RGA Reinsurance also conducts business from a total of approximately 31,000 square feet of office space in Hong Kong, Tokyo, Taipei, Seoul and Beijing. These premises are leased through January 2011, at annual rents of approximately $1,870,000. RGA Australia conducts business from approximately 17,000 square feet of office space in Sydney. These premises are leased through January 2010, at annual rents of approximately $538,000.
Additionally, the Company has financial growth expectations for various operating segments for the intermediate period (next three to five years). In its U.S. and Canada operations, the Company expects growth rates for premium and income before income taxes of 8% to 10%. The Company’s newer international operations, which include Europe & South Africa, and Asia Pacific, are subject to more volatility. For these newer international operations, the Company anticipates growth in premium and income before income taxes of 12% to 15% over the intermediate term (next three to five years).
The Company’s accounting policies are described in Note 2 - “Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements. The Company believes its most critical accounting policies include the 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.
Income before income taxes for the U.S. operations totaled $322.3 million in 2006, compared to $263.8 million for 2005 and $294.1 million in 2004. Continued growth in the total U.S. business in force as well as improved mortality results contributed to the overall growth in income for 2006. The drop in income in 2005 occurred in the Traditional sub-segment and can be attributed largely to the unfavorable mortality experience in 2005.
design, continue to be level as compared to expected increasing mortality or claim costs. Claims and other policy benefits, as a percentage of net premiums and investment income, were 72.0% during 2006 compared to 70.6% in 2005 and 75.3% in 2004. Death claims are reasonably predictable over a period of many years, but are less predictable over shorter periods and are subject to significant fluctuation.
Net investment income increased $6.3 million in 2006, as compared to an increase of $9.3 million in 2005. The increase in both years was primarily due to growth in the invested assets in Australia and favorable exchange rates, along with an increase in allocated investment income. Investment income and investment related gains and losses are allocated to the various operating segments based on average assets and related capital levels deemed appropriate to support the segment business volumes. Investment performance varies with the composition of investments and the relative allocation of capital to the operating segments.
The following tables present the estimated fair values and gross unrealized losses for the 982 fixed maturity securities and equity securities that have estimated fair values below amortized cost as of December 31, 2006. These investments are presented by class and grade of security. The length of time the related market value has remained below amortized cost is provided for fixed maturity securities as of December 31, 2006.
At December 31, 2006, the Company’s estimated changes in fair value were within the targets outlined in the Company’s investment policy.
The Company is subject to foreign currency translation, transaction, and net income exposure. The Company manages its exposure to currency principally by matching invested assets with the underlying reinsurance liabilities to the extent possible, but generally does not hedge the foreign currency translation or net investment exposure related to its investment in foreign subsidiaries as it views these investments to be long-term. Translation differences resulting from translating foreign subsidiary balances to U.S. dollars are reflected in stockholders’ equity on the consolidated balance sheets. The Company generally does not hedge the foreign currency exposure of its subsidiaries transacting business in currencies other than their functional currency (transaction exposure). The majority of the Company’s foreign currency transactions are denominated in Australian dollars, British pounds, Canadian dollars, Japanese yen, Korean won, the South African rand and euros.
The consolidated financial statements include the assets, liabilities, and results of operations of RGA, RGA Reinsurance Company (“RGA Reinsurance”), RGA Reinsurance Company (Barbados) Ltd. (“RGA Barbados”), RGA Life Reinsurance Company of Canada (“RGA Canada”), RGA Americas Reinsurance Company, Ltd. (“RGA Americas”), RGA Reinsurance Company of Australia, Limited (“RGA Australia”) and RGA Reinsurance UK Limited (“RGA UK”) as well as other subsidiaries, subject to an ownership position of greater than fifty percent (collectively, the “Company”).
Other invested assets include derivative contracts, equity securities and preferred stocks, carried at fair value, and limited partnership interests and structured loans, carried at cost. Changes in fair value are recorded through accumulated other comprehensive income. Other invested assets are periodically reviewed for impairment.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS 154”). The statement requires retrospective application to prior periods’ financial statements for corrections of errors or a voluntary change in accounting principle unless it is deemed impracticable. It also requires that a change in the method of depreciation, amortization, or depletion for long-lived, non-financial assets be reported as a change in accounting estimate rather than a change in accounting principle. SFAS 154 was adopted by the Company during the first quarter of 2006.
At December 31, 2006, fixed maturity securities held by the Company that were below investment grade had a book value and estimated fair value of approximately $245.7 million and $246.8 million, respectively. At December 31, 2006, the Company owned non-income producing securities with an amortized cost of $12.5 million and market value of $13.4 million. During 2006, 2005, and 2004 the Company sold fixed maturity securities and equity securities with fair values of $997.0 million, $822.3 million, and $394.0 million, which were below amortized cost, at losses of $31.5 million, $21.8 million and $20.6 million, respectively. Generally, such losses are insignificant in relation to the cost basis of the investment and are largely due to changes in interest rates from the time the security was purchased. The securities are classified as available-for-sale in order to meet the Company’s operational and other cash flow requirements. The Company does not engage in short-term buying and selling of securities to generate gains or losses.
Other invested assets include equity securities, preferred stocks, limited partnership interests, structured loans and derivative contracts. Other invested assets represented approximately 1.5% and 1.9% of the Company’s investments as of December 31, 2006 and 2005, respectively. The Company recognized other-than-temporary write-downs of approximately $4.3 million and $1.3 million, during 2006 and 2005, respectively. The Company did not recognize any other-than-temporary write-downs on other invested assets in 2004.
The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments at December 31, 2006 and 2005. Fair values have been determined by using available market information and the valuation methodologies described below. Considerable judgment is often required in interpreting market data to develop estimates of fair value. Accordingly, the estimates presented herein may not necessarily be indicative of amounts that could be realized in a current market exchange. The use of different assumptions or valuation methodologies may have a material effect on the estimated fair value amounts (in thousands):
The fair value of the Company’s interest-sensitive contract liabilities is based on the cash surrender value of the liabilities, adjusted for recapture fees. The fair value of the Company’s long-term debt, collateral finance facility and the company-obligated mandatorily redeemable preferred securities are estimated based on either quoted market prices or quoted market prices for the debt of corporations with similar credit quality.
The calculation of the claim reserve liability for the entire portfolio of accident and health business requires management to make estimates and assumptions that affect the reported claim reserve levels. Management must make estimates and assumptions based on historical loss experience, changes in the nature of the business, anticipated outcomes of claim disputes and claims for rescission, anticipated outcomes of arbitrations, and projected future premium run-off, all of which may affect the level of the claim reserve liability. Due to the significant uncertainty associated with the run-off of this business, net income in future periods could be affected positively or negatively. The consolidated statements of income for all periods presented reflect this line of business as a discontinued operation. Revenues associated with discontinued operations, which are not reported on a gross basis in the Company’s consolidated statements of income, totaled $2.7 million, $2.5 million and $1.4 million for 2006, 2005 and 2004, respectively.
There were 73 stockholders of record of RGA’s common stock on January 31, 2007.