on existing treaties, lapsed premiums given historical experience, the financial health of specific ceding companies, collateral value and the legal right of offset on related amounts (i.e. allowances and claims) owed to the ceding company. Under the legal right of offset provisions in its reinsurance treaties, the Company can withhold payments for allowances and claims from unpaid premiums. Based on its review of these factors and historical experience, the Company did not believe a provision for doubtful accounts was necessary as of December 31, 2018 or 2017.
As of December 31, 2018 and 2017, the Company held non-income producing securities with amortized costs of $41.3 million and $38.8 million, and estimated fair values of $42.7 million and $39.3 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. During 2018, 2017 and 2016, the Company sold fixed maturity securities with fair values of $5,784.6 million, $2,550.1 million, and $1,055.5 million at losses of $158.9 million, $37.3 million and $47.1 million, respectively. During 2018, 2017 and 2016, the Company sold equity securities with fair values of $32.8 million, $177.7 million, and $126.1 million at losses of $1.9 million, $4.4 million and $2.9 million, respectively. The Company generally does not engage in short-term buying and selling of securities.
Derivatives, except for embedded derivatives and longevity and mortality swaps, are carried on the Company’s consolidated balance sheets in other invested assets or other liabilities, at fair value. Longevity and mortality swaps are included on the consolidated balance sheets in other assets or other liabilities, at fair value. Embedded derivative assets and liabilities on modco or funds withheld arrangements are included on the consolidated balance sheets with the host contract in funds withheld at interest, at fair value. Embedded derivative liabilities on indexed annuity and variable annuity products are included on the consolidated balance sheets with the host contract in interest-sensitive contract liabilities, at fair value. The following table presents the notional amounts and gross fair value of derivative instruments prior to taking into account the netting effects of master netting agreements as of December 31, 2018 and 2017 (dollars in thousands):
The methods and assumptions the Company uses to estimate the fair value of assets and liabilities measured at fair value on a recurring basis are summarized below. See “Valuation Process for Fair Value Measurements Categorized within Level 3” for additional information on Level 3 valuations.
The effective tax rate for 2018 was lower than the U.S. Statutory rate of 21.0% primarily as a result of the release of a valuation allowance on foreign tax credits, which partially offset tax expense related to GILTI and valuation allowance increases. The effective tax rate for 2017 was lower than the U.S. Statutory rate of 35% primarily as a result of accounting for the effects of U.S. Tax Reform and income generated in non-U.S. jurisdictions with lower tax rates than the U.S. See the table below for additional information.
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 2015, Canadian tax authorities for years prior to 2014 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 2013.
The liability for unpaid claims is reported in future policy benefits and other policy-related balances within the Company’s consolidated balance sheet. Activity associated with unpaid claims is summarized below (dollars in thousands):