U.S. and Latin America operations consist of two major segments: Traditional and Non-Traditional. The Traditional segment primarily specializes in individual mortality-risk reinsurance and to a lesser extent, group, health and long-term care reinsurance. The Non-Traditional segment consists of Asset-Intensive and Financial Reinsurance. Asset-Intensive within the Non-Traditional segment provides coinsurance of annuities and corporate-owned life insurance policies and to a lesser extent also issues fee-based synthetic guaranteed investment contracts, which include investment-only, stable value contracts. Financial Reinsurance within the Non-Traditional segment primarily involves assisting ceding companies in meeting applicable regulatory requirements by enhancing the ceding companies’ financial strength and regulatory surplus position. Typically these transactions do not qualify as reinsurance under GAAP, due to the low-risk nature of the transactions, so only the related net fees are reflected in other revenues on the consolidated statements of income.
The change in fair value of the embedded derivatives - modco/funds withheld treaties decreased income before income taxes by $42.5 million in 2015, compared to increases of $72.6 million and $27.2 million in 2014 and 2013, respectively. The decrease in income in 2015 was primarily due to increasing risk-free rates and widening credit spreads. The increases in income in 2014 and 2013 were primarily due to tightening credit spreads and changes in risk free rates.
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, 2015, 2014 and 2013.
Benefits and expenses before certain derivatives decreased by $77.9 million and $140.2 million in 2015 and 2014, respectively. These decreases were primarily due to lower interest credited associated with the reinsurance of EIAs and fixed annuities. The decrease in 2015 was partially offset by the benefits associated with the acquisition of Aurora National. The effect on interest credited related to equity options is substantially offset by a corresponding change in investment income. Additionally, 2014 reflects a decrease in deferred acquisition expenses related to investment related gains and losses associated with funds withheld and coinsurance portfolios.
Loss ratios for the segment were 79.9%, 82.3% and 78.5% in 2015, 2014 and 2013, respectively. The decrease in the 2015 loss ratio is due to favorable traditional individual life mortality experience. The increase in the 2014 loss ratio is due to unfavorable mortality experience. Loss ratios for the traditional individual life mortality business were 92.4%, 99.6% and 93.9% in 2015, 2014 and 2013, respectively. Historically, the loss ratio increased primarily as the result of several large permanent level premium in force blocks assumed in 1997 and 1998. These blocks are mature blocks of long-term permanent level premium business in which mortality as a percentage of net premiums is expected to be higher than historical ratios. The nature of permanent level premium policies requires the Company to set up actuarial liabilities and invest the amounts received in excess of early-year claims costs to fund claims in later years when premiums, by design, continue to be level as compared to expected increasing mortality or claim costs. Excluding creditor business, claims and other policy benefits, as a percentage of net premiums and investment income were 72.2%, 77.8% and 72.6% in 2015, 2014 and 2013, respectively.
Claims and other policy benefits decreased by $25.2 million, or 60.7%, and $16.0 million, or 27.8%, in 2015 and 2014, respectively. These decreases are attributable to favorable experience on disability reinsurance business in the segment. Although reasonably predictable over a period of years, claims can be volatile over shorter periods. Management views recent experience as normal short-term volatility that is inherent in the business.
Loss before income taxes increased by $107.5 million and $11.5 million in 2015 and 2014, respectively. The increase in loss before income taxes in 2015 is primarily due to an increase in total investment related losses of $56.2 million along with an increase of $46.2 million in interest expense. The increase in loss before income taxes in 2014 is primarily due to the decrease in other revenues of $53.5 million, an increase in other operating expenses of $18.7 million, partially offset by a decrease in interest expense of $27.6 million and an increase in investment income, net of related expenses of $27.3 million.
Total revenues decreased $41.5 million, or 37.6%, and $28.6 million, or 20.6%, in 2015 and 2014, respectively. The decrease in total revenues in 2015 was largely due to the increase in investment related losses of $56.2 million primarily due to other-than-temporary impairments on fixed maturities of $48.8 million offset by an increase in investment income, net of related expenses of $12.6 million due to an increase in allocated invested assets and higher investment yields. The decrease in total revenues in 2014 was largely due to a decrease in other revenues of $53.5 million related to a $46.5 million gain on repurchase of collateral finance notes, included in other revenue in 2013, partially offset by an increase in investment income, net of related expenses of $27.3 million due to an increase in allocated invested assets.
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, 2015, the Company had $691.9 million of DAC related to asset-intensive products, all within the U.S. and Latin America Non-Traditional 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:
RGA, through wholly-owned subsidiaries, has committed to provide statutory reserve support to third-parties, in exchange for a fee, by funding loans if certain defined events occur. Such statutory reserves are required under the U.S. Valuation of Life Policies Model Regulation (commonly referred to as Regulation XXX for term life insurance policies and Regulation A-XXX for universal life secondary guarantees). The third-parties have recourse to RGA should the subsidiary fail to provide the required funding, however, as of December 31, 2015, the Company does not believe that it will be required to provide any funding under these commitments as the occurrence of the defined events is considered remote. See Note 12 - “Commitments, Contingencies and Guarantees” in the Notes to Consolidated Financial Statements for a table that presents these commitments by period and maximum obligation.
The Company uses various internal and third-party reinsurance arrangements and funding sources to manage statutory reserve strain, including reserves associated with Regulation XXX, and collateral requirements. Assets in trust and letters of credit are often used as collateral in these arrangements.
The Company earns a spread between the interest rate earned on policy loans and the interest rate credited to corresponding liabilities.
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 Chief Executive Officer ("CEO"), the President, the Chief Financial Officer ("CFO"), and the COO, among others. The RMSC approves targets and limits for each material risk at the consolidated level and reviews these limits at least annually. Exposure to these risks is calculated and presented to the RMSC at least quarterly. Any waiver or exception to established risk limits needs to be approved by the RMSC. The Company also has risk-focused committees such as the Business Continuity and Information Governance Steering Committee, Consolidated Investment Committee, Derivatives Risk Oversight Committee, Asset Liability Management Committee, Actuarial Standards Group, Collateral and Liquidity Committee, and the Currency Risk Management Committee. These committees are comprised of various risk and technical experts and have overlapping membership, enabling consistent and holistic management of risks. These committees report directly or indirectly to the RMSC. In addition to the risk committees at a consolidated level, some of RGA’s operating entities have risk management committees that oversee relevant risks relative to segment-level risk targets and limits.
Derivatives are carried on the Company’s consolidated balance sheets primarily in other invested assets or other liabilities, at fair value. Certain derivatives are subject to master netting provisions and reported as a net asset or liability. On the date a derivative contract is executed, the Company designates the derivative as (1) a fair value hedge, (2) a cash flow hedge, (3) a net investment hedge in a foreign operation or (4) free-standing derivatives held for other risk management purposes, which primarily involve managing asset or liability risks associated with the Company’s reinsurance treaties which do not qualify for hedge accounting.
The other-than-temporary impairment losses on fixed maturity securities for 2015 are primarily due to emerging market and high-yield debt exposures. The fluctuations in investment related gains (losses) for derivatives and other for 2015, compared to 2014, is 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.
During the year, the Company participated in a repurchase program in which securities, reflected as investments on the Company’s consolidated balance sheets, were pledged to a third party. In return, the Company received cash from the third party, reflected as a payable to the third party, included in other liabilities on the consolidated balance sheets. The Company was required to maintain a minimum collateral balance with a fair value of 105% of the cash received. The Company terminated the program and all cash was returned prior to December 31, 2015. The gross balance of the repurchase agreement payable as of December 31, 2014 was $101.4 million, which was fully collateralized by securities with a fair value of $107.2 million.
Funds withheld at interest comprised approximately 14.0% and 16.1% of the Company’s total investments as of December 31, 2015 and 2014, respectively. Of the $5.9 billion funds withheld at interest balance, net of embedded derivatives, as of December 31, 2015, $4.1 billion of the balance is associated with one client. For reinsurance agreements written on a modified coinsurance basis and certain agreements written on a coinsurance funds withheld basis, assets equal to the net statutory reserves are withheld and legally owned and managed by the ceding company and are reflected as funds withheld at interest on the Company’s consolidated balance sheets. In the event of a ceding company’s insolvency, the Company would need to assert a claim on the assets supporting its reserve liabilities. However, the risk of loss to the Company is mitigated by its ability to offset amounts it owes the ceding company for claims or allowances against amounts owed to the Company from the ceding company.
Foreign currency forwards are used by the Company to reduce the risk from fluctuations in foreign currency exchange rates associated with its assets and liabilities denominated in foreign currencies. With a foreign currency forward transaction, the Company agrees with another party to deliver a specified amount of an identified currency at a specified future date. The price is agreed upon at the time of the contract and payment for such a contract is made in a different currency at the specified future date.
The Company performs initial and ongoing analysis and review of the various techniques utilized in determining fair value to ensure that the valuation approaches utilized are appropriate and consistently applied, and that the various assumptions are reasonable. The Company also performs ongoing analysis and review of 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
The provision for income tax expense for the years ended December 31, 2015, 2014 and 2013 consists of the following (dollars in thousands):
The tax effects of temporary differences that give rise to significant portions of the deferred income tax asset and liabilities at December 31, 2015 and 2014, are presented in the following tables (dollars in thousands):
recorded benefits expense of approximately $9.1 million, $5.4 million, and $4.1 million in 2015, 2014 and 2013, respectively that are related to these postretirement plans. 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.
Target allocations of assets are determined with the objective of maximizing returns and minimizing volatility of net assets through adequate asset diversification and partial liability immunization. Adjustments are made to target allocations based on the Company’s assessment of the effect of economic factors and market conditions. The target allocations for plan assets are 60% equity securities and 40% debt securities as of December 31, 2015 and 2014. The Company’s plan assets are primarily invested in mutual funds. The mutual funds include holdings of S&P 500 securities, large-cap securities, mid-cap securities, small-cap securities, international securities, corporate debt securities, U.S. and other government securities, mortgage-related securities and cash.
Mutual funds were invested 32% in U.S. equity funds, 30% in U.S. fixed income funds, 22% in non-U.S. equity funds and 16% in other.
RCM, RGA Reinsurance and 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. The applicable statutory provisions only permit an insurer to pay a shareholder dividend from unassigned surplus. As of January 1, 2016, RGA Reinsurance could pay maximum dividends, without prior approval, of approximately $150.3 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. Chesterfield Re would pay dividends to its immediate parent Chesterfield Financial Holdings LLC, ("Chesterfield Financial"), which would in turn pay dividends to RCM, subject to the terms of the indenture for the embedded value securitization transaction, in which Chesterfield Financial cannot declare or pay any dividends so long as any private placement notes are outstanding. The Missouri Department of Insurance, Financial Institution and Professional Registration, allows RCM to pay a dividend to RGA to the extent RCM received the dividend from RGA Reinsurance, without limitation related to the level of unassigned surplus. Dividend payments from other subsidiaries are subject to regulations in the jurisdiction of domicile, which are generally based on their earnings and/or capital level. In addition, the earnings of substantially all of the Company’s foreign subsidiaries have been indefinitely reinvested in foreign operations.
Total assets for the Corporate and Other segment have been updated to conform with current period presentation for the adoption of the accounting standard update "Simplifying the Presentation of Debt Issuance Costs."