RGA Reinsurance houses its employees and the majority of RGA's officers in approximately 136,000 square feet of office space at 1370 Timberlake Manor Parkway, Chesterfield, Missouri. These premises are leased through August 31, 2009, at annual rents ranging from approximately $2,600,000 to $2,800,000. RGA Reinsurance also conducts business from a total of approximately 1,400 square feet of office space in Norwalk, Connecticut and North Palm Beach, Florida. These premises are leased through December 2005, at an annual rent of approximately $39,000. RGA Reinsurance also leases approximately 2,000 square feet of office space in Mexico at an annual rent of approximately $62,000. GA Argentina, part of the Corporate and Other operations, conducts business from approximately 6,600 square feet of office space in Buenos Aires. These premises are leased through July 2007, at annual rents of approximately $30,000.
RGA Reinsurance also conducts business from a total of approximately 23,000 square feet of office space in Hong Kong, Tokyo, Taipei and Seoul. These premises are leased through April 2008, at annual rents of approximately $1,239,000. RGA Australia conducts business from approximately 8,400 square feet of office space in Sydney. These premises are leased through January 2010, at annual rents of approximately $229,000.
The Company's accounting policies are described in Note 2 to the Consolidated Financial Statements. The Company believes its most critical accounting policies include the capitalization and amortization of deferred acquisition costs ("DAC"), the establishment of liabilities for future policy benefits, other policy claims and benefits, including incurred but not reported claims, the valuation of investment impairments, and the establishment of arbitration or litigation reserves. The balances of these accounts are significant to the Company's financial position and require extensive use of assumptions and estimates, particularly related to the future performance of the underlying business.
The Company periodically reviews actual historical experience and relative anticipated experience compared to the assumptions used to establish policy reserves. Further, the Company determines whether actual and anticipated experience indicates that existing policy reserves together with the present value of future gross premiums are sufficient to cover the
Income before income taxes increased 23.4% and 54.2% in 2004 and 2003, respectively. The increase in 2004 was primarily the result of more favorable mortality experience in the current year, offset by a decrease in realized investment gains of $1.9 million, or 3.2%. Additionally, the Canadian dollar strengthened against the U.S. dollar during 2004 relative to 2003, and contributed $4.4 million, or 7.4%, to income before income taxes in 2004. The increase in 2003 was the result of an increase of $13.6 million or 35.2% in realized investment gains as well as favorable mortality experience. Additionally, the Canadian dollar strengthened against the U.S. dollar during 2003 relative to 2002, and contributed $6.7 million, or 17.3%, to income before income taxes in 2003.
The Company's asset-intensive products are primarily supported by investments in fixed maturity securities. Investment guidelines are established to structure the investment portfolio based upon the type, duration and behavior of products in the liability portfolio so as to achieve targeted levels of profitability. The Company manages the asset-intensive business to provide a targeted spread between the interest rate earned on investments and the interest rate credited to the underlying interest-sensitive contract liabilities. The Company periodically reviews models projecting different interest rate scenarios and their impact on profitability. Certain of these asset-intensive agreements, primarily in the U.S. operating segment, are generally funded by fixed maturity securities that are withheld by the ceding company.
The Company's fixed maturity securities are invested primarily in commercial and industrial bonds, mortgage- and asset-backed securities, public utilities, and Canadian government securities. As of December 31, 2004, approximately
While all of these securities are monitored for potential impairment, the Company's experience indicates that the first two categories do not present as great a risk of impairment, and often, fair values recover over time. These securities have generally been adversely affected by overall economic conditions, primarily an increase in the interest rate environment.
Based on data provided by the ceding companies as of December 31, 2004, the maturity distribution of the segregated portfolio portion of funds withheld at interest was approximately (in thousands):
In December 2004, FASB revised SFAS No. 123 Accounting for Stock Based Compensation ("SFAS 123") to Share-Based Payment ("SFAS 123(r)"). SFAS 123(r) provides more guidance on determining whether certain financial instruments awarded in share-based payment transactions are liabilities. SFAS 123(r) also requires that the cost of all share-based transactions should be recorded in the financial statements. The revised pronouncement must be adopted by the Company by July 1, 2005. The Company expects SFAS 123(r) will increase compensation expense by $1.8 million in 2005 and $1.5 million in 2006.
Change in value of embedded derivatives reflects the change in the market value of specific financial instruments as required upon the adoption of SFAS No. 133 Implementation Issue No. B36, "Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk Exposures That Are Unrelated or Only Partially Related to the Creditworthiness of the Obligor under Those Instruments."
Other invested assets include derivative contracts, common stocks and preferred stocks, carried at fair value, and limited partnership interests, carried at cost. Changes in fair value are recorded through accumulated other comprehensive income. Other invested assets are periodically reviewed for impairment.
The amortized cost and estimated fair value of fixed maturity securities available-for-sale at December 31, 2004 are shown by contractual maturity for all securities except certain U.S. government agencies securities, which are distributed to maturity year based on the Company's estimate of the rate of future prepayments of principal over the remaining lives of the securities. These estimates are developed using prepayment rates provided in broker consensus data. Such estimates are derived from prepayment rates experienced at the interest rate levels projected for the applicable underlying collateral and can be expected to vary from actual experience. 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.
All mortgage loans are performing and no valuation allowance had been established as of December 31, 2004 and 2003.
The Company also provides certain health care and life insurance benefits for retired employees. The health care benefits are provided through a self-insured welfare benefit plan. Employees become eligible for these benefits if they meet minimum age and service requirements. The retiree's cost for health care benefits varies depending upon the credited years of service. The Company recorded benefits expense of approximately $0.7 million for 2004 and 2003, and $0.6 million for 2002, related to these postretirement plans. The projected obligation was approximately $8.6 million and $5.3 million as of December 31, 2004 and 2003, respectively.
The Company is currently a party to an arbitration that involves its discontinued accident and health business, including personal accident business (including London market excess of loss business). In addition, the Company is currently a party to litigation that involves the claim of a broker to commissions on a medical reinsurance arrangement. As of January 31, 2005, the companies involved in these litigation actions raised claims, or established reserves that may result in claims, in the amount of $4.4 million, which is $3.7 million in excess of the amounts held in reserve by the Company. The Company generally has little information regarding any reserves established by ceding companies, and must rely on management estimates to establish policy claim liabilities. It is possible that any such reserves could be increased in the future. The Company believes it has substantial defenses upon which to contest these claims, including but not limited to misrepresentation and breach of contract by direct and indirect ceding companies. In addition, the Company is in the process of auditing ceding companies that have indicated that they anticipate asserting claims in the future against the Company in the amount of $24.9 million, which is $24.5 million in excess of the amounts held in reserve by the Company as of December 31, 2004. These claims appear to relate to personal accident business (including London market excess of loss business) and workers' compensation carve-out business. Depending upon the audit findings in these cases, they could result in litigation or arbitrations in the future. See Note 20, "Discontinued Operations" for more information. During the third quarter of 2004, the Company's discontinued accident and health operations recorded a $24.0 million pre-tax charge related to the negotiated settlement of all disputed claims associated with its largest identified accident and health exposure. Additionally, from time to time, the Company is subject to litigation and arbitration related to its life reinsurance business and to employment-related matters in the normal course of its business. While it is not feasible to predict or determine the ultimate outcome of the pending litigation or arbitrations or provide reasonable ranges of potential losses, it is the opinion of management, after consultation with counsel, that their outcomes, after consideration of the provisions made in the Company's consolidated financial statements, would not have a material adverse effect on its consolidated financial position. However, it is possible that an adverse outcome could, from time to time, have a material adverse effect on the Company's consolidated net income or cash flows in particular quarterly or annual periods.
RGA has issued guarantees to third parties on behalf of its subsidiaries' performance for the payment of amounts due under certain credit facilities, reinsurance treaties and an office lease obligation, whereby if a subsidiary fails to meet an obligation, RGA or one of its other subsidiaries will make a payment to fulfill the obligation. In limited circumstances, treaty guarantees are granted to ceding companies in order to provide them additional security, particularly in cases where RGA's subsidiary is relatively new, unrated, or not of a significant size, relative to the ceding company. Liabilities supported by the treaty guarantees, before consideration for any legally offsetting amounts due from the guaranteed party, totaled $285.4 million and $188.3 million as of December 31, 2004 and 2003, respectively, and are reflected on the Company's consolidated balance sheet in future policy benefits. Potential guaranteed amounts of future payments will vary depending on production levels and underwriting results. Guarantees related to credit facilities provide additional security to third party banks should a subsidiary fail to make principal and/or interest payments when due. As of December 31, 2004, RGA's exposure related to credit facility guarantees was $56.1 million, the maximum potential guarantee, and is reflected on the consolidated balance sheet in short-term debt. RGA has issued a guarantee on behalf of a subsidiary in the event the subsidiary fails to make payment under its office lease obligation, the exposure of which was insignificant as of December 31, 2004.