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| RGA > SEC Filings for RGA > Form 10-Q on 5-May-2009 | All Recent SEC Filings |
5-May-2009
Quarterly Report
Overview
Reinsurance Group of America, Incorporated ("RGA") is an insurance holding
company that was formed on December 31, 1992. RGA and its subsidiaries
(collectively, the "Company") are primarily engaged in the life reinsurance
business, 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 surrenders of underlying policies, deaths of policyholders,
and the exercise of recapture options by ceding companies.
The Company derives revenues primarily from renewal premiums from existing
reinsurance treaties, new business premiums from existing or new reinsurance
treaties, income earned on invested assets, and fees earned from financial
reinsurance transactions. The Company believes that industry trends have not
changed materially from those discussed in its 2008 Annual Report.
The Company's profitability primarily depends on the volume and amount of death
claims incurred and its ability to adequately price the risks it assumes. While
death claims are reasonably predictable over a period of years, claims become
less predictable over shorter periods and are subject to significant fluctuation
from quarter to quarter and year to year. The maximum amount of coverage the
Company retains per life is $8.0 million. Claims in excess of this retention
amount are retroceded to retrocessionaires; however, the Company remains fully
liable to the ceding company for the entire amount of risk it assumes. The
Company believes its sources of liquidity are sufficient to cover potential
claims payments on both a short-term and long-term basis.
The Company measures performance based on income or loss from continuing
operations before income taxes for each of its five segments. The Company's
U.S., Canada, Europe & South Africa and Asia Pacific operations provide
traditional life reinsurance to clients. The Company's U.S. operations also
provide asset-intensive and financial reinsurance products. The Company also
provides insurers with critical illness reinsurance in its Canada, Europe &
South Africa and Asia Pacific operations. Asia Pacific operations also provide
financial reinsurance. The Corporate and Other segment results include the
corporate investment activity, general corporate expenses, interest expense of
RGA, operations of RGA Technology Partners, Inc., a wholly-owned subsidiary that
develops and markets technology solutions for the insurance industry, Argentine
privatized pension business in run-off, investment income and expense associated
with the Company's collateral finance facility and the provision for income
taxes. Effective January 1, 2009, due to immateriality, the discontinued
accident and health operations are included in the results of the Corporate and
Other segment. Prior to 2009, the results of the Company's discontinued accident
and health operations were reflected as discontinued operations.
The Company allocates capital to its segments based on an internally developed
risk capital model, the purpose of which is to measure the risk in the business
and to provide a basis upon which capital is deployed. The economic capital
model considers the unique and specific nature of the risks inherent in RGA's
businesses. As a result of the economic capital allocation process, a portion of
investment income and investment related gains and losses are credited to the
segments based on the level of allocated equity. In addition, the segments are
charged for excess capital utilized above the allocated economic capital basis.
This charge is included in policy acquisition costs and other insurance
expenses.
Results of Operations
Consolidated income from continuing operations before income taxes decreased
$22.5 million, or 39.7%, in the first quarter of 2009, as compared to the same
period in 2008. The decrease in the first quarter reflects an increase in
investment related losses due to the recognition of investment impairments,
adverse mortality experience and unfavorable foreign currency fluctuations.
Offsetting these negative income items were increases in investment income, U.S.
segment net premiums and a slight decrease in the unrealized loss due to
unfavorable changes in the value of embedded derivatives within the U.S.
segment. Foreign currency exchange fluctuations resulted in a decrease to income
from continuing operations before income taxes of approximately $13.6 million
for the first quarter of 2009 compared to 2008.
The Company recognizes unrealized gains and losses due to changes in value of
embedded derivatives on modified coinsurance or funds withheld treaties,
equity-indexed annuity treaties ("EIAs") and variable annuity products. The
change in the value of embedded derivatives related to reinsurance treaties
written on a modified coinsurance or
funds withheld basis are subject to the provisions of Statement of Financial
Accounting Standards ("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" ("Issue B36").
The unrealized gains and losses associated with Issue B36, after adjustment for
deferred acquisition costs, had a favorable effect on income of $31.9 million in
the first quarter of 2009 as compared to the first quarter of 2008. Changes in
risk free rates used in the present value calculations of embedded derivatives
associated with EIAs affect the amount of unrealized gains and losses the
Company recognizes. The unrealized gains and losses associated with EIAs, after
adjustment for deferred acquisition costs and retrocession, had a favorable
effect on income of $16.5 million in the first quarter of 2009 as compared to
the first quarter of 2008. The change in the Company's liability for variable
annuities associated with guaranteed minimum living benefits affect the amount
of unrealized gains and losses the Company recognizes. The unrealized gains and
losses associated with guaranteed minimum living benefits, after adjustment for
deferred acquisition costs, had an unfavorable effect on income of $42.8 million
in the first quarter of 2009 as compared to the first quarter of 2008.
The combined changes in these three types of embedded derivatives, after
adjustment for deferred acquisition costs and retrocession, resulted in an
increase in consolidated income from continuing operations before income taxes
of approximately $5.6 million in the first quarter of 2009 as compared to the
first quarter of 2008. These fluctuations do not affect current cash flows,
crediting rates or spread performance on the underlying treaties. Therefore,
Company management believes it is helpful to distinguish between the effects of
changes in these embedded derivatives and the primary factors that drive
profitability of the underlying treaties, namely investment income, fee income,
and interest credited.
Consolidated net premiums increased $48.0 million, or 3.7%, for the three months
ended March 31, 2009, as compared to the same period in 2008, due to growth in
life reinsurance in force in the U.S. segment. Foreign currency fluctuations
unfavorably affected net premiums by approximately $144.7 million for the first
quarter of 2009 compared to 2008. Consolidated assumed insurance in force
decreased slightly to $2.1 trillion as of March 31, 2009 from $2.2 trillion as
of March 31, 2008 due to unfavorable currency fluctuations. The Company added
new business production, measured by face amount of insurance in force, of
$85.2 billion and $76.4 billion during the first quarter of 2009 and 2008,
respectively. Management believes industry consolidation, reduced capital levels
in the life insurance industry and the established practice of reinsuring
mortality risks should continue to provide opportunities for growth, albeit at
rates less than historically experienced.
Consolidated investment income, net of related expenses, increased
$23.7 million, or 11.9%, for the three months ended March 31, 2009, as compared
to the same period in 2008, primarily due to market value changes related to the
Company's funds withheld at interest investment related to the reinsurance of
certain equity-indexed annuity products, which are substantially offset by a
corresponding change in interest credited to policyholder account balances
resulting in a negligible effect on net income. The first quarter increase in
investment income also reflects a larger average invested asset base offset by a
lower effective investment portfolio yield. Average invested assets at amortized
cost for the first quarter of 2009 totaled $12.8 billion, a 10.7% increase over
March 31, 2008. The average yield earned on investments, excluding funds
withheld, was 5.57% in the first quarter of 2009 and 6.06% for the first quarter
of 2008. The average yield will vary from quarter to quarter and year to year
depending on a number of variables, including the prevailing interest rate and
credit spread environment, changes in the mix of the underlying investments and
cash balances, and the timing of dividends and distributions on certain
investments.
Investment related losses, net decreased $83.0 million, or 53.5%, for the three
months ended March 31, 2009, as compared to the same period in 2008. The
decrease in the first quarter is due to a reduced net loss on the embedded
derivatives related to Issue B36 and guaranteed minimum living benefits of
$149.6 million offset by an increase in investment impairments of $35.1 million
and net hedging losses related to the liabilities associated with guaranteed
minimum living benefits of $18.8 million. See the discussion of "Investments" in
the "Liquidity and Capital Resources" section of Management's Discussion and
Analysis for additional information on the impairment losses. Investment income
and investment related gains and losses are allocated to the operating segments
based upon average assets and related capital levels deemed appropriate to
support the segment business volumes.
The effective tax rate on a consolidated basis was 31.9% and 35.5% for the first
quarter of 2009 and 2008, respectively. These effective tax rates were affected
by the ongoing application of FASB issued Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" and
by the
earnings of non-U.S. subsidiaries in which the Company is permanently reinvested
whose statutory tax rates are less than the U.S. statutory tax rate.
Critical Accounting Policies
The Company's accounting policies are described in the Summary of Significant
Accounting Policies in Note 2 of the consolidated financial statements
accompanying the 2008 Annual Report. 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 fixed maturity investments, embedded derivatives and
investment impairments, if any; accounting for income taxes; and the
establishment of arbitration or litigation reserves. The balances of these
accounts require extensive use of assumptions and estimates, particularly
related to the future performance of the underlying business.
Additionally, for each of the Company's reinsurance contracts, it must determine
if the contract provides indemnification against loss or liability relating to
insurance risk, in accordance with applicable accounting standards. The Company
must review all contractual features, particularly those that may limit the
amount of insurance risk to which the Company is subject or features that delay
the timely reimbursement of claims. If the Company determines that the
possibility of a significant loss from insurance risk will occur only under
remote circumstances, it records the contract under a deposit method of
accounting with the net amount receivable or payable reflected in premiums
receivable and other reinsurance balances or other reinsurance liabilities on
the condensed consolidated balance sheets. Fees earned on the contracts are
reflected as other revenues, as opposed to net premiums, on the condensed
consolidated statements of income.
Differences in experience compared with the assumptions and estimates utilized
in the justification of the recoverability of DAC, in establishing reserves for
future policy benefits and claim liabilities, or in the determination of
other-than-temporary impairments to investment securities can have a material
effect on the Company's results of operations and financial condition.
Deferred Acquisition Costs ("DAC")
Costs of acquiring new business, which vary with and are primarily related to
the production of new business, have been deferred to the extent that such costs
are deemed recoverable from future premiums or gross profits. DAC amounts
reflect the Company's expectations about the future experience of the business
in force and include commissions and allowances as well as certain costs of
policy issuance and underwriting. Some of the factors that can affect the
carrying value of DAC include mortality assumptions, interest spreads and policy
lapse rates. For traditional life and related coverages, the Company performs
periodic tests to determine that DAC remains recoverable, and the cumulative
amortization is re-estimated and, if necessary, adjusted by a cumulative charge
or credit to current operations. For its asset-intensive business, the Company
updates the estimated gross profits with actual gross profits each reporting
period, resulting in an increase or decrease to DAC to reflect the difference in
the actual gross profits versus the previously estimated gross profits.
Liabilities for Future Policy Benefits and Other Policy Liabilities
Liabilities for future policy benefits under long-term life insurance policies
(policy reserves) are computed based upon expected investment yields, mortality
and withdrawal (lapse) rates, and other assumptions, including a provision for
adverse deviation from expected claim levels. The Company primarily relies on
its own valuation and administration systems to establish policy reserves. The
policy reserves the Company establishes may differ from those established by the
ceding companies due to the use of different mortality and other assumptions.
However, the Company relies upon its ceding company clients to provide accurate
data, including policy-level information, premiums and claims, which is the
primary information used to establish reserves. The Company's administration
departments work directly with its clients to help ensure information is
submitted by them in accordance with the reinsurance contracts. Additionally,
the Company performs periodic audits of the information provided by ceding
companies. The Company establishes reserves for processing backlogs with a goal
of clearing all backlogs within a ninety-day period. The backlogs are usually
due to data errors the Company discovers or computer file compatibility issues,
since much of the data reported to the Company is in electronic format and is
uploaded to its computer systems.
The Company periodically reviews actual historical experience and relative
anticipated experience compared to the assumptions used to establish aggregate
policy reserves. Further, the Company establishes premium deficiency reserves if
actual and anticipated experience indicates that existing aggregate policy
reserves, together with the present value of future gross premiums, are not
sufficient to cover the present value of future benefits, settlement and
maintenance costs and to recover unamortized acquisition costs. The premium
deficiency reserve is established through a charge to income, as well as a
reduction to unamortized acquisition costs and, to the extent there are no
unamortized acquisition costs, an increase to future policy benefits. Because of
the many assumptions and estimates used in establishing reserves and the
long-term nature of the Company's reinsurance contracts, the reserving process,
while based on actuarial science, is inherently uncertain. If the Company's
assumptions, particularly on mortality, are inaccurate, its reserves may be
inadequate to pay claims and there could be a material adverse effect on its
results of operations and financial condition.
Other policy claims and benefits include claims payable for incurred but not
reported losses, which are determined using case-basis estimates and lag studies
of past experience. These estimates are periodically reviewed and any
adjustments to such estimates, if necessary, are reflected in current
operations. The time lag from the date of the claim or death to the date when
the ceding company reports the claim to the Company can be several months and
can vary significantly by ceding company and business segment. The Company
updates its analysis of incurred but not reported claims, including lag studies,
on a periodic basis and adjusts its claim liabilities accordingly. The
adjustments in a given period are generally not significant relative to the
overall policy liabilities.
Valuation of Fixed Maturity Securities
The Company primarily invests in fixed maturity securities, including bonds and
redeemable preferred stocks. These securities are classified as
available-for-sale and accordingly are carried at fair value on the condensed
consolidated balance sheets. The difference between amortized cost and fair
value is reflected as an unrealized gain or loss, less applicable deferred taxes
as well as related adjustments to deferred acquisition costs, if applicable, in
accumulated other comprehensive income ("AOCI") in stockholders' equity. The
determinations of fair value may require extensive use of assumptions and
inputs.
The Company performs regular analysis and review of the various methodologies,
assumptions and inputs 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 utilizes information
from third parties, such as pricing services and brokers, to assist in
determining fair values for certain assets and liabilities; however, management
is ultimately responsible for all fair values presented in the Company's
financial statements. The Company performs 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. This process involves
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, initial and ongoing review of third party pricing
services and methodologies, review of pricing trends and monitoring of recent
trade information. In addition, the Company utilizes both internal and external
cash flow models to analyze the reasonableness of fair values utilizing credit
spread and other market assumptions, where appropriate. As a result of the
analysis, if the Company determines there is a more appropriate fair value based
upon the available market data, the price received from the third party is
adjusted accordingly.
When available, fair values are based on quoted prices in active markets that
are regularly and readily obtainable. Generally, these are very liquid
investments and the valuation does not require management judgment. When quoted
prices in active markets are not available, fair value is based on market
standard valuation techniques, primarily a combination of a market approach,
including matrix pricing and an income approach. The assumptions and inputs used
by management in applying these methodologies include, but are not limited to:
interest rates, credit standing of the issuer or counterparty, industry sector
of the issuer, coupon rate, call provisions, sinking fund requirements,
maturity, estimated duration and assumptions regarding liquidity and future cash
flows.
The significant inputs to the market standard valuation methodologies for
certain types of securities with reasonable levels of price transparency are
inputs that are observable in the market or can be derived principally from or
corroborated by observable market data. Such observable inputs include
benchmarking prices for similar assets in active, liquid markets, quoted prices
in markets that are not active and observable yields and spreads in the market.
When observable inputs are not available, the market standard valuation
methodologies for determining the estimated fair value of certain types of
securities that trade infrequently, and therefore have little or no price
transparency, rely on inputs that are significant to the estimated fair value
that are not observable in the market or cannot be derived principally from or
corroborated by observable market data. These unobservable inputs can be based
in large part on management judgment or estimation, and cannot be supported by
reference to market activity. Even though unobservable, these inputs are based
on assumptions deemed appropriate given the circumstances and are consistent
with what other market participants would use when pricing such securities.
The use of different methodologies, assumptions and inputs may have a material
effect on the estimated fair values of the Company's securities holdings.
Additionally, the Company evaluates its intent and ability to hold securities,
along with factors such as the financial condition of the issuer, payment
performance, the extent to which the market value has been below amortized cost,
compliance with covenants, general market and industry sector conditions, and
various other factors. Securities, based on management's judgments, with an
other-than-temporary impairment in value are written down to management's
estimate of fair value.
Valuation of Embedded Derivatives
The Company reinsures certain annuity products that contain terms that are
deemed to be embedded derivatives, primarily equity-indexed annuities and
variable annuities with guaranteed minimum benefits. The Company assesses each
identified embedded derivative to determine whether it is required to be
bifurcated under SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" ("SFAS 133"). If the instrument would not be accounted for
. . .
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