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. 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 transactions, which allow its clients to take advantage of growth opportunities and manage their capital, longevity and investment risk.
Net income in 2014 benefited from the release of liabilities established for uncertain tax positions due to the closure with the U.S. Internal Revenue Service of tax returns for a recent five-year period. As a result of that release and other adjustments, the provision for income taxes in 2014 was reduced and accrued interest expense of approximately $43.9 million was reversed. The effect of recognizing the closure of these tax years and other related adjustments increased net income by $33.0 million.
Net investment income increased $63.1 million, or 9.9%, and $84.0 million, or 15.2%, in 2016 and 2015, respectively. The increase in 2016 was primarily due to an increase in the average invested asset base primarily associated with the aforementioned in force block transactions along with strong variable investment income partially offset by a lower investment yield. The increase in 2015 was primarily due to an increase in the average invested asset base partially offset by a lower investment yield. Additionally in 2015, investment income benefited from the cumulative effect of investment income related to a funds withheld transaction retroactive to the beginning of the year. Investment related gains decreased by $6.5 million in 2016, and increased by $0.9 million
Income before income taxes decreased by $6.0 million, or 42.8%, and increased by $7.6 million, or 121.9%, in 2016 and 2015, respectively. The decrease in income before income taxes in 2016 was primarily due to unfavorable experience on longevity business. The increase in income in 2015 was primarily due to fees associated with financial reinsurance and income from new longevity reinsurance transactions. Foreign currency exchange fluctuation in the Canadian dollar resulted in a decrease in income before income taxes of approximately $0.7 million and $1.9 million in 2016 and 2015, respectively.
Other operating expenses increased by $2.2 million, or 2.2%, and decreased by $4.4 million, or 4.2%, in 2016 and 2015, respectively. The increase in 2016 was in line with expected expense levels to support business growth coupled with a higher level of incentive compensation expense. The decrease in 2015 was primarily due to the effect of foreign currency fluctuations and a decrease in incentive compensation expense. Foreign currency exchange fluctuations resulted in a decrease in operating expenses of approximately $8.1 million and $14.6 million 2016 and 2015, respectively. Other operating expenses as a percentage of net premiums totaled 9.0%, 8.9% and 9.0% in 2016, 2015 and 2014, respectively.
has issued payment guarantees on behalf of two of its subsidiaries in the event the subsidiaries fail to make payment under their office lease obligations. See Note 12 - “Commitments, Contingencies and Guarantees” in the Notes to Consolidated Financial Statements for a table that presents the amounts for guarantees, by type, issued by the Company.
See “Securities Borrowing, Lending and Other” in Note 4 - “Investments” in the Notes to Consolidated Financial Statements for information related to the Company’s securities borrowing, lending and repurchase/reverse repurchase programs. In addition to its security agreements with third parties, certain RGA’s subsidiaries have entered into intercompany securities lending agreements to more efficiently source securities for lending to third parties and to provide for more efficient regulatory capital management.
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 largest asset class in which fixed maturity securities were invested was in corporate securities, which represented approximately 61.1% of total fixed maturity securities at December 31, 2016, compared to 59.7% at December 31, 2015. See “Corporate Fixed Maturity Securities” in Note 4 - “Investments” in the Notes to Consolidated Financial Statements for tables showing the major industry types which comprise the corporate fixed maturity holdings at December 31, 2016 and 2015.
See “Purchased Credit Impaired Fixed Maturity Securities Available-for-Sale” in Note 4 - “Investments” in the Notes to Consolidated Financial Statements for tables that present information related to the Company’s purchases of credit impaired securities in 2016 and 2015.
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 with amounts owed by the ceding company. Ceding companies with funds withheld at interest had an average financial strength rating of “A” at December 31, 2016 and 2015. Certain ceding companies maintain segregated portfolios for the benefit of the Company.
coinsurance contracts. In individual life markets, the Company retains a maximum of $8.0 million of coverage per individual life. In certain limited situations the Company has retained more than $8.0 million per individual life. The Company enters into agreements with other reinsurers to mitigate the residual risk related to the over-retained policies. Additionally, due to some lower face amount reinsurance coverages provided by the Company in addition to individual life, such as group life, disability, and health, under certain circumstances, the Company could potentially incur claims totaling more than $8.0 million per individual life.
The Company accesses the markets each year for annual catastrophic coverages and reviews current coverage and pricing of current and alternate designs. Purchases vary from year to year based on the Company’s perceived value of such coverages. The current policy covers events involving 8 or more insured deaths from a single occurrence and covers $100.0 million of claims in excess of the Company’s $25.0 million deductible.
The primary direct effect on the Company of inflation is the increase in operating expenses. A large portion of the Company’s operating expenses consists of salaries, which are subject to wage increases at least partly affected by the rate of inflation. The rate of inflation also has an indirect effect on the Company. To the extent that a government’s policies to control the level of inflation result in changes in interest rates, the Company’s investment income is affected.
Changes to the general accounting principles are established by the Financial Accounting Standards Board (“FASB”) in the form of accounting standards updates to the FASB Accounting Standards CodificationTM. Accounting standards updates not listed below were assessed and determined to be either not applicable or are expected to have minimal impact on the Company’s consolidated financial statements.
The following table presents activity for the accretable yield on purchased credit impaired securities for the years ended December 31, 2016 and 2015 (dollars in thousands):
The following table presents the total gross unrealized losses for the 1,535 and 2,080 fixed maturity and equity securities at December 31, 2016 and 2015, respectively, where the estimated fair value had declined and remained below amortized cost by the indicated amount (dollars in thousands):
The following tables set forth certain key credit quality indicators of the Company’s recorded investment in mortgage loans, gross of valuation allowances, as of December 31, 2016 and 2015 (dollars in thousands):
The tables below provide a summary of the changes in fair value of Level 3 assets and liabilities for the year ended December 31, 2016, as well as the portion of gains or losses included in income for the year ended December 31, 2016 attributable to unrealized gains or losses related to those assets and liabilities still held at December 31, 2016 (dollars in thousands):
The Company is required by general accounting principles for Fair Value Measurements and Disclosures to disclose the fair value of certain financial instruments including those that are not carried at fair value. The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments, which were not measured at fair value on a recurring basis, at December 31, 2016 and December 31, 2015 (dollars in thousands).This table excludes any payables or receivables for collateral
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. Consequently, allowances would be established for amounts deemed uncollectible. At December 31, 2016 and 2015, no allowances were deemed necessary. The Company regularly evaluates the financial condition of the insurance companies from which it assumes and to which it cedes reinsurance.
The earnings of substantially all of the Company’s foreign subsidiaries have been permanently reinvested in foreign operations. A provision of $4.2 million has been made for U.S. taxes on repatriation. No other provision has been made for U.S. tax or foreign withholding taxes that may be applicable upon any repatriation or sale. The determination of the unrecognized deferred tax liability for temporary differences related to investments in the Company’s foreign subsidiaries is not practicable. At December 31, 2016 and 2015, the financial reporting basis in excess of the tax basis for which no deferred taxes have been recognized was approximately $1,147.2 million and $992.9 million, respectively.
We have audited the accompanying consolidated balance sheets of Reinsurance Group of America, Incorporated and subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016. Our audits also included the financial statement schedules listed in the Index at Item 15. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.